De Soto and *Shadow* Economics

[A BBC interview yesterday with Hernando de Soto on the problem of shadow banking will be followed by an excursus about his impact on a student of development economics in the early 1980s.]

BBC interviewer:  Could the next global financial crisis come out of the shadow banking sector, which accounts for more than a quarter of world’s financial companies? These are the companies that raise money and lend it without being a bank. Official banks have felt the regulatory screws tightened, but shadow banks are still virtually unregulated.

Ben Bernanke [on tape]:  Inevitable side effect of new regulations is that the system will adapt in ways that push risk taking from more regulated to less regulated areas.

Hernando de Soto:  I don’t mind small banks or hedge funds. The question is: do we know what they’re producing, do we know what they’re doing? ‘Shadow’ implies missing information. They produce something like $700 trillion of derivatives, financial instruments, which are not recorded. That is ‘shadow’. They have balance sheets off the books that no longer reflect the values. You don’t get to know who is really in control and what the real debts are. The crisis begins where there is a non-correspondence between the financial instruments and the underlying assets they’re supposed to finance. What needs to be done is open the doors and let people who are not financial inside -- because it has to do with truth telling -- it can only be solved at the highest political level. It’s not about getting a new bureaucracy, or just giving the regulators an insight. It’s about giving information for all of us. “Just report” [say this to them]. In the same way I have to report to government what I own so I pay my taxes. All we’re asking of banks and financial institutions is to publish their books. They are the only ones who are allowed a secret life in the shadows. The result is we are all afraid to invest, including them; they’re not investing with each other. You need governments to take a stand. That’s how you brought down kings in Europe and emperors in Asia, you made them report. We’ve reached that revolutionary moment. What was in place has been eroded over the last 15-20 years. There was a western system where everybody was accountable to the law. Whoever took advantage of the law by incorporating, having limited liability, being able to issue paper, simply had to go out and inform and tell the truth. That took a lot of courage. You had to confront privilege.