With the insanity that’s been going on in the financial world
lately, a bunch of people have asked me to post a followup to my
earlier posts on the whole mortgage disaster, to try to explain
what’s going on lately.
As I keep saying when people ask me things like this, I’m not an economist. I don’t know much about economics, and what little I do know, I tend to find terribly boring. And in this case, the discussion inevitably gets political, so I’m expecting lots of nasty email.
This is the second part of my series trying to answer peoples questions
about how mortgages work, and what went wrong. In the first part, I described
what a mortgage is, and how it works. In this part, I’m going to describe the
mortgage system – that is, the collection of people and organizations involved
in the business of mortgages, how they interact with one another, and how
that system has gotten into trouble. The next and final part will be
from the viewpoint of a homeowner who is taking or has taken out a mortgage to purchase a home, and what can go wrong from their side.
I’ll reiterate my usual warning: I don’t know much about economics. I come
at these things as a math geek who’s spent entirely too much time reading
about the current situation.
One of the big failures in the mortgage system is that the system itself
is broken. Personally, I think it’s deliberately broken – not in the sense of
a conspiracy between people to collude on creating a broken system – but by
the fact that each link in the chain is set up by the people in that role
trying to arrange things to maximize their benefit while avoiding
responsibility. When every link in a chain of responsibility sets things up so
that they have no responsibility, you end up with a thoroughly broken
system.
After yesterday’s article about conversion between the value of
british pounds in the ’70s versus british pounds today, someone sent me a link to
an article at the National Review Online, which just about had me rolling on the floor laughing. The problem is, it’s dead serious.
It’s written by an “engineer” named Louis Woodhill, who argues from what he calls
an “engineering viewpoint” that the whole idea of fluctuating currency value is total nonsense, and we’d all be better off if we just assigned a fixed value to our currency, and never allowed it to change.
The U.S. dollar is in a scary slide. Gold and oil are hitting record highs,
while the dollar is hitting record lows. To get how strange this all seems to an engineer
like me, imagine the following headline: “Foot Falls against Meter for Fifth Straight Day.”The accompanying article would breathlessly report that after the U.S. abandoned its “antiquated” fixed-exchange-rate system (one foot equals 0.3048 meters), our beloved foot began plunging in length. A “length trader” would predict that if the foot fell below the “psychologically important 0.2800 meter support level,” it could fall as low as 0.2500 meters. But an economist would say that as long as the foot didn’t fall more than 10 percent, everything would be okay.
The story would then describe the plight of a homeowner whose garage was no longer within
his lot lines. Then another economist would argue that the falling length of the foot was
actually a good thing, because it caused people to be taller, which reduced their “body mass
indexes,” thus fighting obesity. The head of the U.S. Bureau of Standards would be quoted as
saying the bureau is committed to “a strong foot,” although, “given that imports are longer
than exports, there is only so much we can do.” The story would conclude with Paul Krugman
blaming the falling foot on “Bush’s tax cuts for the rich.”What is going on with the dollar right now is every bit as ridiculous as the fictional story above. Here’s how an engineer would explain the problem.
Economic transactions involve the exchange of “something” for “money.” The “something” is specified in terms of number (1, 2, 3, etc.); length/area/volume (“the foot”); weight (“the pound”); and/or time (“the second”). “Money” is specified in terms of “the dollar.”
The problem with this scheme is that the magnitude of our fundamental unit of market value, “the dollar,” is not defined. Being undefined, the value of the dollar can change. This fact gives rise to huge economic costs and risks for which there are no offsetting benefits.
Sorry, Mr. Woodhill, but that’s not how an engineer would explain the problem. It’s how a pig-ignorant idiot would explain the problem. The explanation of why is beneath the fold.