Economic Activity, Public Trust, XBRL, and Property Law
Hernando de Soto’s brilliant Wall Street Journal op-ed today, “Toxic Assets Were Hidden Assets,” contains a wealth of common sense.
Among the ideas worth mining is his insistence that “[a]ll documents and the assets and transactions they represent or are derived from must be recorded in publicly accessible registries.” This brings to mind the largely inaccessible public registry of ASCII and HTML text spanning multiple “pages” in obscure EDGAR filings created by the securitization industry in the run-up to the crisis.
Last month, I described the “principles-based set of disclosure items” that fell short. The point I didn’t make, which de Soto brings to mind this morning, is that these “disclosures” — if you can call them that — were made with the intent to build private derivatives on top of them. They were converted from nominally public securities (but not good enough for retail investors) to shadow securities after a year or so, contrary to the principle of erga omnes that de Soto explains.
The common sense de Soto advocates, that “[g]overnments can no longer tolerate the use of opaque and confusing language in drafting financial instruments,” has been drowned out by constant whining that the toxic security structure is too complicated for normal human beings to comprehend. But there is good news. The FDIC has key duties in Treasury’s current bailout plan and as the plan proceeds, its years of experience with the XBRL data standard position it to mandate the use of the standard — or give preference to private sector participants who use it — for the purpose of enforcing clarity.
XBRL is simply a version of XML that helps computers verify compliance with business and legal rules. It’s in use around the world and in the U.S. by public companies, banks, the SEC, and the FDIC. Thanks to the SEC mandate that public companies use XBRL, XML geeks nationwide are getting up to speed on the new standard. A simple search for XBRL on Twitter reveals much, in the words of Twitter, about what is happening now on XBRL.
Moreover, XBRL US has testified to Congress that XBRL is ready to be applied to asset backed securities. Properly implemented, XBRL technology could support the vision outlined by de Soto more efficiently than any other technology — including paper.
Much history of economic growth is dominated by the development of property titling and enforceable contract rights. When people enter normal contracts, the contracts usually work because both sides know they can go to court or otherwise enforce them. But when people sell investments of money in common enterprises derived solely from the efforts of others — aka, securities — they create externalities that trigger erga omnes.
That’s why the basic law that all securities must be registered or exempt is so important. The rule that was successful in the past was that issuers had to make strong cases to earn exemptions. By making disclosure faster, better, and cheaper, XBRL lets regulators raise the threshold for exemptions. It’s an opportunity worth exploiting expeditiously.
Thanks to XBRL, there is a means of to achieve the goal of moving from pseudo-capitalism based on speculation to real capitalism based on facts — and a world where willing buyers and sellers can make markets based on those facts.
We already have a remarkable land titling system mostly at the county level. Mortgage servicers have a wealth of data about the performance of every mortgage tied to that land. Integrating those data sets with the heretofore poorly accessible data in the 20,000 or so instruments like these, along with a few other key facts, could result in a highly transparent and competitive market for securitized consumer real estate debt.
Profits might move from industry incumbents to first movers on the de Soto vision, or be retained by borrowers in the form of lower borrowing costs. That is one reason little has happened so far. But someday, soon, and for the rest of our lives, someone will change the consumer debt ecosystem to get us back on track along the technological road that has made the world richer over time. That world, as de Soto describes it, is where “a huge information system…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.”
Improving technology and improving law are the essential ingredients. I don’t know which is the ground beef and which is the seasoning, but it’s time mash those two simple ingredients into patties and fire up the barbecue.
Paul –
I too was impressed by that Hernado de Soto essay. Strong agreement from me.
But now there's an additional layer BENEATH the paper documents. Now the data flows through a variety of sort-of computerized mechanisms before it hits the paper document.
I can't help but remember Robert O'Harrow's description in "No Place to Hide" of how real estate ownership/court judgements data was harvested from court houses for the credit bureaus. (1) Manually record court house data on paper, (2) rekey said data into a PC, and (3) ship data to the credit bureaus. Clearly a process ripe for errors.
No wonder my wife ended up with a spare husband.
Or this, that happened to me. At some point I got my 3 credit reports: Two of the three had problems with my address. One had a wrong zip code on the address/cover sheet & correct zip code on the actual report. The other was just the reverse: correct on the cover sheet & wrong on the report.
Two observations. Zip codes changing (which had happened to me) is NOT news. These reports were something like 5 years after my zip code had changed. These credit bureaus (BIG organizations with lots of computer power) didn't have a process to correctly deal with changing zip codes. I can certainly see such laxity in the handwritten court house registries, but not at the credit bureaus.
Somewhere someone's going to have to vouch for the quality/accuracy of the data produced by the organization. Which means they're going to have to audit the data they produce, particularly if it is presented to the outside world. Now THAT is going to be interesting.
A major reason that de Soto's essay resonated with me is that 30 years ago I worked on a banking application (Letters of Credit – LC) using a tag based language (e.g. like XML). Much of the documentary output of an LC system is actually legal contracts. Then as now, most of the output from computer systems is simply reports. If a report is wrong, you re-run it. If your broker bungles a trade, no problem… simply back-date the trade & send a new confirm.
All this is why I'm cautious about this XBRL stuff. Who's going to assure that the contents are accurate & truthful? The Enron accountants? Having scratched the surface of the 1980s Saving & Loan fiasco (hmmmm… similar to today's mess?) I'm pretty much a believer in "control fraud."
From what I've seen of information systems, there's far too much data to be useful/accurate information. Hence, management gets to pick & choose what "information" is useful to prove their point, make their bonus.
- David
Thanks. Agree 100% that data quality is even more important than whatever language is used to tag the data. Also, the language must be of sufficient quality to make the data meaningful.
The key, it seems to me, is having systems in place to validate both data and the mark-up language. As I understand XBRL, it's easier to write rules to validate data in that format than in other popular formats. And an XBRL taxonomy can be crowdsourced, reviewed by experts, crowdsourced again, etc., in a never ending cycle to improve the taxonomy.
My take is that bad data that's exposed to the market or privately exposed to the people the bad data describes is likely to be detected sooner than bad data that's hidden or only seen by insiders who make money when they sell financial products based on the bad data. Also, silly assumptions like consistent permanent smooth upward trending housing prices are likely to be detected sooner if more and more dispassionate eyes are focused on the facts that would reveal such underlying assumptions.
To the maximum extent possible, investors should be able to pick and choose which information is useful to them before they entrust their money to others, and to get that information quickly and accurately. That's why, for example, I think much of the debate over mark-to-market is needless. Why not let investors see both mark-to-market and held-to-maturity values and let them decide? I realize a choice of valuation data doesn't solve the regulatory capital problem, but it does illustrate the problem with regulator regulation vs. market regulation.
Regulators operating in a non-competitive environment are precisely the opposite of investors operating in a competitive environment. Regulators MUST pass judgment on what they regulate, no matter what information is available to them. Investors have another option — if the information isn't of sufficient quality and quantity and relevance, they can go find another investment with information that is. And investors can diversify their risk across a wide range of investments, whereas mistakes by regulators can damage trust across the board, regardless of the quality of the information disclosed and the quality of the format in which it is disclosed. Perhaps the most efficient use of the time and authority of regulators is, as you suggest, making sure data is accurate and truthful — at least "materially accurate," which seems to work fairly well as a standard. Obviously regulators can't review all of the data, which is what makes the use of surrogates, like accounting firms and auditors, important, and which is also what makes civil and criminal penalties for fraud important as a deterrent.
–more–
On the address issue, I just stumbled across an innovative site, http://static.zumbox.com/mk_about_zumbox_overview... which aims to replace postal mail using an on-line postal metaphor. If you sign up, they say they'll send you a postcard to verify your address and facilitate the use of the system for secure communications — at least as secure as postal mail. Among other things, I'd hope such a system might eventually contribute toward the standardization of data for all consumers and empower consumers to verify their data without needing to draft actual postal letters or stay on hold for hours with call centers.
Finally, I watched a C-SPAN rerun this morning of the new SEC Chair's testimony to the Senate Banking Committee this week. She was too polite when it came to questions about jurisdictional reform in the financial sector and I found myself almost yelling at the TV:
"Why don't you say, 'We regulate real stocks and real bonds for real public companies! You outlawed us from even thinking about regulating whatever that crap was that AIG created! You can't blame us for letting fake financial instruments be traded one on top of another until they collapsed of their own weight. Treasury and the banking regulators couldn't control things either. Perhaps we let too many people have too many exemptions for too many private offerings built on top of too poorly disclosed asset backed securities. When so-called "sophisticated" investors took advantage of those exemptions, they took 100% of the responsibility to analyze and monitor them. Even for public investments, we expect investors to perform due diligence. No regulator can be expected to permanently guarantee the safety of anything beyond the $250,000 in bank savings that Congress has decided is appropriate based on decades of review and analysis and the $500,000 coverage for brokerage insolvency under SIPC. Give us the authority to stop people from building needless complexity into financial instruments and we'll shut 'em down. When instruments are built for the convenience of people selling them, instead of for the convenience of investors, they should be shut down. The ability to hedge risk is critical, and we shouldn't discourage genuine hedging. But the so-called "investment banks" were neither investment houses nor banks, and too many "hedge funds" simply didn't hedge. If nothing else, well-structured data requires clear, transparent, and accurate labels. Job one is to give the SEC the resources to mandate the use of industry standard taxonomies for every investment in every business or asset offered to the public and every private instrument large enough so that its failure would be likely to cause material harm to the investing public. When this universe of investments is properly disclosed, the need for and value from building a financial house of cards on top of these investments will disappear."
Or something like that….
Paul –
>
> The key, it seems to me, is having systems in place to validate both data and the mark-up language. As I understand
> XBRL, it's easier to write rules to validate data in that format than in other popular formats. And an XBRL taxonomy can
> be crowdsourced, reviewed by experts, crowdsourced again, etc., in a never ending cycle to improve the taxonomy.
>
I acknowledge there is a lot of enthusiasm for taxonomies & ontologies.
Particularly in financial services I do not concur.
The whole idea of taxonomies is from natural science where Mother Nature has had 100s of millions of years to organize things.
Financial institutions are sometimes 100 years old (very few) & maybe a few decades old.
Financial institutions have been cobbled together in a totally higgeldy-piggeldy fashion, with no road map or sense of order.
The idea of there is a hierarchical order of concepts & data inside these organizations is fanciful at best.
I have no experience with whether or not XBRL has easy to write data validation mechanisms.
The real problem is at the "source systems" inside the companies. Because these organizations have typically been cobbled together so haphazardly over the decades of mergers & lurching from market fad to market fad there are normally multiple sources of "the truth."
More eyeballs on the data is very important.
Why accounting firms have been so useless (did they learn anything from Enron?) is something of a mystery to me. At least in theory they represent extra eyeballs.
- David
How about this? The current crisis represents the recovery of the accounting firms form the Enron/WorldCom debacles. With PCAOB, SOX, more skeptical equity analysts, increased penalties for violations, etc., people looking to earn economic rents in the finance sector were forced to flee outside of the GAAP/public company world if they wanted to earn more from their work than they added in value, either deviously or by deluding themselves into thinking they were actually adding value. They found an escape valve in ABS, which aren't subject to GAAP or to the degree of accounting firm scrutiny applied to public company finances.
Is GAAP itself a financial taxonomy or an ontology? With more than 25,000 pages of documentation and with it being at the heart of what are still the world's strongest capital markets, I'd say it's both complex and successful — albeit far from perfect. The point is that precisely because financial (and other business) institutions have evolved in such a complex fashion, if they want to raise capital from the public, they must be forced to describe themselves according to common principles. I think that's why transparent capital markets generally work.
The SEC is writing validation mechanisms that are described here:
http://www.sec.gov/info/edgar/xbrlerrormessages.h...
My old friends there are scary smart, but they would be the first to admit that if they can do it, lots of other folks can do it to.
Paul: Part of the issue with the recordation of derivatives is that technology (e-mail, text message and so on) has made the formation of legally-binding contracts very cheap and easy. Efforts to promote better documenation on derivatives will provoke massive campaigns to capture, archive and comprehend electronic financial records. See Details: http://legal-beagle.typepad.com/wrights_legal_bea... –Ben
[...] 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 [...]
When a person tells you that anything is much to complicated for the average person to understand you can be sure it is BS. Like my freind Tommy Davis who ran the numbers game at the Carnivals; used to say ; never had a winner in the 7 years he ran the game. He did all the counting and somehow it allways ended up in his favor, the trick he said was to count fast and allways tell them they were so so close and for sure they were soon going to break the bank. These are the MASTERS OF THE UNIVERSE and our government just smiles and nods they would never tell these very very rich people that they were crooked or dishonest, they beleive the emperor has on a very nice set of clothes.
Twitter Comment
Floyd Norris Another reason ABS needs GAAP style structured disclosure, i.e. XBRL: http://bit.ly/2ezjOt [link to post]
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#SIFMA #XBRL “4 cnfdnce 2 rtrn 2..securitisation mrkts invstrs need a lot more disclosure” http://bit.ly/26yyYj [link to post] Bravo!
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(Reason: stop insider trading) Floyd Norris; asset backed securities; GAAP style structure; XBRL http://bit.ly/2ezjOt [link to post]
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