Talk about a fire sale. This past Saturday, at the 8th floor of Saks Fifth Avenue, women were fighting for their own year-end bonuses: $300 Prada boots and $200 Fendi handbags. That is 40% off original price, then another 50% off on top of that, and then another 10% off if you apply for a Saks membership card.
Looking around the battle field (shoes were covering the whole floor) in the normally elegant and empty designer shoes paradise, it makes you think: why is the same crazy buying not taking place in the toxic assets arena? Depending on credit ratings, those assets were selling anywhere from 70 cents on the dollar to less than 20 cents on the dollar – similar in terms of the discount level of these beautiful shoes. Why do buyers see value in discounted Prada boots, but not discounted CDOs?
Warren Buffett says price is what you pay, value is what you get. But financial assets have a particular characteristic. Other concrete assets, such as a house, a car or a pair of Prada, all have a salvage value. That is not necessarily true for financial assets. How financial value can disappear explains the pricing of assets:
Asset prices rise not because of “buying” per se, because indeed for every buyer, there is a seller. They rise because those transacting agree that their prices should be higher. All that everyone else — including those who own some of that asset and those who do not — need do is nothing. Conversely, for prices of assets to fall, it takes only one seller and one buyer who agree that the former value of an asset was too high. If no other bids are competing with that buyer’s, then the value of the asset falls, and it falls for everyone who owns it. If a million other people own it, then their net worth goes down even though they did nothing. Two investors made it happen by transacting, and the rest of the investors made it happen by choosing not to disagree with their price.
Some of those toxic assets, such as synthetic CDO, are backed by nothing except pieces of paper that promise to pay. They can easily go up in smoke without even leave any ashes. If the bottom fishing experience at Saks taught me anything, that is buy things that you can put your hands – or feet – on. Those paper aren't good for wrapping fishes.