A Stitch in Haste

Every so often, I see a Wall Street commentator defend his failed predictions by insisting that his analysis is indeed perfectly correct, even though his picks turned out to be dead wrong. I call this ego defense mechanism, “I’m not wrong, the market is!”

But of course the market (by which I mean any market and not just the stock market) is never “wrong” in that sense. The prevailing price of a good is always, by definition, correct. The value of anything — a house, an iPod, a subprime mortgage-backed security, anything — is whatever people are willing to pay for it, based on the information then available to them.

Now consider this statement by our (Harvard MBA) president:

Second, as markets have lost confidence in mortgage-backed securities, their prices have dropped sharply. Yet the value of many of these assets will likely be higher than their current price, because the vast majority of Americans will ultimately pay off their mortgages. The government is the one institution with the patience and resources to buy these assets at their current low prices and hold them until markets return to normal. And when that happens, money will flow back to the Treasury as these assets are sold. And we expect that much, if not all, of the tax dollars we invest will be paid back.

We’re not wrong, the market is!

But again, the market is by definition never “wrong” and the “value of many of these assets” is by definition the current price. The president’s statement is an objectively demonstrable absurdity.

The supposed (i.e., wrong) resolution of the paradox is that everyone knows that these securities will rise in price, but that no one — no banks, investment funds or other market participants — have the money to buy them.

An analogy would be someone offering to sell you a house for $100,000 that you’re sure is worth $500,000 — but you have no money or credit with which to buy it.

But while that hypothetical might apply to a single investor, or even a single institution, it can’t possibly apply to the whole market. Somebody, somewhere, would have the $100,000 — or more — to buy the $500,000 home.

Far more likely, certain in fact, than “no one has the money” is that “no one wants to pay the money.” There’s a difference. A home that somebody, somewhere could pay $500,000 for, but no one is willing to pay $500,000 for, is simply not “worth” $500,000. No matter how many politicians or bureaucrats insist, “We’re not wrong, the market is!” to the contrary. The market, by definition, is never wrong.

One quick example: Warren Buffett has plenty of liquidity to slosh around the financial markets. He’s just not willing to slosh it at the subprime mortgage market. (The other obvious example here.)

Paulson’s not wrong — Warren Buffett is? (And by “Warren Buffett” I mean all of them: the collective action or inaction of every private financial investor and institution, aggregated throughout the financial markets.)

I think not.

Previously:
–Do Leveraged Buyouts Prove Stock Markets are “Wrong”?
–Gas Prices Reviving the “Water-Diamonds” Fallacy

Filed under: Economics & Finance, Politics