Our production-meister Rick Gordon sent me this on the recent financial collapse, his email was titled: (Happy New Year [anyhow] from Rick Gordon):
The bottom of this SF Chronicle article —
— has an interesting analysis of the the market crash. I’ve also quoted the pertinent portion below (my emphasis added):
Charles Biderman, chief executive of TrimTabs Investment Research in Sausalito, has a different explanation. He says that from the market’s bottom in 2003 until its peak in 2007, the market value of all publicly traded stocks worldwide grew from about $20 trillion to $45 trillion.
During this period, only about $1.5 trillion in cash went into the market. Debt accounted for some of the remaining increase in market capitalization, but most of it existed only on paper. “Market capitalization and money aren’t necessarily related,” he says.
Suppose a company has 1 million shares of stock priced at $100 each, giving it a market value of $100 million. Over the next few days, someone buys $5 million worth of stock. Speculation drives the share price to $140, and suddenly, the company has a market value of $140 million. In this case, a $5 million investment has created a $40 million increase in market value.
Is the company really worth $140 million? Not if everyone tried to sell their stock at once. The first person might get $140, but everyone else would get less, probably much less. “It’s not any different than a Ponzi scheme, a legal one,” Biderman says.
The same thing happens in real estate. Suppose the house next door sells for $700,000. Suddenly, every family on the block thinks their house is worth $700,000. But if everyone on the block put their house on the market, everyone could not get $700,000.
Multiply that by just about every asset class in the world, and you’ll get a sense of what happened last year. “The perceived value evaporated,” says Ken Winans, president of Winans International, a research and money management firm in Novato. “Are there trillions of dollars that have simply evaporated? The answer is yes.”
An enlightening and entertaining analysis of how deep this process is — and why even if the stocks were only valued at their actual cash investment, it would only be a drop in the bucket — can be found in this 47-minute video:
(Don’t get discouraged by the 16 seconds of blank video at the beginning.) Check it out.
Happy New Year!