Logic can explain the mortgage mess

By BRENDAN MINOGUE

SPECIAL TO THE VINDICATOR

The sub-prime mortgage mess is leading us into a recession, and understanding it is as much a logical matter as it is an economic matter. At the heart of the mess is what I will call “the self-deception game.” The game is driven by a logical fallacy and played by three separate parties, all of whom are infected with a dose of self-deception.

The game has a very popular goal: to sell homes to people who cannot afford them. So the first players in the game are the millions of Americans who want to own a home but cannot afford to pay for it. They want immediate gratification even though they do not have a down payment. Because they cannot postpone gratification, they choose to play the self-deception game. From the viewpoint of traditional lenders, these folks have no credit. Traditional lenders do not want to give them any money because they have no chance of paying it back.

Having no credit, however, is not intrinsically evil. By our standards Jesus was a lousy credit risk. However, having zero credit is something we do not like to face. We need to find someone, who will use smoke and mirrors to support our self deception.

We need a second player in the game. He is the miracle worker. He will give us the wonderful smoke to hide behind. He will give us a magical mirror that will show we deserve a loan. The banking industry is not our miracle worker. Banking legislation has worked well to keep the banks from entering this smoky, mirror distorted sub-prime domain. A more creative industry had to be developed, one far less regulated than the banks.

During the Bush years, the mortgage brokerage industry stepped forward to meet the consumer’s need for smoke and mirrors. It did so because the Bush administration and the sworn enemies of regulation — the Republican Party —would not restrain this free and very creative industry.

Categorical imperative

The mortgage industry had a categorical imperative: get signatures on mortgages. Heck, didn’t everybody get 15 mortgage offers last year? All you really needed was a telephone number. This was the smoke. It was easy.

The real trick involved the mirror. After these murky mortgage companies had the worthless loan agreements, what did they do with them? How did they transform these pigs’ ears into silk purses? They had to show them to the world using a very magical mirror. This mirror would hide the fact that these mortgages were really worthless.

It is difficult if not impossible to make a single pig’s ear look good, but could you wrap millions of pig ears with fancy paper and make them appear to be elegant silk purses? This is what the largely unregulated mortgage industry did. They did what the regulated banks could never do. And it worked. With the help of some unregulated investment specialists, they wrapped up these millions of worthless mortgages in brand new fancy terminology. They called these packages of pigs ears “collateralized debt obligations” or CDOs. Surely something with such a fancy title had to be a silk purse.

So far, we only have two players in the self-deception game. The third player is the investor, who desperately wants to believe that he can give his dollars to money market funds without risk. The “money market investor” had the capital to buy these pig’s ear mortgages. We should never have bought them but we did because we wanted to believe that something that was wrapped so nicely could never be a package of pig ears.

But how could we be so stupid? Here is where we meet the logical fallacy, which fuels everyone’s self-deception. In logic classes we call it the “division” fallacy. Here is an example. It is surely false that the parts of a red car are all red. When you divide the car you find that many of its parts are green or black, even though the whole car looks red. CDOs are like red cars. Wrapped up in fancy terminology they are made to look valuable. They look like silk purses.

Worthless pig ears

But when you look inside the bundle or if you divide the bundle, what you find are worthless pig ears.

The public needs to learn two lessons from this nasty recession that we are entering. First; let’s stop bad mouthing governmental regulation. This recession might have been avoided if we had some regulators demanding that the mortgage industry refuse to lend to people who cannot pay off their loans. Secondly there have been calls for protecting the sub-prime industry by infusing federal money into it. Such calls are bogus. The sub- prime industry is nothing but alchemy. It is not a business; it is a pseudo business because there really is no way to make a silk purse out of a pig’s ear.

X Brendan Minogue is a Professor of Philosophy at Youngstown State University.