The Government's Role in the Economy

Here is the opening bit from an excellent article in Business Week by Hernando de Soto:

During the second half of the 19th century, the world's biggest economies endured a series of brutal recessions. At the time, most forms of reliable economic knowledge were organized within feudal, patrimonial, and tribal relationships. If you wanted to know who owned land or owed a debt, it was a fact recorded locally—and most likely shielded from outsiders. At the same time, the world was expanding. Travel between cities and countries became more common and global trade increased. The result was a huge rift between the old, fragmented social order and the needs of a rising, globalizing market economy.

To prevent the breakdown of industrial and commercial progress, hundreds of creative reformers concluded that the world needed a shared set of facts. Knowledge had to be gathered, organized, standardized, recorded, continually updated, and easily accessible—so that all players in the world's widening markets could, in the words of France's free-banking champion Charles Coquelin, "pick up the thousands of filaments that businesses are creating between themselves."

The result was the invention of the first massive "public memory systems" to record and classify—in rule-bound, certified, and publicly accessible registries, titles, balance sheets, and statements of account—all the relevant knowledge available, whether intangible (stocks, commercial paper, deeds, ledgers, contracts, patents, companies, and promissory notes), or tangible (land, buildings, boats, machines, etc.). Knowing who owned and owed, and fixing that information in public records, made it possible for investors to infer value, take risks, and track results. The final product was a revolutionary form of knowledge: "economic facts."

Over the past 20 years, Americans and Europeans have quietly gone about destroying these facts. The very systems that could have provided markets and governments with the means to understand the global financial crisis—and to prevent another one—are being eroded. Governments have allowed shadow markets to develop and reach a size beyond comprehension. Mortgages have been granted and recorded with such inattention that homeowners and banks often don't know and can't prove who owns their homes. In a few short decades the West undercut 150 years of legal reforms that made the global economy possible.

There is much, much more. Go read the whole article.

The right wing political push to deregulate the economy has created a new era where nobody knows who owns what or what anything is worth. Government provides the legal matrix within which business can be contracted, but right wing ideologues have spent the last 40 years destroying that matrix by claiming it was "bureaucratic red tape":

When then-Treasury Secretary Henry Paulson initiated his Troubled Asset Relief Program (TARP) in September 2008, I assumed the objective was to restore trust in the market by identifying and weeding out the "troubled assets" held by the world's financial institutions. Three weeks later, when I asked American friends why Paulson had switched strategies and was injecting hundreds of billions of dollars into struggling financial institutions, I was told that there were so many idiosyncratic types of paper scattered around the world that no one had any clear idea of how many there were, where they were, how to value them, or who was holding the risk. These securities had slipped outside the recorded memory systems and were no longer easy to connect to the assets from which they had originally been derived. Oh, and their notional value was somewhere between $600 trillion and $700 trillion dollars, 10 times the annual production of the entire world.

The right wing mania to "let business get on with it" under the blinkered notion that business management is smart enough to look after its own interest and avoid pitfalls and mistakes has been shown to be a misguided delusion. The past is littered with stories of business that made bad decisions that run the enterprise into a brick wall. In the current crisis, the banking industry has "unburdened" itself of the legalities of maintaining ownership records in its rush to securitize mortgages:

Banks that have tried to foreclose on nonperforming mortgages have discovered that in many cases they can't collect the debts. Why? Because some companies that pooled, packaged, and converted those mortgages into liquid securities had dispensed with the usual procedures to record mortgage owners and passed the property to a shell company called MERS, which pretended to own the mortgages. The intent was to streamline what many real estate experts recognize are outdated, disaggregated, and cumbersome processes. The result, however, is that today, says professor Christopher L. Peterson of the University of Utah, "about 60 percent of the U.S.'s residential mortgages are now recorded in the name of MERS rather than the bank, trust, or company that actually has a meaningful economic interest in the repayment of the debt. For the first time in the nation's history, there is no longer an authoritative, public record of who owns land in each county."

Already the lack of facts is being felt around the U.S.: Courts from Kansas to New York have decided that foreclosures have been improper, and some authorities can't figure out whom to tax. Without facts, credit will continue to be scarce, the value of bonds backed by mortgages will be at best doubtful, the value of houses is likely to slide further, foreclosure backlogs should increase, and banks will see their balance sheets burdened by more nonperforming paper.

Under the rightward drift of the last 40 years, the America's "rule of law" has been replaced by do-it-yourself legal exceptionalism as big money has corrupted politics and the judiciary. As de Soto points out, the US is very much like the legal "badlands" of the post Communist countries:

When the recession sent the prices of financial holdings spiraling downward, some banks and financiers were exempted from the U.S.'s long-established "mark-to-market" accounting standards, which force firms to report the value of their assets at current market prices. It's reasonable to establish value other than through market prices, according to proponents, if the market is unusually depressed. But such a privilege creates the ability to destroy facts by hiding losses, increasing the price of assets to levels at which no one will buy. In the U.S., the Financial Accounting Standards Board and the Securities and Exchange Commission are reviewing accounting rules, while Congress has been holding hearings on the subject. Meantime, businesses are left to figure out reality on the basis of connections, influence, and private information. Just like we do in developing and former communist countries.

Corruption has become endemic and even after the fiasco of the spectacular bankruptcies of the dot.com bubble, the legal system has not yet fixed the lawlessness:

The modern balance sheet can be traced to Luca Pacioli, the 15th century mathematician and father of accounting. In the 1990s governments began destroying Pacioli's legacy by allowing companies in financial difficulty to pass facts concerning debts from their public balance sheet to a less visible memory system called a special purpose entity (SPE) (or to sweep debt information into the balance sheet's footnotes in words so obtuse that the statements cease being factual). Such "off-balance-sheet accounting" makes companies appear more profitable, despite their debts. By the time Enron closed its doors in 2002, it had created some 3,500 SPEs.

According to Frank Partnoy, a professor of securities law at the University of San Diego and one of the most insightful observers of the financial crisis, "abusive off-balance-sheet accounting" was its major cause. Yes, the Sarbanes-Oxley reforms were an effort to counter such abuses, and principles-based accounting where companies are told what they can do rather than how to do it may be steps in the right direction. But until we get the facts, we won't know what to repair.

The political right has walked society off a cliff with its ideological attacks upon the proper role of government that undermined the rule of law in the interest of short term greed:

We are now staring at a legal and political challenge. A legal challenge because American and European governments allowed economic activity to cross the line from the rule-bound system of property rights, where facts can be established, into an anarchic legal space, where arbitrary interests can trump facts and paper swirls out of control. The rule of law is much more than a dull body of norms: It is a huge, thriving information and management system that filters and processes local data until it is transformed into facts organized in a way that allows us to infer if they hang together and make sense.

Mainly, though, it's a political challenge. Politicians must raise the financial crisis to commanding heights, where the entrenched institutional problems of a failing order can be addressed. Markets were never intended to be anarchic: It has always been government's role to police standards, weights and measures, and records, and not condone legalized sleight of hand in the shadows of the informal economy. To understand and repair one of mankind's greatest achievements—the creation of economic facts through public memory—is the stuff of nation-builders.

Sadly Obama has not yet faced up to the depth and breadth of the crisis he was handed when the economy collapsed at the end of the eight years of misrule by George Bush. Obama's timid actions stopped the collapse, but the economy continues to just tread water waiting for the rule of law to be reintstated. Obama and his economic advisors have not yet recognized the nature of the beast they are dealing with. Hopefully sooner, rather than later, Obama will wake up and undertake the changes to reinstitute sound government, a government dedicated to the rule of law and clearly understands its role in providing regulated and fair playing field on which businesses can compete.