What makes garbage garbage?

The answer to this is known: entropy. Garbage is any mixture so disordered that it isn’t worth separating into usable components. What makes household waste a resource is keeping its parts separate right in the kitchen, instead of throwing them all together into a single pail. Creating economic resources, more generally, is in large part a matter of separating stuff that’s mixed together in nature, like metal from ore and food plants growing randomly with each other in the wilderness. A cornfield is valuable because it has low entropy.

The same principle applies to the mortgage bonds. Individual loans to specific owners, on particular properties, got smushed together on the theory that their risks were uncorrelated. Oops. They’re called “garbage” now not because we know that everything in any one of them is worthless, or even worth less, but because they are high-entropy phenomena. While it’s not a big deal to sort out individual mortages into risk categories, as when a bank is wound up, these bonds are nearly worthless for exactly the same reason mixed household waste costs money to get rid of, while separated piles of cardboard, paper, food waste, and containers are worth something.

One question that should interest regulators, after we get to think calmly about an ongoing credit business, is to what extent it should be allowed to destroy the value of financial instruments by mixing them into a disordered mélange.

Author: Michael O'Hare

Professor of Public Policy at the Goldman School of Public Policy, University of California, Berkeley, Michael O'Hare was raised in New York City and trained at Harvard as an architect and structural engineer. Diverted from an honest career designing buildings by the offer of a job in which he could think about anything he wanted to and spend his time with very smart and curious young people, he fell among economists and such like, and continues to benefit from their generosity with on-the-job social science training. He has followed the process and principles of design into "nonphysical environments" such as production processes in organizations, regulation, and information management and published a variety of research in environmental policy, government policy towards the arts, and management, with special interests in energy, facility siting, information and perceptions in public choice and work environments, and policy design. His current research is focused on transportation biofuels and their effects on global land use, food security, and international trade; regulatory policy in the face of scientific uncertainty; and, after a three-decade hiatus, on NIMBY conflicts afflicting high speed rail right-of-way and nuclear waste disposal sites. He is also a regular writer on pedagogy, especially teaching in professional education, and co-edited the "Curriculum and Case Notes" section of the Journal of Policy Analysis and Management. Between faculty appointments at the MIT Department of Urban Studies and Planning and the John F. Kennedy School of Government at Harvard, he was director of policy analysis at the Massachusetts Executive Office of Environmental Affairs. He has had visiting appointments at Università Bocconi in Milan and the National University of Singapore and teaches regularly in the Goldman School's executive (mid-career) programs. At GSPP, O'Hare has taught a studio course in Program and Policy Design, Arts and Cultural Policy, Public Management, the pedagogy course for graduate student instructors, Quantitative Methods, Environmental Policy, and the introduction to public policy for its undergraduate minor, which he supervises. Generally, he considers himself the school's resident expert in any subject in which there is no such thing as real expertise (a recent project concerned the governance and design of California county fairs), but is secure in the distinction of being the only faculty member with a metal lathe in his basement and a 4×5 Ebony view camera. At the moment, he would rather be making something with his hands than writing this blurb.