Skin In The Game

Over at Yahoo there is a fellow who bills himself as the mortgage professor. His topic gains a lot of attention. A kindly older man, he has abuse heaped upon him. His theme this week is whether all of the people in the mortgage chain should have "skin in the game."



The question has to do whether in particular mortgage brokers and mortgage bankers, the front line sales people, should have their compensation tied to the performance of the loans they write. His answer is "no."

The people posting comments on his blog are split 50/50 in essence arguing either the people writing have no control so you cannot penalize them, or the people writing are on the front lines, and know when they write junk.

One fellow makes a suggestion: why not spread their pay across the life of the loan. You write a five year ARM, you get paid over 5 years; 30 year mortgage, pay over 30 years? Your loan goes bad, your pay stops. That would sort things out.

These are the kinds of "neat ideas" that keep policy wonks at think-tanks in business. They are like entertainment studios, where people think up entertaining ideas and then sell them to the public. And about as useful for solving our problems as a Seinfeld episode.

The error all 235 posters (and counting) are making is they fail to perceive the genesis of the problem. The housing bubble, and the concomitant mortgage mess started with the FED printing too much money and "missing the mark" in setting the correct interest rate (only a free market in money, and a free market in interest rates can ever get it right, and keep it stable).

With low interest and a flood of money, plus Japan offering near-zero interest rates, and plenty of cheap YEN to go around, and add governments leasing out gold at extremely low rates, you have very many millionaires becoming billionaires borrowing gold from sovereign nations and shorting it, taking the cash and coverting to yen and Japanese financial instruments that gave them near free money, and then offering to buy anything and everything banks in USA could finance in Home Loans.

As this bubble started, money and investment left productive areas, and moved into unproductive areas (the housing boom) and the salespeople and the armies of staff were drawn in by the attractive compensation. (Let Frank Shostak teach you about how a bubble here robs us of a benefit there.) Those people who moved to mortgages would have been engaged in other productive pursuits. To get them to move over to "mortgages" took the money that was paid. If you offered them a deal that paid over thirty years, they would not have moved over. The compensation worked out was precisely what was necessary to do the deal. No policy from on high would solve any problem. These people would have done as well in other pursuits, but the other pursuits were robbed of a natural credit availability, and of course the human talent as well. In short, diseases have gone uncured, maglev transport has gone unintroduced, so Americans can have granite countertops in houses they cannot afford.

Of course the banks knew they were writing junk. The people putting up the money, the people with all of the skin in the game, the secondary market buyers for the paper, know it was junk and were happy to finance it. All of the responsible parties, especially with those with "skin in the game" knew that when it failed, when it all came crashing down, the governments would bail them out and pass the losses to the taxpayers.

The problem isn't who has skin in the game, we know: it is you and me. The problem is the Federal Reserve System, the fact we have one.

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