Sunday, 5 April 2009
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Attempts by the G20 leaders to halt the global recession are doomed unless they get to grips with the "toxic" debt hidden in the shadow economy, warned to Hernando De Soto, the prize-winning Peruvian economist.
Mr De Soto said: "This toxic debt is the elephant in the room and solving the problem is the missing link to getting the world economy moving again. Until we know what proportion of the estimated $600trn [£400trn] of derivative contracts is toxic, then credit markets will remain in a state of chronic paralysis."
He added: "No amount of fiscal stimulus or new international regulation will get the banking system fixed until we know how much poisonous paper there is on the balance sheets of the banks. The G20 leaders have given the world economy a blood transfusion but now they need to get on with the operation if they are to save the patient's life."
Mr De Soto welcomed the efforts of the US Treasury Secretary, Tim Geithner, to put pressure on institutions to establish how much toxic debt they hold. "But there must be more focus on forcing all the financial institutions and banks to face up to the bad debt hidden away in the shadow economy. Lawyers and bankers must now work on bringing these contracts out of the shadows so they can be given a value and be traded."
The economist also claimed that it was fear which forced Mr Geithner's predecessor, Hank Paulson, not to go ahead with his original $780bn rescue plan to ring-fence toxic paper: "I'm told that the bankers told him they didn't know where it was hiding." Mr Paulson's U-turn over toxic debt – switching instead to recapitalising the banks – was never fully explained. "My sources told me they were terrified that they couldn't find out where all the contracts were lodged and that's why Paulson dropped the plan," he said.
An adviser to presidents around the world, Mr De Soto runs the Institute of Liberty and Democracy in Lima, and advises emerging economies on how to alleviate poverty by giving the poor property and other legal rights. "The problems are similar," he said. "US and European authorities find it difficult to believe that the fundamental cause of a recession could be a badly documented legal system. But this is what this crisis comes down to and will only be alleviated when that paper is documented, has a value and can be traded."
Mr De Soto reckons there are only a few hundred billion dollars of toxic paper: "Until we acknowledge this toxic debt then this crisis could get even worse. Let's learn the lessons of Iraq and find out if these derivatives are the financial equivalent of weapons of mass destruction or not, and if so, get them documented."
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