If a non-market price falls in value does it make a sound?

Do markets even set prices anymore..

Photo by Andy Mai on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter that does not shy away from the big questions we don’t want to face, but must answer. And is also willing to answer the easy questions too.

The existential question of our time

Can a non-market price be in a bubble? Can any price truly be in a bubble? Not really. Not if you define a bubble as a price that is too high and destined to fall, timing such events is impossible. But I digress. The question we face today is: can an asset that lacks an objective price and is entirely subjective, like a private equity valuation, be overvalued?

It seems like something is off in the market. The sheer volume of capital that flowed into private markets—the result of low rates, various regulations, and a lack of accountability—is a recipe for disaster, and it went on for about fifteen years.

Now it seems many funds lost money. The LPs, counting on those phantom returns all these years, will be disappointed when they finally are paid out—or never paid out. Many pension funds and endowments already are in trouble. Their money is locked up in “zombie funds” that will never pay off. Not a good sign.

I knew I'd seen enough when I met yet another 25-year-old paid nearly half a million dollars for work in private equity. I don’t doubt their talent or how hard they work, but unless you are an athlete or a pop star, few people have skills that valuable at that age. It reminds me of 2007 when everyone in New York had a nebulous-sounding job in finance that paid them a silly amount of money. It suggested that the industry was due for a correction, and it was.

I blame public pension accounting—it always comes down to that. It violates the basic principles of finance by discounting liabilities at the expected rate of return of the invested assets. It makes no sense and creates an incentive for pensions to chase illiquid investments that promise high returns, which are not realized until decades later, while ignoring risk. This created a significant distortion, and now we are paying the price.

The other question: what kind of damage will it cause?

It won’t pop like a market bubble and cause a crash. The illiquidity means the LPs can’t suddenly pull out their money (secondary markets are growing but still not that big or transparent). The result will be more like a slow bleed and a misallocation of capital. The industry will shrink, which is probably not a bad thing.

One reader wrote to me, concerned that LPs will need to pull their money out of public markets to make up for their zombie PE funds, which could destabilize the broader economy too.

In any case, I don’t think we’ll learn the right lessons.

Clearly a bad idea

PE is not all bad. Right-sized and with the right incentives, I think it can fulfill an important role in the economy. On that note, I wrote about the Democrat’s national rent control plan. I assume it is now the Harris plan. Because, I swear, neither party is giving the economically literate much to work with. The plan will discourage new construction, even with the carve-out for new buildings—because national rent control will be a thing. Who would make such an investment knowing your upside is capped by regulation?

It seems part of the motivation is to target PE-owned residential real estate—the new economic boogeyman. We like to romanticize small landlords who are willing to take a loss and charge cheap rent because they care, but that is rarely the reality. The presence of PE money in residential real estate feels offensive, especially if they—gasp—charge as much as they can for a unit. However, the high rents are a symptom of constrained housing supply, not the cause. In fact, PE-backed real estate might even improve housing markets. If the market functioned better and there weren't such significant constraints on multi-family zoning, PE could be beneficial. The funds can diversify across geographies and achieve economies of scale, potentially leading to lower rents in high-cost areas.

While they are at it, the administration is also going after grocery prices, demanding food sellers lower prices too—even if inflation on food-at-home is near 0. I suppose they are trying to finally address the public’s unhappiness with inflation. It is not only a day late and a dollar short—it is just bad economics. Price controls?! Really. I thought people knew better.

It’s not all Democrats—somehow the no taxes on tips is actually becoming a thing. People are talking about it, and there is even legislation. Soon, we might all be paid in tips—even for jobs like asset management.

This is what happens when a degree from Yale Law is what qualifies you to run the economy—and not a single economics class.

You can save too much for retirement

I recently gave some controversial advice to a young colleague. She admitted she had not signed up for her 401(k). She was nervous about locking up her money for so long while living paycheck to paycheck, despite the company's generous match. She dealt with it the way many of us do with difficult financial decisions—avoidance.

I insisted we sit down and sign up together. As a retirement economist, I am full of good advice. But when we got to the contribution rate, things got complicated. Given her liquidity constraints, I suggested she contribute what she felt comfortable with. Everyone in earshot was horrified. The full match required a very high contribution rate, and a golden rule of personal finance is never to leave the match on the table.

I mostly agree, but if it's a choice between that and having to take a payday loan, I am not so sure. Life-cycle finance (the economics I subscribe to) is not about having as much money as possible at the end; it's about consistent and reliable consumption throughout your lifetime. If you need to live with your parents to get the full match (even if that is a thing these days), maybe it is okay to leave a little money on the table—even if it compounds tax-free.

Until next time, Pension Geeks!

Allison