COLD, HARD REALITY

excellent editorial by thomas friedman, author of "the world is flat", in saturday's new york times.

in his post, he claims the reason why banks keep asking for more money, is that their balance sheets are in much worse shape than they dare to tell us.

his point boils down to the same old thing which i have been writing on this blog for the last 3 months, and before that in letters to colleagues: asset prices are still way above their real value, and the only way out of the crisis is to face the cold, hard reality that companies are worth probably only half of what they are trading for today.

as of december, the standard & poors p/e （市盈率） has travelled back to its long term average, so you hear people saying that therefore the worst is over now. a look at the graph tells you that cannot possibly be true, because after you have soared way above a long term average for the last 20 years, you need to dive way below it, and stay there for a while, usually in the range of 5 to 10. add to this that corporate profits are in free fall, and a 50% discount on today's prices might even be considered not that bad.


the evidence is all around us, although, as friedman puts it, the american government and the banks are too scared to admit it. one of the reasons why bank of america needed yet more bail-out money, is obviously because last september they were forced to buy merrill lynch at usd 50bn, a whopping 70% premium over what the company was worth according to the stock market the day before. that price had nothing to do with the real value of merrill lynch, and everything with the hope that a high transaction price would calm the market.

friedman's suggestion is for obama to call all ceo's of the banks together in his office, and tell them that their balance sheets have been reviewed, given a fair value, and following that they will be either nationalized, merged, or shut down.

that would be an unprecedented move in the history of capital markets, forcing the values of financial companies dramatically down, with lasting consequences. these are unprecedented times though, and the road we are on now doesn't seem to be leading us out of the woods.