Property as currency: property possession laws are a cornerstone of successful capitalism. Latin America is finally on its way to developing them

Latin CEO: Executive Strategies for the Americas, March-April, 2002 by Peter Dr. Watson

PERUVIAN ECONOMIST HERNANDO DE SOTO, in his book "The Mystery of Capital," calculates that residents of developing countries hold more than US$9.3 trillion in property--but it earns them next to nothing. No laws or institutions exist by which they may use this capital as collateral for cash or credit. What makes real estate in the United States so powerful, by contrast--what allows property owners to extract additional value from their assets--is the property documentation system. It goes beyond defining ownership; it is a system by which value is transferred.

In developing countries, property rights lack the legal framework that allows them to become currency. This legal framework in developed countries enables property to move to its highest valued use, with a great deal of security. The nations of Latin America have before them an opportunity to convert their huge, untapped assets - "dead capital," in de Soto's term--into transferable capital. And they could do so at relatively little cost, with limitless benefit.

This is not merely an opportunity. it is an imperative, and an urgent one. Latin American nations must now begin to organize property structures in legal systems of real estate - with registration and transfer of property claims, foreclosure laws, enforceable loan payment systems, regularized interest rates and tax policies, and quality construction - so they may tap the deep power of property to stimulate economic growth.

The major barrier to meeting housing needs in Latin America is lack of long-term capital. The pool of international capital is large, but competition for long-term funding is fierce. International investors are primarily institutional, and therefore mostly risk-averse. Their first priority is liquidity, with yield a distant second. This means that emerging markets will find it difficult to compete with established issuers from developed countries. While local pension funds may have the capital to invest in mortgages or real estate, they often prefer to buy government-backed bonds. As a result, most housing in Latin America is funded directly by government institutions, with loans offered by banks on a short-term, variable rate basis - or not at all. But people are not willing to take on long-term debt unless they have some assurance of payment stability, fair enforcement of the loan contract and ultimate economic value of the home investment.

Development institutions around the world have begun to focus their attention on this housing challenge. The International Finance Corporation and World Bank have facilitated the creation of second-tier financial institutions to bring new capital to housing by selling bonds and using the proceeds to purchase long-term loans originated by local intermediaries. While the structure of these institutions varies, they perform a valuable market function by facilitating standardization of loan terms, documents and underwriting guidelines, and by collecting market data for investors. They can become a regular issuer of bonds in the marketplace, helping create confidence in the quality of housing-related investments.

The development of this crucial secondary market also generates housing-related activities such as insurance, appraisal, credit reporting, technical services, brokerage, and property management. These institutions reduce risk for borrowers and investors by reducing costs and improving liquidity and flexibility in the system.

Taking into account the challenges, the Overseas Private Investment Corporation, a US government agency which provides financing and political risk insurance to US investors in overseas projects, has begun to work with Latin America to organize its real estate systems in ways that will attract investment. OPIC can work with local companies to provide management capacity, with government and aid agencies to ensure appropriate legal and regulatory frameworks; with private risk-sharing entities to enhance their products; and with investment bankers and rating agencies to structure creative financings. OPIC can also help educate the investment community about real estate-related risk, so that risk factors can be measured in each market.

Progress toward the establishment of fully realized real estate systems in Latin America will be incremental, sometimes frustratingly so. But with it will come opportunity for investors, ideally in a fashion that will generate economic growth for all involved. In the best-case scenario, de Soto's vision will have spun the axiom "Possession is nine-tenths of the law" on its head to read, "Laws of possession of property are nine-tenths of success in capitalism."

Dr. Peter Watson is President and CEO of the Overseas Private Investment Corp.