Written by Bob Schneider Posted on April 24, 2009
A few weeks ago Paul Wilkinson published a terrific post on Hernando de Soto's WSJ op-ed Toxic Assets Were Hidden Assets. To oversimplify his multifaceted blog, Paul argues that XBRL is part of the solution to the current inadequacies in recording, tracking, and analyzing toxic asset data that de Soto describes in his piece.
The Peruvian economist’s thinking had also figured prominently in a post I wrote a year ago on XBRL and microfinance institutions, which provide microloans to the poor in developing nations. In his masterwork The Mystery of Capital, de Soto described how, contrary to received opinion, the poor entrepreneurs in these countries possess real assets (in the form of land), business acumen, and the same "animal spirits" as small business people in advanced economies; what they lack is a system for legal ownership of their property, making it impossible for them to borrow. Microfinance institutions provide the capital they need, and their repayment rates have been excellent. The XBRL data standard has been adopted by the Microfinance Information Exchange (MIX) for the detailed financial and social performance information generated by leading microfinance institutions.
Paul's post made me wonder what it is about de Soto's arguments that they simultaneously speak so powerfully about two asset classes that couldn't be further apart on the economic hierarchy, namely, (1) the unregistered land holdings of the poor in countries like Peru, Haiti, and Indonesia, and (2) the quant-driven derivatives traded by the 21st century Masters of the Universe (well, until recently) in New York and London. Why do de Soto’s writings, which so far as I know never mention interactive data, inspire calls for XBRL-based solutions?
The question demanded I read The Mystery of Capital. Reviewing the front and back matter first, I noted in the acknowledgments that the book's title was suggested by Bob Litan of the left-of-center Brookings Institution, while the text was worked by David Frum, a noted right-leaning pundit. Moreover, the book had received kind words from both liberal organs like the New York Review of Books and conservative journals like Commentary. Clearly we weren't in the balkanized states of Olbermann and Hannity anymore.
Read against the context of TARP bailouts and a bankrupt financial sector, de Soto provides a startling reminder of how parts of our economy have descended into Third World status. Here's the introduction to the chapter entitled The Mystery of Missing Information:
Imagine a country where nobody can identify who owns what, addresses cannot be easily verified, people cannot be made to pay their debts, resources cannot be conveniently turned into money, ownership cannot be divided into shares, descriptions of assets are not standardized and cannot be easily compared….You have just put yourself into the life of a developing country.
How distressingly similar that is to the toxic-asset sector described in de Soto's WSJ article:
These derivatives are the root of the credit crunch. Why? Unlike all other property paper, derivatives are not required by law to be recorded, continually tracked and tied to the assets they represent. Nobody knows precisely how many there are, where they are, and who is finally accountable for them. Thus, there is widespread fear that potential borrowers and recipients of capital with too many nonperforming derivatives will be unable to repay their loans.
Whether it's land in the poor neighborhoods of Port-au-Prince or securities cooked up by the Best and the Brightest on Wall Street, assets' value is crucially tied to the efficiency and efficacy of their recordkeeping systems. From de Soto's WSJ article:
Property is much more than a body of norms. It is also a huge information system that processes raw data until it is transformed into facts that can be tested for truth, and thereby destroys the main catalysts of recessions and panics — ambiguity and opacity.
De Soto spends a good part of his book describing how the legal system for real property we take for granted today developed over many decades in the United States. In the beginning:
Every farm or settlement recorded its assets and the rules governing them in rudimentary ledgers, symbols, or oral testimony. But the information was atomized, dispersed, and not available to any one agent at any given moment. As we know too well today, an abundance of facts is not necessarily an abundance of knowledge. For knowledge to be functional, advanced nations have to integrate into one comprehensive system all their loose and isolated data about property.
Unlike the recording of securities based on real property, recordkeeping for U.S. real property itself is excellent. But it is the end result of a complex historical process extending 200 years. In his book, de Soto pays particular attention to the abundance of squatters who attempted to establish ownership through extralegal bodies like claim associations and miners organizations. Only after decades-long battles about title in the 18th and 19th centuries were extralegal and legal systems of property combined and these conflicts ultimately resolved. The economic success the U.S. subsequently enjoyed depended vitally on that resolution.
In contrast, recordkeeping for mortgage-backed securities (MBS) is a throwback to the chaos of earlier times. In a sense, it is a betrayal of our economic heritage. Here's how Philip Moyer of EDGAR Online describes MBS reporting in his January 2009 whitepaper Bringing Transparency to the Mortgage-backed Securities Market:
As a loan moves through the many participants in the MBS supply chain, each member of the supply chain — originators, retail banks, wholesale banks, issuers, servicers and ratings agencies — decides what to report publicly and when to report it. Additionally, all players use different report formats, different data labels, different ways of tracking the status of the collateral and even different models for tracking the identity of the individual loans. As a result, a loan can receive as many as five unique IDs between its origination and when it is bundled into an MBS. There is no centralized regulator that validates or collects all of this data. There is no central repository that can be queried… Therefore, it is difficult to track the status of a single loan in an MBS — even if it is in default — because every participant has completely different reporting models. The industry is awash in a sea of disconnected and incomparable data.
How can XBRL help? On pages 17-18 of his paper, Moyer describes eight benefits of using XBRL in a centralized MBS reporting system instead of current document/spreadsheet formats:
- Data Quality Consistent labels and content, a structure for organizing data, and, most important, "a model to validate that the structure and the content of a report adheres to appropriate standards."
- Security and Privacy Traceability and detailed control of the information reported.
- Historical Comparability Versioning and an enduring structure allow comparisons regardless of changes in reporting requirements over time.
- Platform Compatibility XBRL is platform agnostic.
- Multicurrency and Multilingual Investors can view data in their own language and multiple currencies.
- Reduced Reporting Costs Sunk costs for existing regulatory and banking XBRL reporting can be leveraged.
- Reduced Data Processing Costs Receiving better data from upstream business partners offsets the costs incurred by each member of the supply chain.
- International Industry Standard Leveraging the existing body of knowledge for XBRL saves resources that would otherwise go to resolving technical and financial reporting problems.
XBRL is not a cure-all, of course. To the extent that the data continues to be plagued by incompleteness and both intentional and unintentional error, MBS reporting still will have significant problems.
Nevertheless, introducing XBRL into the process will go a long way to providing the consistent, comparable, and accessible information that de Soto recognizes as an essential element in asset value, no matter what the asset class.
Leave a comment