Liquidity and the Sociology of Knowledge: “How To Value” Toxic Assets

How do we know what an asset is worth? I want to argue that, societally, we have decided that there is one best answer to this question: the market price*. Unfortunately for us, the market price can only work as measure of value when certain felicity conditions are met. Namely, the market must be functioning ‘smoothly’ or ‘normally’ or with sufficient liquidity (I am being a bit vague here on purpose). Carruthers and Stinchcombe (1999) wrote an article arguing that liquidity is “an issue in the sociology of knowledge”. Carruthers and Stinchcombe argue that we can only think about markets and liquidity once goods have been standardized – that is, there cannot be a market for truly heterogeneous goods, because the price of one gives us no information about the value of the others**.

Why this little digression on markets and felicity conditions? I was watching last Thursday’s Daily Show when the guest, the author of a recent book on the collapse of Bear Stearns, made a common enough argument: that we no longer know “how to value” toxic assets. What interested me was the difference between knowing the value of something and knowing “how to” value it (a difference the guest did not discuss much). As a society, we still know how to value anything: just look at its current market price. The problem with toxic assets is that the felicity conditions for the market no longer hold. That is, we no longer see the market for such assets (which exists, even if there are relatively few trades) as sufficient. It’s not simply that fewer people are trading, but rather, we’ve lost faith in the tools that we used to make such assets “hold together” (cf. Desrosieres). The bond rating agencies and the quantitative magicians that successfully built homogeneous assets no longer can do so, and thus purchases of specific assets no longer constitute a market.

So, to return to my earlier point, do we not know how to value these assets or do we simply not know their value? I think, perhaps, we do not even know what these assets are. That is, we have a failure in our practical ontology. Things that were treated as the same, that held together, have since fallen apart. If there were simply a decline in the number of transactions, a government agency could step in and start buying up assets (as has been attempted or proposed several times since the middle of 2008, e.g. the original TARP proposal). But if the problem is not just one of # of transactions, but rather liquidity in the Carruthers and Stinchcombe sense of information from one transaction being useful to understand the value of another potential transaction because the two goods are commensurable/homogeneous, then simply upping the number of transactions cannot help. If we want to rebuild our knowledge about the value of currently toxic assets, we first have to rebuild the homogeneity of those assets. But I’m not sure we actually want to do that – these assets failed to hold together (counterperformed?) in a spectacular way once already. Does that make sense?

There’s a larger issue here that I’m having trouble nailing down into words, but I’ll give it a go. There are some preconditions about stability over time that we need to make our current economic arrangements functional. For example, we often discuss inflation expectations and (related) expectations about interest rates. If bankers believe that there will be large shifts in inflation rates or interest rates, they may become incredibly reticent to loan out money. This can, in turn, create some of the conditions they feared***. But I wonder if the same kind of reasoning (although not necessarily the same kind of self-fulfilling loop) holds for other aspects of our economic system. For example, if 20 years ago you began to work at Ford, thinking that your skills as a factory worker would be sufficient to get you through life, and today you are laid off, what do you do? How do teenagers or young adults right now decide what skills to invest in, given the rapid pace of change witnessed in their lifetimes? When change (another semi-purposefully vague term here) happens at a pace significantly faster than generational, how do we adapt? It’s one thing for a company to close down because it made a bad bet as to how technology and society were going to move (in terms of capacities or preferences), but how do you deal with entire segments of the population who made similarly reasonable, but ultimately infelicitous, bets about the future?

For starters, we’re going to need a bigger welfare state

* I think of this as constituting a “market epistemology”, a term I think I coined, though apparently Da Costa uses the term “market episteme” in a 2007 article sitting on my desk waiting to be read. I want the term to capture stories like the one Porter (1995) tells about how the Army Corps of Engineers in the US always uses a market price for an input whenever one can be found, because those numbers seem somehow less arbitrary or more valid. I am working on telling a similar story with regards to the national income accounts and debates over how to value non-market labor. [EDIT: An alert reader reminds me that GFE. According to google scholar, about a dozen articles have used the term in one way or another. Oh well, just another story of academic convergent evolution.

** I am reminded here of Peter Levin’s interesting discussion of “Markets 2.0” in a vaguely recent blog post, incidentally written on my birthday last year.

*** This post was also inspired in part by the recent post on SocFinance about performativity, self-fulfilling prophecies and the idea of “economic fundamentals”. The whole idea of economic fundamentals is fascinating to me – why do choose to enshrine certain arrangements as “fundamental” while others are more contingent or risky? There has to be some idea of ‘fixed-ness’ across time to those things we name as fundamental. But, at a deeper level, those fundamentals are built on things like preferences and technology, which are very malleable over the short and long term. But, in order to make the whole system work right now, we seem to want to recast some of the malleable, social underpinnings of the economy as fundamental. That works well enough if the timespan of changes is long enough, and gradual enough, as it has mostly been. But that need not continue. So, I think we need to inquire into what makes something an “economic fundamental” and whether our current set of fundamentals will work well into the future as foundations for an economic system.



  1. Mark

     /  April 12, 2009

    Interesting discussion! That paper by Carruthers-Stinchombe should be read widely by people involved with the financial crisis. I keep hearing people on tv and in newspapers, and even in economics blogs, misusing the word. Sometimes liquidity even becomes synonomous with money itself, as in the more money we print the more liquidity we have. You cannot read that C&S piece and make such a mistake.

  2. Natalie

     /  April 12, 2009

    I think you’re making more “thingness” of value than even many practitioners do. For example, mergers & acquisition professionals all know that there is no one true “value” of anything that is complex — the value of an asset really varies depending on who you are and what you can do with that asset (that other people can’t). That’s especially why the concept of “synergies” matters a whole lot in valuation for mergers & acquisitions. These professionals all have a variety of valuation tools at their disposal to come to an appropriate value for an asset — and especially because those tools come up with *different* values, plenty of folks would admit there’s some art in it, and lots of guessing. Hence, the perspective has always been on valuation tools (the “how to”, as you put it).

    So, the fact that “market value” is considered a gold standard of sorts (and therefore a default) supports your inquiry into where this concept came from and how it’s become entrenched. I’d just warn against assuming that everyone thinks it’s the holy grail or a singular thing.

    You could take a valuation class in the MBA curriculum, BTW — that may help illuminate some of the differences between practitioner and economist perspectives. Economics may have primacy in our current world (and I know that’s what your emphasis is on studying), but that doesn’t mean that business professionals have adopted the economistic perspective in its entirety 😉

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