Wednesday, October 8, 2008

True Value


What are our assets truly worth?

The recent real-estate and stock-market debacles tell us that housing and equities were grossly overvalued.

There were two overvaluation bursts: The late 1990s and the recent real-estate run-up.

The late 1990s boom gave us an exaggerated notion of stock-market values. We came to believe that the dot-com boom’s lofty heights were true value, while the dot-com bust’s comedown was somehow artificial.

After the recent real-estate run-up, we embraced the notion that the recent boom was real and the subsequent bust was merely a bad dream. We feel that home values will pop back up to their earlier levels as soon as the nightmare is over.

The same is true for the latest stock-market reversal. Somehow the boom was true and the bust is false. We deserved those out-size values which, after all, were no higher than the levels we enjoyed during the late 1990s dot-com boom.

So when will the markets snap out of it and return us to true value?

Unfortunately they’re doing that right now, but not in the way we want. Capitalism may be a tale of wealth-creation, but it encompasses episodes of wealth-destruction. And we’re experiencing one today.

Think of the economy as a gigantic balance sheet, with real estate and stocks on the left side and debt on the right side. We pumped up the left side’s real estate and stocks by taking on enormous amounts of right-side debt. Now, as real-estate and stock-market holdings deflate, we are desperately attempting to repay our debts. The entire balance sheet is shrinking.

How far will it shrink? Back to true value.

© 2008 Michael B. Lehmann

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