Applying the Concept:  Collateral and Property Rights                                   

Having legal title to physical assets like land, homes, businesses, and cars is not just about piece of mind.  Simple and binding property rights are very important for a healthy financial system.  In Chapter 11, we discussed mechanisms that lenders use to ensure borrowers repay loans.  And on page 276, we introduced the most common of these, collateral.  Things that people and firms own – houses, cars, equipment – can act as collateral for mortgages, auto loans, or business lines of credit.

If you live in a developed country, like the US or Germany, you take property rights for granted.  Most of us assume that every piece of land and building has an owner, and that somewhere, there exists a governmental record of who that owner is. Just as important, we know that there are clear laws that allow for the sale and transfer of property from one owner to another.

As hard as it may be to imagine, this is not the norm.  Much of the world’s population lives on land and inside of structures that they do not legally own, and to which they have no legal rights. People do this because it is so time consuming and expensive to make their ownership legal.  In Haiti, for example, it takes 176 bureaucratic steps over 19 years to gain legal title to a piece of land owned by the government. That’s once the Haitian government has decided to sell it.  In Egypt it takes 14 years, with visits to 31 public and private agencies.  And in Peru, it takes 7 years and 207 steps to 52 government offices to get legal permission to build a house on state-owned land.[1]

The problem with this is that to pledge something as collateral, you have to both legally own it and be able to transfer that ownership to someone else.  So if a person cannot obtain legal title, then the property cannot be used as collateral.  Since lenders insist on collateral as insurance in case a borrower defaults, the lack of collateral greatly curtails lending in these countries.  Without loans, the financial system cannot do its job of allocating resources to the best possible uses.  So, before a country can develop economically, its people have to have property rights.