Can Financial Values "Disappear"?

Conquer the Crash was finished in March 2002. Look at Figure D-8 and notice that the fewest debt downgrades of the decade occurred that year. As CTC said, "as an investor you cannot wait until problems are obvious to act; by then it's too late. You have to anticipate problems and then get out of the way before they happen."


As for the price of mortgage debt, Figure D-9 tells the story, thanks to the diligence of Markit Group Ltd., whose work has brought some transparency to this field. The lower line denotes the price of sub-prime mortgages, and the middle line shows prices of "alt.-A," the mid-grade mortgage paper. The top line prices prime mortgages, the ones whose payers have some equity and a good source of income. But these graphs rely on dealers for prices, and many of these mortgages are not trading. So even these data do not show the true extent of losses. There is a big lag between what everyone in the industry suspects is the real price and what happens to the index. As Pete Kendall says, "It's a surreal world where prices are lagging actual values."


The rating services fulfilled their usual role [in failing to warn of the danger]. But readers of Conquer the Crash are not surprised, and we didn't own any such debt.

Some readers of Conquer the Crash took exception to this statement, from Chapter 9:

[F]inancial values can disappear into nowhere... The "million dollars" that a wealthy investor might have thought he had in his bond portfolio or at a stock's peak value can quite rapidly become $50,000 or $5000 or $50. The rest of it just disappears. You see, he never really had a million dollars; all he had was IOUs or stock certificates. The idea that it had a certain financial value was in his head and the heads of others who agreed. When the point of agreement changed, so did the value. Poof! Gone in a flash of aggregated neurons.

This warning is being borne out today. Read this except from a Bloomberg news report of July 11:

As delinquencies on home loans to people with poor or meager credit surged to a 10-year high this year, no one buying, selling or rating the bonds collateralized by these bad debts bothered to quantify the losses. Now the bubble is bursting and there is no agreement on how much money has vanished: $52 billion, according to an estimate from Zurich-based Credit Suisse Group earlier this week that followed a $90 billion assessment from Frankfurt-based Deutsche Bank AG.

Do you see that line, "money has vanished"? It's not really money; it's financial value, but it didn't move from one asset to another. It just disappeared.