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Proving The Effectiveness Of The Only Known Antidote For Economic Suicide

Stock-Markets / Credit Crisis 2009 Aug 25, 2009 - 07:15 PM GMT

By: Andrew_Butter


Best Financial Markets Analysis ArticlePutting aside colorful sensationalism (tales of greed, fraud, and incompetence), the instrument of the recent suicide attempt was banks lending money against collateral and not taking reasonable or responsible steps to make sure that the value of collateral was more than the loans that were outstanding, at the point in time loans defaulted.

A common argument by bankers is that they did not know that this would happen. This is (probably) true in most cases (i.e. they say it was incompetence not fraud), but the reason they did not know was that they did not do, or commission, proper valuations. That is self-evident, but then they say, "Oh but it is impossible to do a valuation of an asset for some date in the future, so we used some jerry-built concoction of "the market" to do the valuation".

First: The "market" did not deliver satisfactory valuations, it could not, and it can never do that. That's like doing a valuation based on a popularity contest, there may be a weird logic there, but (a) that is not how you do a valuation under any coherent valuation standards, particularly not International Valuation Standards and (b) evidently it does not work, if it did work there would be no crisis.

Second: It is not impossible to make a reliable estimate of what an asset can sell for in the future, that happens all the time. People who make auto loans understand this, they understand for example that a new car will be worth less in ten years time that it is worth today, and they account for that. So why should a building or a security be any different?

The problem was not that no one could do such a valuation; it was that no one asked the question. This is the question that should have been asked and answered: "What is the minimum price that I can reasonably expect to be able to sell this asset for over the next five, ten or twenty years".

Is that difficult to do? Not really, it obviously takes more skill than simply finding out how much the asset could sell for today, but it's not hard. The problem then was no one asked, the problem now is that still no one is asking that question, and the problem there, is that the global financial system will have to rely on the morphine drip of state handouts until (a) that question is routinely asked and (b) market participants believe the answer.

How can you do that?

This article is not about how to do valuation; if someone needs to have that explained to them, then they would be well advised to hire someone who knows, valuations are tricky, they are not things that amateurs should attempt without adult supervision. This article is simply to demonstrate that it can be done, with deadly accuracy.


The current problem was started with housing, so perhaps that's a place to start?

I have done valuations of real estate for a big part of my life, I can demonstrate that a properly conceived valuation of housing in USA in 2004 would have flagged the fact that housing was at that time on average 23% over-priced, and thus after allowing for they dynamics of corrections after mispricing (which are not a mystery (, the maximum value that should be attributed to housing when used as collateral at that time was 60% of the current (then) mark-to-market value ( But that's in the past, and anyone can be smart after the fact, so that's hardly proof.

How about all those toxic assets sitting on bank balance sheets, what will they be worth in five years time?

The problem with that is as explained (, it always was and it still is impossible to value those assets, because sufficient market-derived data is not available in the public domain. And until sufficient data is made available to market participants those assets will sit in the stomach of the banks un-digested, and the government will have to play "make-believe" until they eventually "mature" and can be passed through the digestive system.

So what's left?

How to demonstrate that it is possible for anyone who is "skilled-in-the art" to do a reliable valuation of a complex asset; in the future.

Here is an example:

In January I decided to do a valuation of the US stock market using well-known valuation techniques. I was not making a prediction; I was doing a valuation.


On 26th February 2009 (, I reported:

US Stock markets values will decline to a point when DJIA hits 6,600 and S&P 500 hits 675.  Thereafter values will increase markedly.


A follow up confirmation was made in 17th April 2009 (

US Stock Markets values will increase 13% to 30% before the end of 2009.

Is that accurate enough?

That's 99.77% accurate, you don't need that level of accuracy; 10% is easily good enough. In any case that valuation model was only accurate 8% at the 95% confidence level, the fact it was spot-on was just luck.

But that was not alchemy, nor was it a "prediction" made thanks to some inside track or special knowledge that I have of the markets (I have none). That was simply a valuation done strictly in accordance with International Valuation Standards, it could have been for a car, second hand bottling plant, or a herd of pedigree cows; the methodology is identical.

Proper valuation as an antidote to Economic Suicide:

Lending money against collateral that can be expected (by reasonable and rational valuation techniques), to be worth less than the outstanding amount of the loan, is financial suicide.

Governments that implicitly or explicitly support financial institutions that engage in such practices, are committing economic suicide,

Free markets depend on government providing sufficient regulation to prevent market participants from poisoning the market. A good example is the sale of melanin tainted milk in China, a few criminals caused huge damage to the FMCG industry over there.

There is no reason why in a free market, anyone should not be allowed to commit financial suicide, but when they decide, metaphorically, to do that by hijacking a plane and flying it into a building, it is the duty of government, to prevent such actions.

The antidote is that governments must absolutely require any financial institution that relies on their support, either explicitly (via the discount window) or implicitly (via the prospect of bail-outs), to do their valuations properly.


(1): By "proper valuations" I explicitly exclude the Voodoo Valuation Standards employed by FASB and IFRS (

(2):  The valuation of the US stock market made on 26th February was valid for six months, from today no opinion is expressed about the future price of the US stock market, the valuation was done simply as a demonstration of capability.

By Andrew Butter

Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Andrew Butter Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Andre Taiakin
26 Aug 09, 04:27
Stock Market Valuation

I am sure I am not the only one sincerely impressed by the accuracy of your 6600 and 675 numbers. I am also sure that I am not the only one wondering how you got those numbers. As someone who had never even heard of International Valuation Standards before reading your articles on this website, I would certainly appreciate a little more insight into this subject. Obviously it would be particularly interesting to find out how to derive the other-than-market-value for a market index, such as the one used in your chart in


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