Wednesday, September 17, 2008

A Lesson in Pricing

Wall Street is a mess right now. The biggest, oldest investment banks in America are tumbling like dominoes. The world’s largest insurance company is in deep trouble. And looking at your 401(k) at this moment is an act of self-torture.

The New York Times had a very interesting article describing this entire situation, “On Wall Street as on Main Street, a Problem of Denial,” by Joe Nocera. I’m intrigued by the idea that these big institutions have been in the same denial as individual homeowners, thinking their property is worth more than it is. Market determines worth. It’s a hard lesson right now for some people.

Yet only a few years ago, we sold our house for a fabulous profit because of the rising market. Not because our house had suddenly become wonderful. It was an ordinary home with no architectural distinction, and it had some flaws. But suddenly, in that crazy rising market, it was worth twice what we had paid for it 15 years before. Did we object to the absurdity of that high dollar amount? Of course not. We took the money.

Right now another modest suburban home is for sale a couple of doors down from my relatives. It is priced to sell, as the phrase goes, but there have been no takers. Even though the price has been lowered several times, the house is lingering on the market as so many houses are across the country. But it should be noted that the price they started with was way, way beyond what that level of house was valued at only a few years ago. It’s a fair price for the market that no longer exists. Until the price is reduced to meet the market as it exists now, the house isn’t going to sell. Even though they have dropped the price more than $60,000, that impressive dollar figure is only a reduction of 15% in price. We expect 15% and more off when an item is on sale in a store. Why not expect a house to be similarly discounted? This house still has not been reduced to the price level of what those houses were worth five to eight years ago. Depending on how far the market has fallen, the owners may still be out of luck even though they aren’t in denial. But as long as they have owned that house throughout this entire bubble, they haven’t lost any money; they’ve simply lost expected profit.

According to the Times article, the big investment firms have been and may still be in denial. They aren’t longtime owners of specific dollars the way a homeowner can be the longtime owner of a property; their money gets shifted around constantly. So they are looking at real losses. Except that the values they have assigned to their now tumbling assets have always been arbitrary. And right now, retaining the old pricing is a form of denial. They simply haven’t been willing to admit that they need to discount until the stated price of their holdings reaches the current market value. Because they’re talking in billions of dollars, we ordinary mortals find it hard to grasp that the percentage is the issue here, not the dollar figure. But the house near my relatives tells the true story.

Who knew that these big companies could get as silly and stubborn as we individual homeowners? It’s a lesson in scale. Also in pricing.

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