Via email, reader Denis wonders “Where did the Money go?”

Hello Mish

I read many times on your blog how bubbles created by the Fed led to the overpricing of assets such as real estate and stocks. Someone paid those overpriced valuations. So, where is the money? At some point will that money be used to mitigate the economic doom?


Illusion of Wealth

Let’s take a look at a real estate example, then the stock market. Please consider home ownership rates.

In 2002 there were 71,278,000 owner occupied homes. In 2006 there were 75,380,000 owner occupied homes. The difference is 4,102,000 homes.

Thus, the overwhelming percent of the population did not buy a house in the biggest bubble years 2003-2006. Most had a house for many years and millions of others rented throughout.

Therefore it’s safe to say that most homeowners rode home valuations up, then down, feeling rather wealthy in 2005-2006, and decidedly less wealthy now.

Anywhere, USA

Consider a typical subdivision of 200 houses, Anywhere USA where the homes are all relatively similar in size and value. Assume those homes were worth $250,000 in 2002 and $450,000 in 2006, with a few of sales at varying prices, but no sales since 2006.

Now let’s assume one person has to sell now and all he can get is $220,000. Poof. Conceptually, the entire subdivision was just repriced on one sale.

Disregarding that sale, no money went anywhere (except of course via rising property taxes over the years to pay overly generous wages and pension benefits to police, fire department and other government workers).

On a percentage basis, few bought or sold during the years in question.

In general terms, the winners were those who sold at or near the top (and those benefiting from rising property taxes). The losers were those who bought near the top (along with taxpayers under the burden of rising property taxes).

Of course, many millions took out home equity lines and bought boats or made home improvements. However, those loans (except for loans in foreclosure or default) are still on the books of banks, most likely not marked-to-market.

Repricing Events

In the example above, 1 house out of 200 sold, yet that lone sale set the price for the entire neighborhood. Given that current buyers will not pay 2006 prices, repricing occurs whether any transactions take place or not.

Such repricing events happen all the time in the stock market as well.

For example, in premarket trading of as little as 100 shares, stocks can rise or fall 5% or more easily. Money does not go anywhere per se. Rather valuations change, just as happened in my housing example above.

To understand how valuations change over long periods of time, please consider Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It’s Far More Likely Than You Think

Cycles of PE Compression and Expansion

Over long periods of time PE ratios tend to compress and expand. Unless “it’s different this time”, history says that we are in a secular downtrend in PEs. From 1983 until 2000, investors had the tailwinds PE expansion at their back. Since 2000, PEs fluctuated but the stock market never returned to valuations that typically mark a bear market bottom.

Of course, there are hedge fund managers who made $5 billion or more in the crash, but that pales in comparison to the valuation of the stock market which changed by $trillions on the way up and the same amount on the way down.

On an ongoing basis, broker-dealers and CEOs take their cut (and huge bonuses as well). Here is a case-in-point: Anthony Mozilo, CEO of Countrywide Financial, single-handedly cashed out over $1 billion in shares and options (but that was over the course of a decade).

Will Mozilo use his $billion to help mitigate the economic doom?

How far would it go, even if he did? $1 billion is extremely tiny compared to the total stock market valuation and housing bubble bust.

So Where Did the Money Go?

Clearly, Wall Street took a tiny percentage (and continues to do so). Those CEOs and broker-dealers take their cut whether the market goes up or down. They don’t care what happens to anyone in the process.

A few big hedge funds betting the stock market would drop made out very well. However, the stock market would have plunged whether anyone bet against it or not.

At the housing and stock market peaks, presumed wealth was nothing but an illusion caused by the Fed’s serial bubble blowing policies. It would have been impossible for everyone to cash out then, or cash out now.

Thus, most of the money went to “money heaven” which is to say nowhere at all. It was not really “money” in the first place, but rather unrealistic valuations (and in regards to real estate, a mountain of debt that cannot be paid back).

Valuations went up, then down, repriced over time (with Wall Street siphoning off a bit in both directions). This helps explain why the rich get richer and the middle-class continually shrinks.

Millions of lives, late to each bubble-blowing party, take on too much debt and are destroyed in the process. Bernanke’s policies ensure it’s going to happen again.

Mike “Mish” Shedlock
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