Last week, Hernando de Soto (the insightful Peruvian economist and author of The Mystery of Capital) wrote one of better pieces I’ve seen about the financial meltdown and all these “toxic assets.” In the Wall Street Journal, De Soto made the compelling case that “the real problem is not the bad loans, but the debasement of the paper they are printed on.” The $50 trillion in bad paper, he says, is far more than the $1 trillion in subprime mortgages that supposedly started all of this.
To put the magnitude of the derivative financial creations in perspective, de Soto describes simply the scale of all assets in the world: $100 trillion of tangible goods (land, buildings), $170 trillion of semiliquid asssets (mortgages, stocks), and $1 quadrillion of new derivatives (mortgage-backed securities, collateralized debt obligations, and so on). Let me repeat that. One quad-rill-ion — as in one thousand trillion. First, I’ve never heard anyone use figures like that outside of my 5-year-old making jokes about wanting infinity or googol more minutes to play a favorite game before bedtime.
Ok, shocking numbers aside, de Soto outlines six prescriptions to avoid this kind of market failure in the future. In short, the answer is making sure “property” is not some financial figment, but something definable and trackable, something we can guarantee the value and legitimacy of. The first two guidelines he provides are why I’m writing about this.
First, he says, “all documents and the assets and transactions they represent or are derived from must be recorded in publicly accessible registries.” Second, “the law has to take into account the ‘externalities’ or side effects of all financial transactions…” This sounds an awful lot like themes of sustainability and business. Internalize the externalities and get much more knowledgeable and open about your impacts. I couldn’t agree more. The solution de Soto recommends hinges on a renewed commitment to transparency so there’s no “back-room” financial market that regulators and, more importantly, investors can’t see.
Transparency is one of the driving forces keeping the green and sustainability waves moving (it’s a theme I touch on in my new book, Green Recovery, coming out this summer, so I’ll return to this topic over the coming months). I believe that we’re rapidly entering an era of radical openness, driven both by regulation — see the EPAs recent announcement that it plans to “ask” 13,000 facilities in the United States to share data on carbon emissions — and the rising demands of employees and customers, particularly the younger ones. The new level of transparency will make any of us old enough to remember a world before MTV uncomfortable. But the Facebook and MySpace generation will have no problem with it — in fact, they’ll be expecting it.
A renewed transparency drive may be partly fueled by the latest emotional issue of the day — executive pay and bonuses. I don’t really believe in government-mandated 90% tax brackets for bonuses, no matter how repugnant the payments may seem. But I do think the government can set standards for openness. Let’s list everyone who got bonuses at these firms and how much they made. Let the court of public opinion (and that of peers and co-workers) be the judge.
I’m going to make a seemingly unlikely prediction: companies will increasingly reveal all salaries and bonuses (far beyond sharing the pay to a few top executives as required by the SEC). The most responsible companies already do this to some extent — Seventh Generation has a public commitment to keeping the CEOs salary below 14 times the lowest salary. The biggest companies will, painfully, follow suit (about sharing, not about the 14x multiple) over the coming years as it becomes clear that the more open they are, the more trustworthy they’ll be.
Imagine what openness about salaries and bonuses might do for some other thorny issues, such as equal pay for women and minorities. Wal-Mart is facing a highly publicized class action suit about its treatment of women. Will complete openness about pay generate more of these kinds of claims, or help companies avoid these problems? I have no idea, but I certainly hope it’s the latter since the transparency is coming, like it or not.
How do you prepare for this new open world? It’s not easy, but some of those old grandmotherly maxims seem to gain some force: don’t say anything about anyone that you wouldn’t be comfortable with that person hearing…or don’t do anything you wouldn’t want on the cover of the paper…or the standard Golden Rule certainly comes to mind. No doubt there will be some real challenges in handling increased transparency, but my hopeful view is that it will drive more ethical, sustainable behavior.
In this view, those who can’t meet the standard will struggle. But those companies that are proud of their operations will be fine talking about what’s in their products, how products are made, how much energy they use, how much they pay people, who else is involved in the production, and what their executives receive in compensation. They will also attract and retain the best people who trust their employers. And they will build a more loyal base of customers that feel the authenticity. Sorry for all the unbridled optimism in such a pessimistic time, but maybe it’s time to look on the bright side of some of these massive changes in the works.
This post first appeared at Harvard Business Online.
