Friday, March 06, 2009

Confederate Currency

Let me get this straight:

Stocks are pieces of ownership in a company. Stocks have value because a company makes profits for stockholders. The better a company is, the more profit a stock makes. The more profit a stock makes, the more valuable the stock is, which raises the prices of the stock as value increases and scarcity drives up the price.

Because of that scarcity, a whole industry sprang up trading these stocks. Once that happened, the prices of stocks began to fluctuate in more extreme ways than the actual value of a stock based on the piece of ownership it represented, or the interest generated on that piece of ownership’s returns.

Because of that fluctuation, money could be made by a stock without the company actually producing anything or providing any service. (And they say Socialists are utopian….)

Because a rational person tends to maximize their wealth potential for personal financial security, putting money into stocks seems a fine investment idea. Retirements, homes and children’s college tuition can be paid in such ways, as the money a rational person earns with their job can now be employed making additional money. Wealth is created, new businesses are created using that wealth, more people get jobs, more people have money to invest in new stocks created by new business, creating more wealth. This is a good thing.

Expanding liberty in our society means that more and more people can participate in wealth creation. This is also a good thing.

Unfortunately, the people who ran the companies that stocks represented were also paid in company stock. Because of this, increasing the value of those stocks, now based more on the “stock market” value than on goods the company actually produced or services the company actually provided, became a higher priority than producing goods or providing services. This is a bad thing.

With less emphasis on goods and services, consumers bought less goods and services from the companies. The company stock made less profit. The less profit a stock makes, the less actual value it has. The remaining value is only a trick of the market. This is a very bad thing.

To keep values up, the people who ran the companies made up stories about how much money the company had and how much money the company would make in the future. The people who reported on the companies and on the stock market did not investigate the actual value of stocks. Rational people believed these experts, and kept putting their money in the stock market because experts said stocks were worth thus and such. This went on for many, many years, and was very, very bad.

Rational people began to realize that the companies’ stock values were a trick of the market. But the people who ran the companies and the people who reported on the companies and on the stock market kept telling the people that everything was OK. As the housing market collapsed and financial institutions began to fail, we heard the talking: The fundamentals of the economy are sound. There is no recession. Lehman Bros. is no Bear Stearns. Bank of America is overcapitalized. Buy, buy, buy.

And then the rational people realized that the companies and the business media had been whistlin’ Dixie for years, and that stocks were overvalued. Remember, the market fluctuates more extremely than the actual companies are worth. Rational people were now frightened because the owned stock in companies that didn’t produce goods or provide services. They tried to sell, sell, sell. The value of stocks plummeted and continued to go down.

Like the boy who cried wolf, no one believes the companies or the business media anymore.

Why should we? The first group got us here, and the second group never warned us what was coming.

All I’ve heard them do this week is blame our new President for the mess we’re in. At least they still have balls, if not credibility or expertise.

They’ve been on the job for years and are the reason the stock market is sagging. They could have taken some responsibility, did their jobs and worked on righting this ship years ago. But they loved their kool-aid more than the most fervent Obama supporter.

We're out to save the free market folks, and once that's handled, the 'invisible hand' will put the stock market back where it needs to be.

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6 comments:

Dante said...

If stocks were valued at what a business actually produced, there would be absolutely no reason to buy and sell stock in the first place. Stocks are sold to attract market capitalization. Business need money to grow and one of the ways they get that money for growth is to sell off a piece of the ownership. Making things "right" will make the entire market irrelevant for it's intended purpose.

"Unfortunately, the people who ran the companies that stocks represented were also paid in company stock."

But that's been the case for generations. What's different now is that it's in a company's best interest to avoid actually giving business executives actual money or anything that can have a taxable valuation. You can thank Clinton tax code for that.

Since the job market dictates that an executive is worth a certain amount and a business is penalized for actually paying them that amount, they find ways around it. A very very popular one is the stock option. A stock option has absolutely no value. It's a promise that when the value of the stock hits X amount, the holder of the option can take the specified amount in stock or in cash. It drew in executives without facing tax penalties. But it also made executives value the stock price as much or more than the company's actual financial shape.

But THAT has been happening for years and isn't the whole reason we're in this mess. The in-a-nutshell reason is that we spent more than we made and we did it borrowing money we didn't have. No, Obama didn't cause that. But he sure as hell isn't helping things any. The stock market needs investors to survive. Investors live off of buying low and selling high. The President of our country telling us things are going to get much worse just so he can pass legislation allowing the government to spend like a drunken sailor is giving a lot of new and recently-burned investors the idea that maybe they should hold off a bit to get back in the game.

This country needs optimism and hope. Those were things that Obama was supposed to bring to the table. I guess he will as long as they don't get in the way of his political agenda.

Cousin Pat from Georgia said...

If stocks were valued at what a business actually produced, there would be absolutely no reason to buy and sell stock in the first place.

Stocks can have value more than that of the actual company, based on projected profits that share of ownership is expected to bring. Scarcity of such a stock will also increase price, and these are all good things, so long as the stock value is at least nominally based on reality.

But there have to be controls over how manic stock value is, as our economy suffers when stocks become too overvalued (where we were) or too undervalued (where we are). The most effective way to control that is to have authenticity in business reports, robust market watchdogs, and credible investigative journalism surrounding the business world.

If you didn't notice, all three of those controls have taken a pass for several years. With no one to accurately report on what business has been doing, they've been able to get away with all the practices that led us here. Confidence in the market derives more from credibility than on Presidential policies because stock value is usually worth more than the real value.

It takes faith and trust to invest in something overvalued. Remove that faith and trust, and you get a DJIA hovering around 6000.

Dante said...

"With no one to accurately report on what business has been doing, they've been able to get away with all the practices that led us here."

If that were entirely true, then the market would've hit 6000 when Enron went tits up. It does take faith and trust to keep the market going but faith and trust in business reporting isn't any more damaged now than it was back when the market was hitting 14,000.

Cousin Pat from Georgia said...

Enron was just one business, and that could be blamed on one small group of people. That's where things were limited.

The situation now is that so many major institutions failed, are about to fail, or have admitted they aren't all they're cracked up to be - and it all happened in the same year.

That is crushing to stockholders, because, even if they were highly diversified, they took a huge hit. And this is after all the experts and analysts have been telling everyone that things were safe for months and months and months.

Dante said...

"The situation now is that so many major institutions failed, are about to fail, or have admitted they aren't all they're cracked up to be - and it all happened in the same year."
...
"The most effective way to control that is to have authenticity in business reports, robust market watchdogs, and credible investigative journalism surrounding the business world."

Yeah, it hurts that a lot of businesses are failing at once but you're trying to paint this as companies being dishonest and misleading the investors. Leaving out the true fraud cases like Enron, that's pretty far from the truth. These companies that are failing now were living by the same forecasts and projections they were showing to investors. They were wrong but it's not like the companies were out there saying one thing and doing another.

I guess what I really don't get is what exactly do you propose we do? Nobody lied on their SEC filings. The reporting was rock solid. It's the forecasting that failed them. The numbers were all there to see. Investors did a poor job of interpreting those numbers but so did the businesses themselves. Are you proposing we inject the forecasting opinions of financial analysts into the filings? If so, which analysts and why? Are you proposing we limit the market cap of a stock? If so, to what and why? Are you proposing we limit the speech of independent financial analyst? Are you proposing we limit the speech of company representatives who are acting foolishly but in good faith?

It's easy to say we need more regulation but unless I'm missing something, the Securities and Exchange Commission already has the reporting in place that you're asking for here. And in those reports are all of the tools a watchdog group or investigative journalist would need as long as the company is not breaking the law, which is pretty rare.

Cousin Pat from Georgia said...

So everyone used the wrong forecasts, all believed the same wrong stuff, and no one could tell that a contraction was coming?

This still doesn't refute that the managers, investors, regulators and experts have no credibility left - especially if they're excuse is "we didn't know."

And I don't buy that there wasn't an effort to mislead folks. There may not have been any malicious intent (on the parts of those businesses not convicted of fraud), but you don't get bubbles with robust discussion of pros and cons. I'm sure there were warning signs that were ignored or downplayed on our way here.

And I'm not proposing caps or cherry picking analysts. You can't blame people for trying to make as much money as possible. But you can't overstate the importance of the stock market, you can't confuse the stock market with the free market, and you can't tell me to listen to folks who have zero credibility when they say President Obama is to blame for the stock market.

Sorry.