Thursday, January 1, 2009

Good-bye, $6.9 trillion

The Washington Post:
After months of tortuous trading, Wall Street rang out its worst year since the Great Depression yesterday, leaving shareholders $6.9 trillion the poorer.
It hardly mattered that the market finished the last day of the year with a modest gain.
The losses in 2008 were so broad and deep that every sector in the Standard & Poor's 500-stock index took a double-digit hit, and the financial sector lost more than half of its value.
You may be wondering: Where did that $6.9 trillion go? Well, it didn't go anywhere. It never existed. Or, to put it another way, it existed only as a value.

This is why people don't understand economics -- they don't understand value. What is a thing worth? Whatever you can sell it for, and not a penny more.

Price is the intersection of supply and demand. The securities traded on Wall Street have value only as reflected by the current price or, perhaps, what someone thinks the price will be a year or five years from now. A year from now, the net value of the S&P 500 might be higher than it is now, or it might be lower. If you think it's going to be higher, buy. If not, sell.

People don't understand this. You can see the miscomprehension of value in everyday behavior. Take, just for an example, clothes. Go look in your closet and ask yourself, what did I pay for this wardrobe? Now, ask yourself, what would it sell for today? No, not what it would sell for in a store, if it were new, but what you could sell it for yourself.

However expensive your clothes, whatever the name brands and designer labels, if you held a yard sale tomorrow, your warddrobe would fetch pennies on the dollar in terms of what you paid for it. That Calvin Klein sweater that retails for $125 may have seemed like a bargain when you bought it on "sale" for $75, but try to sell that sweater secondhand. What price will it fetch at a yard sale or a consigment shop? You'd be lucky to get $5 for it. So much for your "bargain."

Despite this economic reality, some people still spend extra money to buy designer name-brand clothing. Some even borrow money (using credit cards) to buy this overpriced merchandise which loses about 90% of its resale value the first time they wear it. And it cannot be argued that name brands have any "use value" that compensates this depreciation. Whatever the difference in quality between an $80 pair of designer jeans and no-name jeans that sell for $20 at a discount store, it's not enough to justify the difference in price. The purchaser of the designer jeans is buying a status symbol, and paying an extra $60 for the supposed prestige of wearing something with a designer label.

What does this have to do with the $6.9 trillion of Wall Street that evaporated in 2008? Well, remember that the financial meltdown originated in the mortgage market, during the housing bubble that burst. People borrowed money against what they thought the house was worth -- its value in an overheated market -- so between optimistic appraisals and lenders willing to extend "no money down" mortgages, you had people owing 100% of what their home was supposedly worth. Which was fine, if the market continued ever upward.

What happened, however, when the market stopped rising? Suddenly, those homes became depreciating assets -- not really different, in economic terms, than that designer sweater. And just like the silly bimbo who maxes out her Macy's credit card to buy a wardrobe of designer clothes, the overleveraged homeowner finds himself making payments on a possession that he cannot resell for anything near what he borrowed to buy it.

So, what happens now? Well, it seems some people are slow to get the message:
HOUSE PRICES: Still too high? I think so, and I’m surprised at how unrealistic sellers still seem to be. I’m seeing people put houses on the market for 10-15% more than they paid two years ago, when those houses are probably worth 10-15% less. Or worse.
It's as if the bimbo with the maxed-out Macy's card decided to hold a yard sale and put an $85 pricetag on the designer sweater she paid $75 for. These unrealistic home-sellers have in their mind the idea that, because they paid $250,000 for their house, its current value must represent some specific percentage (whether it's 90% or 110%) of what they paid for it. But if the best offer they get is $120,000, that is what the house is actually worth, and not a penny more.

This is what is intrinsically wrong with the bailout mentality that has prevailed, with Congress making plans to "help" homeowners who are upside-down on their mortgages. Such "assistance" only prevents the market correction that is the only real solution to the problem.

Why not also bail out those investors who lost $6.9 trillion on Wall Street by propping up the securities markets? Which is to say, why not prevent securities from selling at what they're actually worth? The idiocy is apparent: If you bought Acme Widget at $20 a share, and today can't find a buyer at $5 a share, why should the federal government step in to offer $10 a share to cushion your loss? Nobody forced you to buy that stock and, in point of fact, no one is forcing you to sell it now. You can either hold onto Acme Widget and hope the price recovers, or else you can sell it at $4 a share and take the loss.

Given current economic realities, this ought to be a buyer's market for housing, a chance for young people who were priced out of the "bubble" market to jump in and get their slice of the American dream at rock-bottom prices. But if the government intervenes to prop up overleveraged homeowners, they discourage this necessary market-clearing process. Yes, some people will be losers in that process, just as there were lots of losers in the $6.9 million Wall Street sell-off. But real recovery cannot begin until the market hits a solid bottom.

In the meantime, good luck selling those designer sweaters for $85 at the yard sale, bimbos.

1 comment:

  1. But if the government intervenes to prop up overleveraged homeowners, they discourage this necessary market-clearing process

    The Party of Government (or Party IN Government, P.I.G.) will do whatever it takes to get re-elected.

    That has nothing whatsoever to do with facts, logic, or realities, as you should know by now.