Cool explanation, Zaphod.
Looks like a solid enough system.
Question, though, is there much use for displacement mapping outside of terrain applications? Or is there any sort of comparison to Q3/D3's patch meshes? The patch meshes give a level of control that it would take another piece of software to do in any other engine. When you do need a model, one plugin for Lightwave and you can export to the modeler and bring the model in-game with 2 clicks. Personally, I think combining the patch meshes with models gives you the most control possible over your raw geometry and it keeps pretty much all of it in the hands of a designer in the editor, though most of us can and do build our own models from time to time.
That's another question for you Unreal/Source lackeys - how many of you do your own prop models and how many have the art team do them for you? If you do build them, do you guys texture them as well?