Slumdogs vs. Millionaires

Has the subprime mortgage market become a shadow economy?
Subprime mortgages are not a shadow economy. But what happened is that a lot of these mortgages got repackaged into securities. Then they became collateralized debt obligations and some of these mortgages were sliced and diced and put into tranches. When some of these mortgages went sour and people started defaulting on their payments, then of course a lot of the securities tied to them also started defaulting. But when you try and trace who's ultimately responsible for the value of that paper, you couldn't find it. That's the part of the market that has become the shadow.

So basically ill-defined property rights in the subprime mortgage sector caused a meltdown. Does the same happen in the developing world?
Yes. That shadow hopefully is a temporary condition in the United States and in Western Europe. And it might pass in a year or 10 years, but it will pass. That passing condition that's occurring now in developed countries, that's a chronic condition in developing countries. We're always chronically in credit crunches—because you don't know who owns what, nobody dares lend to somebody else. Bringing the law to emerging markets is possibly the most important measure that can be taken to help these countries become rich. Look at the Iranians, look at the North Koreans—they're building nuclear plants. Look at the computer—they're being built in northern India. The issue isn't the expansion of technology. We can all get it, borrow it, buy it or steal it. The issue is how do you get a legal system that allows people to cooperate so as to create more complex systems and objects.

So at this point, a Wall Street banker in a $10,000 suit is encountering basically the same problem that Nairobi slum dwellers have had to deal with for decades or more.
Absolutely. The difference, however, is that in Nairobi they are still struggling to understand that a property system is the best way that they can do things. In the United States, every piece of land, every house, every automobile, every airplane, every manuscript for a film, every patent is written up and recorded and described. There's only one thing in the United States which is not recorded in such a way and that's derivatives. We're only talking about 7 percent of the subprime market being in default, yet it is causing a major contraction in your economy. You're not getting your credit flowing because you don't know what is where and who it belongs to.

What's the answer? How do we assign "property rights" to derivatives?
The banks and the holders of all of these instruments have got to report them in such a way that your government and the public knows who owns what and where. Once the light shines, you will know who's solvent, who's insolvent. You'll be able to have a clean debate as to who to help and who not to help. And you're going to have a much better idea of the consequences of not helping or helping. Right now you're talking about all of those issues, but you still don't have the facts. So the first thing is to have the law require those people who own these things to fess up.

It sounds so simple when you put it like that, but I guess there are special interests blocking that from happening.
I am convinced that there are special interests. Creating property rights in the United States [was much easier to do], because a lot of the land, the assets, the woods and the rural areas actually belonged to nobody, or they belonged to indigenous people or Mexicans. But in Britain, those who owned property were able to resist registration throughout part of the 19th century. They even argued that public knowledge of who owned what could eventually lead to kidnappers or things of that kind. And they managed to avoid the light being shined [up until 1925]. The fact is that a market economy works on information. If you don't have the facts, you don't have a market and you can't have justice.

Have we in the West forgotten that?
Einstein was credited with having said, "What does the fish know about the water in which it swims?" You've got to be a human being and look at it from the outside—then you'll understand why the fish lives where it lives. So I think what's happened is that Westerners got property [rights] very early on, about 200 years ago if you're American, and you've grown accustomed to it. You're the fish in the water.

© 2009