TOXIC Paper.(International Edition; FINANCE)

The Obama administration must tackle a problem that has bedeviled the emerging markets for years.

Wall Street harshly judged U.S. Treasury Secretary Timothy Geithner's proposals for saving the nation's banks. His televised remarks in mid-February were supposed to reassure watchers by outlining the Obama administration's plan for fixing the financial markets, but the market plunged as he spoke. Yet Wall Street was wrong. The lack of details in Geithner's presentation doesn't really matter right now. More important is the fact that the administration has finally focused the U.S. on the primary cause of the current economic crisis: the trillions of dollars of "toxic paper" on the balance sheets of financial institutions. This poisonous paper is scaring off potential creditors and investors who lack the legal means to understand what this paper signifies, how much there is, who has it and who might be a bad risk. Finally, policymakers in the White House seem to be coming to grips with the real enemy: the debasement of the legal financial documents that represent value, allow it to be transferred and signal risk.

Look around: everything of economic value that you own--house and car titles, mortgages, checking accounts, stocks, contracts, patents, other people's debts (including derivatives)--is documented on paper. You are able to hold, transfer, assess and certify the value of such assets only through documents that have been legally authenticated by a global system of rules, procedures and standards. Ensuring that the relationship between those documents and each of the independent assets they represent is never debased requires a formidable system of legal property rights. That system produces the trust that allows credit and capital to flow and markets to work.

It is through paper that we connect and know the global economy. It is impossible to do business on a national level--never mind in a globalized marketplace--without reliable legal documentation. Yet this worldwide web of trust is now crashing down. In recent years, governments have debased paper by carelessly allowing into the market a biblical flood of financial instruments derived from bad mortgages nominally valued at some $600 trillion or more--twice as much as all the rest of the world's legal paper, whether it represents cash, traditional financial assets, or property, tangible or intangible.

The astonishing quantity of these documents, and the fact that they're so tangled up and poorly recorded, is making it difficult to determine how much there is, what it's worth or who holds it. Given that the volume of these derivatives dwarfs all other paper, the mess is also undermining one of the greatest achievements of property law: the power to identify and isolate with precision every asset and every particular interest on that asset. Thus a meager 7 percent default on subprime mortgages that were funded or insured by derivatives--maybe only a few hundred billion dollars worth of toxic paper--is debasing the rest of the economic paper and contaminating the entire economy. Because this toxic paper refers to credit and capital, it affects all economic activity; the loss of trust spares no one, spreading out in all directions and beyond local bubbles, whether subprime housing or dotcom. And then staring you in the face may be the worst recession in modern history.

U.S. and European authorities find it difficult to believe that the fundamental cause of a recession could be a poorly paperized legal system. But in emerging markets, like the one I come from, the importance of paper is pretty obvious. Most of our people are poor and live in the anarchy of the shadow economy, where their assets and contracts are covered by paper that is endemically toxic: not recorded, not standardized, difficult to identify, hard to locate and with a real value so opaque that ordinary people cannot build trust in each other or be trusted in global markets. In the shadow economies of the developing world, credit paralysis is a chronic condition. So when I look at the recession that has started in the West--triggered by toxic paper--I feel right at home.

The main challenge for Obama and Geithner is to restore trust in the prime vehicle of credit--not money, which we know how to control, but paper, which we clearly don't. The overwhelming amount of available credit is made up of proprietary paper, such as mortgages, bonds and derivatives, all of which is not money per se but has some of the financial attributes of money--what economists used to call "moneyness." To ...