Confidence: It’s all in the mind—and always has been

The Northern Marianas is as far away from Wall Street as any state or territory under the American flag can be. Wall Street investors and those around the world from Berlin to Tokyo and all the places in between have already lost many millions, indeed trillions of dollars in stock market values. Do you know to how much “only” one (1) trillion dollars equates? The enormity of a trillion dollars is almost impossible for the average person to conceive. It is an astronomical thousand billions, ($1,000,000,000,000). To maintain a degree of perspective, the U.S. national debt now stands at a mind-numbing $10.25 trillion, and still climbing, prompting U.S. Sen. John D. Rockefeller (D. W.Va.) to state, “We have a government that has no money.”

In addition to being broke, the United States has seriously eroded its international financial standing as a result of its trade and account deficit, which are sustained only because foreign entities such as China purchased U.S. stocks, bonds and other assets. At least they did—we have to wait and see what position they will take in the coming months.

For many people their 401k or IRA savings for their children’s college, or money to meet the next payroll or make necessary equipment purchases, plan for their retirement—or whatever—has evaporated like so much smoke. But you already know that if you have listened to, or read the news. What happened? The money was there last month—the value of your house was worth more last month than this month. How can that be? Let’s step back and look at what happened.

Imagine a person on Wall Street sitting 30 or 40 floors up in a skyscraper staring at a computer screen reading the financial statements of a particular company and comparing the financial condition of that firm with others in the same industrial or business sector. We call that person a stock or market analyst. There are thousands like him or her. Such a person will attempt to predict market trends and recommend business action often either to buy, sell or hold stock. To do this the person will often use a combination of tools known as ratios. Let’s look at a couple of widely used ratios used to evaluate stock.

A financial or accounting ratio is a ratio (comparison) of selected values on a firm’s financial statements with other values. There are many standard ratios used to evaluate the overall “apparent” condition or worth of a corporation or business.

We hear a lot lately about liquidity. Liquidity ratios measure the availability of cash to pay debts. Debt ratios measure a firm’s ability to repay long-term debt. Market ratios measure investor response to owning a particular company’s stock and the cost of issuing stock.

Say, for instance that the analyst mentioned above is aware of stock which has been valued at $30 per share. It has remained at that price for some time—all other factors being equal and the status quo of the general economy and that particular industry remain without significant change. It is assumed that the stock at that time is worth $30 per share. Along comes a bid from someone somewhere willing to buy at $35 per share. The owner sells and makes $5 on his original $30 investment. This is somewhat an over simplified for the point I wish to make but generally the stock market works that way—buying and selling stock ownership in businesses all over the world.

But we have watched in dismay as banks and investment houses fail one after the other like so many falling dominoes and wiping out untold millions in wealth in the form of housing values, 401k retirement funds and more.

What happened to the money? Who has it? Does Saudi Arabia, China or some unknown entity have it? No. It isn’t anywhere—it was all an illusion as long as people had confidence in an economy where one could buy and sell and things retained or increased their value. In the example cited, someone thought the $30 stock was worth $35 and purchased it at that price. If many such transactions like that would follow, the value of the stock across the board will have increased in value. In this instance only because someone had the confidence that it was worth $5 more.

As Yale economist Robert Shiller points out, “The notion that one loses a pile of money whenever the stock market fails is a ‘fallacy’. Stock has never been the same as money—it was always only a ‘best guess’ of what someone, or some group, thought it was worth.”

An example might be an appraiser who values a house at $250,000, a week after saying it was worth $300,000. What happened to the $50,000 that disappeared? Nothing happened to it—it was all in the mind of an appraiser.

But something is disappearing as markets and real estate values go south and that “something” was the future “potential money” we were all counting on. In terms of housing it would be called appreciation for those owning the land in fee simple.

“Still, one runs into trouble when you think of that ‘potential money’ (now lost) as being the same as cash in your pocket or in your checking account,” so says Dale Jorgenson, Harvard professor of economics. “We’re gonna have a huge shrinkage in the financial sector. It’s lost and it’s not coming back.”

It was all built on confidence. Confidence that prices would continue to rise and things would always get better. But the confidence is gone and that, my friends, is the really serious matter.

No one really knows where it will all end.

Of course, with everyone sharing the same illusion of wealth, inflated housing values and many other things, the trick was to know when to get out of the market, thus making a reality of the illusion and not waiting to wake up poorer than when you went to sleep, thinking it’s all a bad dream. For many who waited—and stayed in the market a bit too long—the illusion of wealth is no more.

One often hears the expression “fair market value” as applied to real estate. What does it mean?

Realtors will tell us it’s the price agreed upon between a willing and informed seller and a willing and informed buyer under ordinary circumstances. Fair market value is the highest price estimated in terms of money which property will bring if exposed for sale on the open market within a reasonable time allowed to find a purchaser who buys with knowledge of all the uses and purposes to which the property is best adapted and for which it can be legally used.

The financial manipulators who conceived the sale of subprime mortgages to people who could not otherwise qualify for a loan and who did not meet the above criteria, those financiers turned the theory upside down and brought about the collapse of the financial system as we have known it. They committed an economic crime the likes of which this country has never seen.

One thing is certain: America is changing and things will never again be the same. The year 2008 will go down in history as a watershed year in the nation’s economic history.

I was a preteen during the Great Depression. I remember it and I fear history may be repeating itself as history is often wont to do. I hope I’m wrong.