Loose Ends... Vol. XII

It was a wild ride across the world in the equity markets. It was hard to miss the news of the crash in the U.S. this week, but we were not alone. The chart below summarizes the week that was for the major stock indices of countries around the world. (Compiled using Yahoo! Finance.)

This results in severe losses for those who participate in the markets. This includes your 401(k), pension plans, and the small investments of people across the country (and world). But, it also includes major institutional investors, investment bankers and speculators. It really doesn't matter who are the biggest losers. It signals significant problems with the fundamentals of economies around the world.

Why would we see such a fall? Let's go back to the basics for a second. Owning a stock is owning a share of the company. The price of the stock is essentially an attempt at pricing the value of the company. The price of the stock multiplied by the number of shares outstanding places a price or value on the entire company (this is called the market capitalization). So, a decreasing stock price indicates a decrease in the overall value of the company. This can be caused by numerous factors. Two important factors are determined by the two key financial statements of a company: the balance sheet and the income statement (or P&L). The balance sheet looks at a company's assets and liabilities (debts). The income statement summarizes the profits for a company. If a company is overwhelmed with debt (as many are experiencing) or is expected to have a reduction in profits (perhaps due to a recession), the valuation should decrease.

This is clearly an oversimplification of the way the markets work, and, as such, an oversimplification of what happened last week. But, the increased risk of debt and the fear of an overall economic slowdown are the two basic reasons (in my opinion) that we had the crash.

As a result, the world's economic leaders met in Washington to work on solutions to the problems. The joint press release from the G7 leaders with their action plan can be read here. Henry Paulson's statement following the meeting can be found here.

This week I hope to get around to the next installment on the Fannie and Freddie rescue. I've also been continuing my reading of Ludwig von Mises. Our laptop is back - it seems to be working - but we are going to install a new operating system. So, once that's taken care of, I hope to increase the frequency of new posts. Until then...