One of my mean little tricks when a financial advisor tries to sell me something is to ask him/her to tell me when stocks regained their pre-Great Crash levels. The answer, depending on which stock price index you use, is anywhere from 1952 to 1954 -- i.e., about a quarter of a century after the Crash itself. I realise that posing this question makes me look like a smartarse, but I happen to think that it's a piece of information that anyone selling financial products to someone of my age should know. (They never do).
In today's Independent, Hamish McRae suggests that the "wealth" that has been destroyed in the current crisis may not be rebuilt for at least a decade. If the Great Crash and the subsequent two decades are any guide, McRae is an optimist. But is it really correct to talk about "destruction of wealth" in the current context?
Many of the commentators who have responded to McRae on the Indy's website have made the point that the real "wealth" of the global economy has hardly been impaired at all. Sure, the argument goes, lots of sub-prime mortgages have gone sour, but the houses that they financed are still there. That's true, but it's a very backward way of looking at things. The non-payment of those mortgages means that future housebuilding plans, and likely a lot of other things too, are going to be put on hold or cancelled outright because of a lack of financing. That's already happening, and it's a real problem, as you can easily tell from the increasingly loud pleas from the business sector for governments to do something to restore the flow of credit to the global economy.
It all comes down to how you define wealth. The backward looking view adds together the housing stock, factories, roads, Buckingham Palace, the Colosseum, the Statue of Liberty etc. Fair enough -- it's certainly good that we have those things. But they're of only limited value for the future, which is where we and the financial markets are going to be spending our time. Most financial assets are valued on the basis of the earnings (both income and capital gains) they can be expected to produce in the future, rather than on the value of the assets that may have been put up as security against them. The collapse in global equity and corporate bond values is telling us that the expected value of that earnings stream is much lower now than it was when the crisis hit. So if you regard wealth as a measure of future income, then we are indeed witnessing a destruction of wealth, even if your house and mine are still standing.
If that's all there was to it, this crisis would not look much different from any of the recessions of the post-WW2 period, and would presumably be no harder to resolve. There is one big difference this time, however, and it relates to the huge quantity of impossible-to-value assets on bank balance sheets. It's well established that the total value of the infamous credit default swaps outstanding, at over $600 trillion, is many times greater than the value of the underlying assets (i.e the bonds against whose default they supposedly insure). There's no reasonable way that these CDSs can possibly be regarded as "wealth".
It stands to reason that if some magical way could be found for the world's financial institutions to net out their CDS positions, the financial crisis would be massively eased. Absent a way of doing this, we find ourselves in a situation in which non-wealth is contributing to the destruction of real wealth. No wonder Warren Buffett called CDSs "weapons of financial mass destruction".
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