As a Peruvian educated by British and American teachers, I learned never to embark on a major task without first "doing the math." No more of that Latino "happy go lucky, trust your gut and say three Hail Marys" approach to life.
Without measurement, my teachers advised, I wouldn't be able to identify and disentangle the very reality before my eyes. By doing the math, I would see order and coherence, the way things were organized; invisible relationships would come into view, and right behind order would come meaning, followed by confidence. Thanks to my Anglo-Saxon education, I learned the lesson: You cannot manage what you have not previously measured.
So imagine how I have felt watching my role models go to war over weapons of mass destruction that they never actually assessed, or now, watching them wage a losing war against derivatives -- which both Warren Buffet and George Soros have called "financial weapons of mass destruction" -- without locating or counting them either.
And, man, do those financial instruments need measuring: pooled, packaged and traded around the world, they are now the principal reason for today's massive credit contraction. The fear among financial institutions that potential borrowers and users of credit and capital could be burdened with so many nonperforming derivatives that they would be unable to repay their loans and protect their investments has plunged the global economy into a recession.
The Securities and Exchange Commission estimates that derivative paper is worth $596 trillion (10 times the value of total world production), while studies at the Bank for International Settlements in Basel, Switzerland, conclude that it could be twice as much -- $1.2 quadrillion. And exactly how many of those derivatives are actually nonperforming and would have to be surgically removed to stop their toxicity from spreading and destroying trust among creditors and investors? Nobody knows that for sure either. U.S. Treasury Secretary Timothy F. Geithner has set aside $1 trillion to assist in buying those toxic assets, but the SEC has guesstimated that there might be upward of $3 trillion worth.
With so much at stake, clearly an accurate accounting is in order. Once this paper is brought "into the sunshine," as former SEC Chairman Christopher Cox said at the beginning of the crisis, "money and credit will begin to flow again." Government has to assure that it is located, quantified and usefully categorized so that the market can again gauge risks and restore trust by isolating the toxic from the healthy paper.
So what are we waiting for? Many worry about government meddling in the affairs of financial institutions. Some contend that Wall Street has Washington in its pocket; others suspect that the bankers are afraid that the numbers will be so high as to spark a run on their banks. And then there are those who still believe that the market will be able to sort it all out -- if we would just stand back and let the vulture capitalists dispose of the toxic stuff in their discreet and profitable ways.
Let me offer just four of the many good reasons I could give for why "doing the math" -- right now -- is still the best strategy for halting the global economic meltdown threatening us.
First, the vultures I've talked to tell me that buying a significant amount of paper in the dark will take years. With information about derivatives not standardized and thousands of idiosyncratic bonds sold, resold and scattered helter-skelter all over the market, it will be difficult for any individual vulture to calculate their worth until someone locates and categorizes them. In fact, some derivative paper is so sloppily structured that banks have been unable to figure out the contents of their own portfolios, and U.S. courts continue to reject many foreclosures that are based on this kind of paper. So before we could really hand over the solution to the vultures, someone still would have to do the math.
And even while the vultures are, minimally, at work, the contamination will continue as this huge shadow economy of derivative paper infects everything it touches. Consider that a mere 7% default on subprime paper -- equivalent to maybe $1 trillion or $2 trillion -- quickly contaminated other paper, creating a $50-trillion hole in the U.S. economy from losses in stocks, home values and revenues in less than one year. By not counting and identifying derivatives one by one and drawing a legal boundary around each by means of the rules of property law (things such as registration, traceability and standardized identification), we are unable to protect every asset and every particular interest on that asset from contamination. The longer we wait to do the math, the worse it will get. And the more likely the anarchy of this shadow economy will spread.
In the world where I come from, it is the typical state of affairs. In fact, apart from the elite Westernized minority, most people's as