No Speculators Allowed

Storage Wars is a great show about capitalism. I love it!

Storage WarsThe premise of the show is that buyers  bid on storage units that have been foreclosed. The people who originally owned the storage units have gone into arrears and are no longer able to pay for the units.

The show is really a glimpse into the dark underside of the housing crash. What we get to witness is the complete liquidation of ones person’s life and all of their possessions. During the housing crash, when foreclosures were rampant, owners moved their possessions into storage units in the hopes of reclaiming their assets once the economy improved.

But that never happened. The storage owners eventually gave up on paying for their personal belongings and left their property for the storage companies to liquidate.

The liquidation starts when the  auctioneer opens the unit and allows the buyers to peer into the units. Inspection of the goods and opening the boxes to verify the items worth is not permitted.  Bidders can look but cannot touch. So, for example,  if there is a safe in the unit, the buyer can not inspect the contents of the safe. There might be millions of dollars inside…or nothing.

Before the auction, the buyers take a quick scan and gauge if the unit owners may have money.  The presence of a piano  might signal that the family had money and, therefore, that the unopened boxes might have value. To the contrary, a unit with Tupperware lying around might be a signal that the person was from a middle class or poor background. Sometimes the signals are correct; other times they can throw the bidder off where he or she ends up paying too much for a unit.

Needless to say, the show is fascinating because the information is imperfect and even the best of buyers make mistakes.

The storage buyers are essentially like vultures picking at the last remnants of a rotting carcass… sucking off the last bits of flesh at the bone. The auction is a total liquidation of someone’s tragedy. The show is both beautiful and tragic. The tragedy in the liquidation. The beauty is the creation of new wealth.

In some cases bid winners of the units have founds gold coins, memorable collectibles and jewelry. Other times the boxes might contain worthless clothes, pictures and housewares with no value.

The second part of the show, equally fascinating, is when the buyers of the units then go to get their newly acquired items valued and sold. It can be a crap shoot as a seemingly simple item can be turn out to have significant value.. In one show, one of the shows stars liquidated a box of yo-yos for over $2,000 dollars.

A typical transaction involving valuation might go as follows:

  • Storage owner: How much is the piece worth?
  • Appraiser: Given the condition and the uniqueness of the item, I would value it at $500.
  • Storage owner: $500 wow , that is  a lot higher than I thought. Great I would like to sell it.
  • Appraiser: I agree the item is worth $500 but I can only pay you $250 for it.
  • Storage Owner: $250, that seems low you just told me it was worth $500
  • Appraiser: It is worth $500 but I can only pay $250. I need to make a profit on this transaction. I will be taking the risk of storing it and marketing it and if I don’t sell it I am out the full amount.
  • Storage owner. Fair enough, sold.

The show is very instructive. It shows that both parties need to make money in order for the transaction to be successful. If the appraiser can not make any money on the transaction, he will not buy the item.

Which leads me to something very interesting that is happening in the bond market that is halting the trading flow and liquidity of bonds.

Around 10 years ago the bond market was, for the most part, unregulated. Trades were negotiated between buyers and sellers. On any  given day a bond could trade with a variance of 5 points or more. In addition, the trades did not have to be reported right away. Consequently, there was always an element of price discovery that took place in pricing up the security correctly. Significant variations in price could have been the result of liquidity, risk or straight greed.

Given the variance of prices, fund managers and the regulators got upset. They felt it was unfair to have such huge price variances in the market so they came up with a system called TRACE, whereby all of the prices of the trades had to be reported immediately. Now when a trade takes place everybody knows what the price is immediately. Fund mangers and regulators are now happy because there is much less variance in bond prices.

But there has been a downside to all of this: less trading. Even though the market has perfect information, trading has come to a halt. Perfect information has taken away the need to speculate.

A typical transaction now looks like this:

Fund Manger: I need a bid on 50 million Brazil 5 year bonds.

Trader: I can pay you 99.5 for those bonds

Fund Manager: The bonds last traded were just reported at 100.10 and I want to sell there.

Trader: If I pay you 100.10, I can’t make any money. Once the trade gets reported, the market will now know that there is a trader who now has to sell 50 million of these bonds and they will move the prices lower. So I will be taking a risk and need to be paid for doing so.

Fund Manger: I can’t sell at 99.5 because my boss will want to know why I am selling 60 cents below the market and he will not authorize the trade.

Trader: O.K. No trade.

This conversation is happening all over the world each and every day. Most people could care less about the world bond markets, but they should! It affects and touches all areas of our lives. Bond markets affect the rates we pay on credit cards, home loans, car loans and more.

The government has interfered and determined that if given perfect information, the market players would trade more. But the opposite has happened. They are doing no business. As less and less trading takes place, bond funds are full of positions they cannot sell and are growing more and more bloated. There will come a time when there will be a need to liquidate these excesses.  As it stands right now there is no mechanism for doing so.

Storage units liquidations  are a great example of the free market clearing out excesses and allocating capital and resources to the people best suited for it. But what the government is creating in the bond market by not allowing bonds to clear at a level where both parties can make money is creating a problem that will result in an even bigger crisis than the one we last went through.