The price of everything, in flux

(Fortune Magazine) -- "No one knows what anything is worth." Lately I've heard that from lots of people. We're in one of those odd periods when things feel unmoored.

Six months ago you knew, or at least you thought you knew, what your house would sell for. Now you probably don't. The bond market is quaking with fear about the credit crisis, while the stock market is saying rock on.

"Either U.S. economic conditions are really not that bad after all, or investors are suffering from a collective attack of wishful thinking," Martin Barnes, editor of the Bank Credit Analyst, wrote recently.

Valuation is supposed to be a science, sort of, but there are times when it feels more like a demented form of multivariable calculus. Bond guru Bill Gross of Pimco recently wrote that "the modern financial complex has morphed into something unrecognizable to many astute market veterans and academics."

But while you may not be able to analyze the price of a security right now, you can at least analyze the insecurity.

The first issue is that the nationwide decline in home prices that wasn't supposed to happen -- even Alan Greenspan said he didn't expect it -- and there's no historical precedent for it. Pros like Steven Romick, who heads the FPA Crescent Fund, look to the past for lessons.

After 9/11, for instance, Romick studied how Israel's economy coped with the threat of terrorism. But he says home prices haven't fallen nationwide (in nominal terms) since the 1930s.

Another issue is that our homes are assets with two dangerous traits: They are laden with emotion, and they are illiquid. While you could sell a share of IBM (Charts, Fortune 500) today, you probably couldn't sell the roof over your head in a day, or maybe even a year.

The inventory of unsold and new homes is still extremely high, which suggests that a "clearing price" -- a price that buyers and sellers agree upon -- has yet to be found. It's hard to feel secure when your feet can't touch the bottom.

But the scariest thing is that today the price of every asset -- houses, stocks, and bonds -- seems to rest on a foundation that looks increasingly shaky. David Wyss, the chief economist at S&P, puts the losses from the subprime meltdown at around $150 billion, a manageable figure in and of itself. But the subprime crisis was like a termite coming out of the wall. It made everyone start worrying that there were deeper problems.

In the past few years, there's been an explosion of what the Street calls "structured credit" -- everything from mortgages to loans used to finance LBOs was carved up into exotic new securities and sold to buyers who didn't understand what they were purchasing. (For a close look at one such security, see Junk mortgages under the microscope.)

Now it turns out that Wall Street didn't understand its own mad, tangled creations either. A Bank of England official called the tests that financial firms used to measure the risk of these new products "completely hopeless." Firms from Citigroup (Charts, Fortune 500) to Merrill Lynch (Charts, Fortune 500) have declared multibillion-dollar write-downs due to losses on these products. And they're still guessing.

In August a Morgan Stanley (Charts, Fortune 500) equity analyst recommended that investors buy the stock of insurer Ambac, which guarantees the payment on billions of dollars of bonds backed by subprime mortgages. A Morgan Stanley fixed-income trader promptly fired off an e-mail calling the recommendation "absurd." "My analyst has no idea how to value" the securities Ambac guarantees, he wrote. "No one in the world can put a definitive view on recovery levels" for some of these bonds.

The subprime crisis was also the first visible sign of a weird inversion that took place during the past few years. Instead of the value of an asset dictating the amount of debt you could use to purchase it, the availability of the financing began to dictate the price of the asset.

In 2004 even the Federal Reserve Bank of New York argued that a chunk of the increase in house prices was justified by the easing of lending standards. "The price exists at the pleasure of the financing," is how one hedge fund manager put it to me recently. "That is true for stocks and houses and bonds and buyouts." But if the financing doesn't exist, or only maybe exists, then how do you determine price?

In early October a Craigslist posting, in which a self-described "spectacularly beautiful 25-year-old girl" asked for advice on meeting a man who made at least $500,000, sparked a raging debate on how you measure the value of a man or a woman.

How appropriate.