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EYE ON THE PIE: Economic turmoil hinges on ignorance

September 29, 2008

What we don't know does hurt us. Many builders constructed houses assuming there was a continuing strong market of qualified home buyers. Some mortgage brokers and some bankers gleefully ignored or misrepresented the abilities of home buyers to sustain homeownership.

Too many home buyers did not bother to learn what their obligations as homeowners would be. They didn't know about paying property taxes or how adjustable mortgage rates could escalate beyond their capabilities to meet their monthly payments.

The companies that bought the mortgages from the banks or brokers often did not bother to get into the details of the packages they bought. After all, a bundle of mortgages on American homes cannot be a bad investment.

Soon, these companies had billions of dollars of mortgages and no idea how many were delinquent or likely to default. They tell us they had no way of knowing, no way of discovering and evaluating their mortgage holdings.

In the meantime, they kept selling those mortgage bundles to others and inventing new financial products that were not mortgage bundles but something else much more speculative. Often, those who bought these "derivatives" did so without any understanding of how they worked. All they knew was that they could easily be sold because they were "insured" and somehow related to American homes.

American homes are sacred. They are subsidized by the federal government, state and local governments because of our shared mythology. We know homeownership reduces crime and promotes family values. Home prices will rise year after year. Second mortgages allow us to use growing equity to satisfy ever-growing consumer wants. Thus, homeownership is the first basket into which we should put our eggs.

Now some of the firms that hold mortgages or mortgage derivatives are smelling the rot in the bundles they bought. Frightened, they persist in ignorance of the value of their holdings. Without any clear knowledge of reality, they spin into bankruptcy or conservatorship or merge with others.

The U.S. government, anticipating chaos emerging out of fear in the financial markets, opens its supply of tranquilizers to calm the markets. Now you and I own a host of mortgages and mortgage derivatives. The government will sort through them, collect on the good ones, and absorb the loss on the bad ones. It may be that we won't lose a fortune when it turns out that many mortgages are actually going to pay off.

But don't worry. Although some of the assets we now own are not sound, we won't notice our losses. All this will ultimately be covered by increased federal debt, a little more inflation, and a lot of self-congratulation for avoiding another Great Depression.

Ignorance is costly. Most of those MBAs on Wall Street and in financial firms right here probably never had a course in the economic history of the United States. They don't know what caused the panic of 1873. They are without a clue as to why the Federal Reserve and the Securities & Exchange Commission were formed.

Of course, we have politicians willing to blame other politicians for the problems, but unwilling to blame the ignorance and arrogance of ordinary people, of home builders, home buyers, real estate agents, mortgage brokers, bankers and investors. We will blame regulators, even though Congress and our national administration reduced the funding and powers of the regulatory agencies.

Finally, we will not learn from this economic disaster. We will teach our children about Sept. 11, 2001, but what will we teach them about September 2008? They will learn to fear foreigners, but will they learn to fear financial ignorance?



Marcus taught economics for more than 30 years at Indiana University and is the former director of IU's Business Research Center. His column appears weekly. He can be reached at mmarcus@ibj.com.
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