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B. Jeffrey Madoff Headshot

The Illusion of Value

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About thirty years ago, my dad was negotiating with someone over the price of some real estate.

"It's worth a lot more than I'm charging you," said the realtor.
"To who?" countered my father.

"I'm giving you a good price -."

"Based on what?"

"This land is going to be worth a lot someday."

"It may be, which is why I'm interested. But it might not be, which is why I'm not willing to pay you what you're asking."

"You're passing up a great deal."

"Maybe, if the person who I'm trying to sell it to agrees on the value I place on it. But if I can't sell it, I'm going to have to dump it at a loss. I can't afford to keep my money tied up in something I have to hold onto for a long time."

"This is priced to sell."

"How long have you had it on the market?"

"Nine months."

"You haven't priced it to sell yet or it would be sold. You have my offer. If you don't want it, find someone else who shares your illusion about its value."

My dad didn't buy the property.

The realtor called my dad back two months later, ready to sell it for what my dad had offered.

"That was then. This is now and it's worth less to me," my father told him.

"What're you talking about, it's the same property."

"It's the same property two months later."

"If it was worth that to you then, why not now, nothing has changed."

"Something has changed: You couldn't sell it to anybody else, so it's less attractive to me."

I had thought things had an intrinsic value. I looked at the stock market pages, all those columns of numbers, PE ratios, shares sold, it certainly seemed like everything was so carefully calculated to arrive at a certain value. If a person could somehow crack those codes, what the numbers were telling us, we could arrive at a way to invest in the market without risk or at least very little risk. Numbers don't lie -- I thought.

It wasn't until many years later that I realized numbers are words that form a language. Those words can be used to create fact or fiction. There are many people who are very creative with the stories they tell with numbers and like all great storytellers, it's ultimately the emotional engagement that takes in the audience. Like fiction, it's the illusion that is created that people believe in or don't believe in that ultimately determines the value. There is no intrinsic value in words, it's how they are put together and how they are interpreted and whether they are believed. It's the same with the numbers that tell the story of the economy.

The stock market went up 497 points on March 23rd. What happened in one day that made the value of the DJIA go up the equivalent of billions of dollars? What made the market drop so far the past several months, losing almost half its value? Last month the market hit a 12 year low. Why has it come up 19% in the past few weeks? The news hasn't gotten any better.

For example, Apple Computer was $192.24 in May of 2008, it dropped as low as $78.20 in January of 2009. Was Apple really worth that much less 9 months later or conversely, that much more eight months ago? People must think so, because that is what it was trading at -- but is that a reflection of any true value or is it a shared illusion of value?

Here are reactions from the financial press to the 497 point gain:

"This is what the markets wanted" (New York Times)

... the Geithner plan -- panned by Wall Street on Feb. 10 -- got a big thumbs-up from investors Monday. Bank of America, Citigroup, JPMorgan and Wells Fargo all surged at least 19%.
"There's some sense of a bottoming process in the economy" and markets are anticipating that
"maybe this will work." (Investor's Business Daily)

"Is this a bear market rally or a new bull market?" (Marketwatch, Wall Street Journal)

Analysts warn that the recent gains could collapse just as quickly if the administration's asset purchase program hits a snag or housing deteriorates further. (New York Times)

The conclusion I reached after reading several financial journalists is there is a general agreement that the Geithner's financial plan will either work or it won't. The market may have bottomed and is poised for recovery or not.

According to the Federal Reserve Report of March 12th, household net worth dropped by $11.2 trillion in 2008, reflecting steep declines in the housing and stock markets.

Where are those trillions of dollars the stock market lost? Where are the trillions of dollars the household net worth lost? Where did the money go? I don't think it ever existed. We just thought it did.

Hundreds of millions of dollars were given in bonuses based on profits that didn't exist. Billions were spent on purchasing homes by people who didn't have the money to buy them. Those "toxic" now called "legacy" assets were repackaged into financial vehicles that almost no one understood, like "credit default swaps" valued at hundreds of billions of nonexistent dollars, sold generating illusory profits on nonexistent funds. Then there were the Ponzi schemes that cost billions of dollars that were allegedly generating great profits except that they weren't. Everything was going just fine until people started to question the whole illusion. As long as no one questioned how it was done and believed in it, money or the illusion of it, kept gushing forth.

When I was a kid, I went to my grade school carnival where a magician appeared to keep pulling silver dollars out of my friend's nose. Later, when my friend tried it at home he gave himself a whopper of a bloody nose but didn't pull out any silver dollars.

"Find someone else who shares your illusion about its value." My father's wisdom was pretty simple and direct -- value is subjective. On the most basic level, at least one buyer and one seller must be in agreement for a transaction to happen. When value is questioned, when the market is steeped in uncertainty and no one agrees as to what something is worth, markets collapse. When enough people agree on the promise of value, markets go back up. It may be an illusion, but I think it is how markets work.

By the way, my dad bought the property for what it turned out to be a great price.