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In praise of equity

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By Sell on News, a macro equities analyst. Cross posted from MacroBusiness.

The stock market fate of Facebook has focused attention on the state of the public equity markets. Already, the company is being sued for allegedly misleading investors about the state of its business. There is much hand wringing about the problems of being publicly listed — the onerous burden of regulation, the public scrutiny, the short termism of professional investors. It’s not easy being a billionaire these days. Chief amongst the hand wringers is The Economist, which ran a cover story on the demise of the public company. And there is certainly evidence of a problem:

The number of public companies has fallen dramatically over the past decade—by 38% in America since 1997 and 48% in Britain. The number of initial public offerings (IPOs) in America has declined from an average of 311 a year in 1980-2000 to 99 a year in 2001-11. Small companies, those with annual sales of less than $50m before their IPOs—have been hardest hit. In 1980-2000 an average of 165 small companies undertook IPOs in America each year. In 2001-09 that number fell to 30. Facebook will probably give the IPO market a temporary boost—several other companies are queuing up to follow its lead—but they will do little to offset the long-term decline.

This has probably had a lot to do with the poor returns in global stock markets in the wake of the GFC, but The Economist is entirely correct to be worried. The reasons given for the concern are that public companies create jobs, they “let in daylight” and they allow the public to invest in companies. I would add two others. First, big stock markets tend to distribute economic power. This is more of a political point, but in countries with large stock markets, the extremely rich are not as powerful. Gina Rinehart may be the world’s richest woman at $29 billion. It sounds a lot. But compare that with the ASX $1.4 trillion of public companies. It is drawfed by BHP’s $160 billion market capitalisation, or Rio’s $100 billion. That works against the concentration of power that extreme wealth can catalyse. In countries in South America, for instance, there is no such counterbalance and rich families have a much greater influence. This is not to argue that it is democratic or shares power; it patently does not. The owners, superannuants, usually don’t even know what they own. But it is a useful limit.

Second, public stock markets, and to a lesser extent bond markets, can be re-priced in a way that bank debt cannot. Big swings in share prices act like a shock absorber when there is a financial crisis. Bonds can also be repriced, although because debt has to repaid the shock absorber effect is less pronounced.

Banks, on the other hand, are extremely vulnerable to repricing. They only have to have a small number of defaults on their loan book for it to result in collapse. So when economies largely depend on bank debt, they are far more vulnerable to financial crises than countries that have a balance between bonds and equities. In America Japan, the balance between bonds, equities and bank deposits is about equal. In Europe, there are smaller stock markets and more bonds, but there is a reasonable balance.

In Asia (ex-Japan), there is a heavy bias towards bank debt. So much so, McKinsey is anticipating a $12.3 trillion “equity gap” in Asia by the end of the decade.

What exactly an equity “gap” is remains problematic, because it must be based on some notion of what is a “normal” capital structure. But the trend is clear. Too many economies are becoming too dependent on bank finance, and with out of control derivatives markets, that is extremely dangerous. GFC-style problems are far more likely in economies dependent on banks than economies with more balanced structures.

To a large extent, big equity markets are an English language phenomenon. I would love to know why, so if any readers out there have any references please tell me. It is doubly strange given that the bourse was largely a French idea. It seems to be linked to non-conformist groups in the north of England during the rapid period of industrialisation in the nineteenth century: mutual funds such as Manchester Unity which invested in shares. Australia was an early entrant with its innovations in health funds. Of course, many of those non-conformists went to America, perhaps taking the practice with them. But that is a very sketchy guess; its historical origins are worth studying closely

Given the importance of equity markets to healthy financial system, aggressive efforts should be made to protect them against the hordes of meta-money marauders: locusts such as high frequency traders, and derivatives players who are doing an excellent job of destroying the purpose of equity markets, which is to raise capital to fund businesses in the medium to long term for the benefit of shareholders. The whole purpose of such a process is to differentiate between the companies based on the nature of their business. The algorithms used by HFT traders make no distinction between any company or asset class, they are entirely generic.

The problems associated with activities such as short selling are harder to define; prima facie short selling seems a reasonable form of price discovery. But is much lost when it is prevented from happening? After all, if you don’t like the stock, sell it. If the point if equity markets is to fund business, rather than reward clever financial plays, then it seems reasonable to enforce that by discouraging financial trickery.

The argument given in favour of HFT and other forms of meta money activity on the stock market is usually that it increases “liquidity”. This is circular. It can be restated as: “The more trades there are, the more trades there are.” I know such tautologies are popular in economics and finance, but please. Surely regulators can see through such absurdities. The point is: “What should the trades be for?”

Many big corporations are trying to find ways to defend themselves against the meta money marauders, especially the high frequency traders. But it is probably a losing battle, and the attractions of going private will increase. Given that equity markets provide much needed redundancy in financial markets — a redundancy that will be needed more and more — it is a cause of real concern. The meta money parasites will eventually end up destroying the host.

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65 comments

  1. addicted

    While I understand the benefits of equity markets, the reality, it seems to me, is that the need to grow every quarter (in order for the CEO to keep their jobs) has meant that public companies are severely mismanaged compared to their private brethren, at least from a long term perspective.

    Until we eliminate “increasing shareholder value” as the primary guiding principle of a public firm, I am not so sure public firms serve society very well.

    1. Chris Rogers

      I agree,

      Quarterly reporting far from aiding transparency has had the perverse effect of driving a very narrow set of values, i.e., growing the stock price above the longterm viability of a listed entity.

      Indeed, it is short-termism as undertaken by numerous CEO’s that creates many of the egregious payouts for senior management, lack of R&D spending and mantra that all this is in the interests of the shareholders.

      When a company celebrates the fact that it can layoff its most valuable assets – this being the workforce – in the interest of maintaining high stock values by slight of accounting hand – one has troubles.

      Further, and given the present global crisis, alarm bells should be ringing when listed companies produce record profits from reduced sales – this may be great for the senior management, but its a disaster for the company itself – just look at HP to see where I’m coming from.

      1. addicted

        Funnily enough, HP was exactly the company that has led to this line of thought for me. As an HP fan, I was thrilled with the “revival” of HP under Mark Hurd, only to learn that it was the result of him basically gutting the soul of the company. They were simply forfeiting their future in favor of the present by gutting all investments which did not have immediate returns.

      2. Jim A

        somebody smarter than me once said “The only number that I believe is the one on the dividend check. Everything else is some degree of fiction.” What can be done to encourage a stock market whose prices are based on anticipated dividends(=investment) rather than price gains(=speculation)?

    2. F. Beard

      is that the need to grow every quarter (in order for the CEO to keep their jobs) addicted

      How much of that needed growth is due to interest the company has to pay?

    3. Art Eclectic

      I agree was well. This is one of the primary reasons I’m out of the market and staying there. There is no incentive to CEO’s for long-term planning and sound fiscal management.

      Between HFT and lack of strong corporate governance, these are dangerous waters for small retail investors to be swimming in. There are safter places to put your money and safer investments where you might not necessarily grow your wealth, but at least you’ll hang onto it long enough to enjoy it in retirement.

      1. Mark P.

        ‘Between HFT and lack of strong corporate governance, these are dangerous waters for small retail investors….’

        If anything, an understatement. The stock market became largely a Potemkin-type spectacle during 2009-2010, and remains highly manipulated today.

        Good, straightforward post, and it’s encouraging to see from the comments that there’s so much common sense about how obviously corrupted and manipulated the market has become.

        1. LucyLulu

          Is there anybody in the market anymore besides the institutional investors? I’m not, after 30-some years, of consistently better-than-average returns. I was always a buy ‘em and forget about em’ person, definitely not a winning strategy these days.

          It hasn’t always been like this. I don’t know what changed, never having delved more than superficially into the governance/politics of companies. Long-term profits used to be important and balance sheets used to have value outside of garden mulch. Twenty years ago, for two years we could buy stock options annually for 1/2 current share value at my ex’s company, with the stipulation that they couldn’t be sold for 1-5 years (20%/year). Both years I completely cleaned out our savings to buy them, after hubby told me not to, that we couldn’t afford to buy any stock. We had two young kids and not much money then. He was pretty pissed, but it was a well-run, well-capitalized insurance company (ever the good wife, I’d become well-versed in such topics as capital reserves, reinsurance, regulatory req., etc. from countless mandatory business functions), and I was sure the stock would go up. Six years later the company was purchased by Fortis, at $58/share, after I had sold half for $67/share on news of another buyout that fell through a couple months earlier. I bought the options for $3.50 and $4.50, and there was a 2 for 1 stock split prior to the company sale. That stock bought us a really nice house with acreage for our horses.

          There is a moral to the above story. That company was very well-run with an eye on the long-term future. One solution is to pay management a down-to-earth salary and for a bonus, perhaps a modest cash sum. Then, supply remaining compensation in equity shares, with a three or five year required holding period. I mean, who’d have ever thunk you could have your efforts recognized with a handsome bonus by running, not only the company, but the entire economy into the ground. Apparently, I’ve been working in the wrong industry. Heck, I was lucky to get a bonus even WITH a profit…. though one employer fittingly gave me a turkey every Christmas!

          Good post, Yves. The equity market is getting gutted. It’s not an investor-friendly place anymore. Not only is the market stacked against the investor, but the likes of Corzine and JPM are welcome to plunder investor accounts.

          1. LucyLulu

            I’m sorry! Got confused over who wrote which article. It should read “Good post, Lambert!!!” Quite thought-provoking. And with some guilt-eliciting comments.* :(

            *It’s not fair to assume everyone who has owned stocks is a member of the “elite” or 1% or trying to steal wealth from others.

    4. MacCruiskeen

      Short-term maximizing of value for shareholders frequently seems to lead to minimizing value for consumers and society at large. While there’s no guarantee that a privately-held company will be a better “corporate citizen” than a publicly held one, as a consumer it seems that on average, dealing with private companies is often a better experience. I guess it just depends on how vested the owners are in the operation of the business. If they are just a group of vultures who treat the business like a black box to extract wealth from, then it’s it’s not really any better.

  2. F. Beard

    Thanks for this post, Sell on News. I’ve bookmarked it. I’ve been saying for a long time that credit is the problem and that common stock is the solution to the private money problem. It’s nice to see some support. I especially enjoyed seeing this:

    First, big stock markets tend to distribute economic power. This is more of a political point, but in countries with large stock markets, the extremely rich are not as powerful. Gina Rinehart may be the world’s richest woman at $29 billion. It sounds a lot. But compare that with the ASX $1.4 trillion of public companies. It is drawfed by BHP’s $160 billion market capitalisation, or Rio’s $100 billion. That works against the concentration of power that extreme wealth can catalyse. In countries in South America, for instance, there is no such counterbalance and rich families have a much greater influence. Sell On News [emphasis added]

    Banks are unnecessary intermediaries between real capital, including labor. The common stock of a company can ITSELF serve as private money (How’s that for recursion?) and avoid the need the need for paying usury (Usury is ANY positive interest, let’s be clear, not just high interest.)

    As for this:

    This is not to argue that it is democratic or shares power; it patently does not. The owners, superannuants, usually don’t even know what they own. Sell on News

    That would be much less true if companies no longer have access to counterfeit money – so-called “credit”. Then it is likely that companies would be forced to issue far more common stock to finance themselves and even to promote their stock as private monies.

    1. Michael W

      You say: First, big stock markets tend to distribute economic power. You are correct, but all stock markets tend to distribute economic power and wealth upwards to the top few percent of wealthiest individuals. The last few decades clearly demonstrate this fact, unless you consider the sick concentration of wealth into the hands of a few realized over this recent period to be a co-inky-dink or a very convenient accident which, by some mysterious means, for decades has totally benefited the very wealthiest few.
      Morality and fair valuation of assets and distribution of wealth is used and implied in many places in this argument about market based economic organization of society and distribution wealth, and yet none of the preachers of corporate or market morality could really tell one exactly what is morality. Morality is comprised of human, social and spiritual values – none of which can be measured or described in terms of dollars. Morality has three positions: moral, one knows what it is and does it; immoral, one knows what it is and doesn’t do it; and amoral, one never considers morality in the first place.
      There can be no better example of amoral than one whose only value considered before decision or action is dollars.
      Corporations only, and single, value considered before action is dollars and therefore they have zero ability to act morally. This is why they must be carefully regulated by democratic national governments. Add to this their relatively recent ability to create ‘money’with the compliance and active help of Wall Street and too big to fail big international banks, which are also corporations and therefore amoral.
      The macro economic nonsense about the divinity and perfection of markets and ludicrously manipulated and totally non-representative “economic models” ( None of which are able to predict outcomes with anything approaching 100% accuracy more than a few weeks into the future; and are completely manipulated, make many un-publicized but convenient assumptions for the benefit of the financial and economic top few percent.)
      It has recently been revealed that the total dollar value of the derivatives which are about to become toilet paper is usd 200 billion. Are the supposedly ‘moral’ bankers and corporations whose owners have made many many billions going to pony up and pay for their 200 billion dollar mistake? Or will the supposedly perfect ‘market’ which has freed itself from any meaningful regulation actually take responsibility for its 200 billion dollar error? Please don’t hold your breath. Middle and lower economic class taxpayers (if not now then soon to be the only taxpayers) will be forced to pay for these losses and democratic governments will be forced to cut all socially beneficial programs and sell off public assets cheap to corporate (controlled by the economic top 1-2%) interests. The so called “invisible hand” isn’t invisible it is just corporate and therefore holier than God.

      1. skippy

        What you said…

        Squared and cubed like the 200T of vapor that goosed, the already fraudulent asset[?] valuations, and left the this plain of reality like a higson boggs particle.

        Skippy… well said Michael.

      2. F. Beard

        Add to this their relatively recent ability to create ‘money’ Michael W

        That is as old as double entry book keeping which goes back to the 13th century, if I recall.

        Also, the parts of my comment in italics are quotes from Sell on News.

    2. EconCCX

      >>(Usury is ANY positive interest, let’s be clear, not just high interest.) FBeard

      Usury should be thought of as the full cost of the use of money, including consumer fees and merchant fees…which are per transactional dollar rather than per annum, and make a mockery of low nominal or interbank interest rates.

  3. Conscience of a Conservative

    It’s not just high frequency traders. Share holder rights have been whitled away, such that investors no longer believe management is running the firm for their benefit. We see that in the dual class structures of Facebook and Google, and we see that in the lack of disclosure at MF Global and JP Morgan Chase. The boards work more for the benefit of the CEO than the stock holders and the auditors are not aggressive in making sure numbers and methodologies are questioned. Buying a stock is about being an owner of a firm, yet share-holders are all too often not thought of in that light.

    1. Art Eclectic

      When key players start referring to shareholders as “muppets” that really tells you all you need to know. I guess “rubes” was too transparent a term….

  4. burnside

    I suspect the global distribution of large bourses arose during periods of exploration and development. While the English-speaking world can hardly claim an exclusive purchase on imperialist aspirations, it’s distinguished to the extent its adventures were in large part privately funded. Earlier examples (and one or two contemporary ones) have been the pursuit of command economies, where the resulting growth has usually been initially brilliant, though not especially durable.

    It would be interesting to winkle out why.

  5. Tom Crowl

    Regarding the history:

    The whole idea of a ‘broad’ stock market with both many listings and many investors… is that (in modern terms) ‘crowd wisdom’ will result in better decisions than either mob rule or autocracy.

    Crowd wisdom is a concept based on the ‘independent-decision-maker”…

    So it is the product of a culture at least asserting democratic ideals of governance.

    Hence, such markets were more likely to develop in that sort of political environment.

    The ‘decay’ in equity markets may well be connected to decay in Enlightenment culture. In anthropological terms, I call this the Second Scaling Dilemma in human civilizations…

    The monsters-from-the-id dilemma:

    The first is the Altruism dilemma… which has to do with not only its roots in defining the boundary between in-group and out-group…. but perhaps even more significant the unavoidable gap between biological and intellectual altruism…

    Its essence lies can be summed up in this obvious truth:

    “Its natural to feel more emotionally upset by the death of a spouse or even your family dog than the death of thousands of people (or dogs) far away… no matter how intellectually altruistic we try to be.”

    While that statement is obvious… the implications are not…

    Issues in Scaling Civilization: The Altruism Problem

    The second is what I call “The-Monsters-from-the-Id” dilemma.

    Its a phenomena surrounding the truth that the rational mind evolved to serve the lizard-brain rather than the other way around.

    What it comes down to is that success breeds satisfaction and satisfaction promotes inertia and a desire to preserve the status-quo.

    In hunter-gatherer society there are no classes. So whether satisfied or not… they’re all subject to the same condition. If things are going well they have a big party and get lazy for a while… but if not they get humping since they’re all in the same boat.

    NOT SO with a scaled society… where one segment may be well-satisfied but another not… and that segment may be powerless to respond.

    The “will-to-power” has un-checked avenues available to it that are not there in a hunter-gatherer society.

    ( post on this is coming soon)

    And when all this pathology build up we get to the third dilemma:

    “ICT and the Ultimatum Game” which is about how technology and complexity make justice ever more imperative and dangerous to neglect.

    (also coming soon)

    But this recent paper by Freeman Dyson has relevance to that issue:

    Iterated Prisoner’s Dilemma contains strategies that dominate any evolutionary opponent

    More important than any particular form of representation used by governments… is the speech-related microtransaction and related P2P networking capabilities… such a transaction network has fundamental connection to the necessary scaling of influence, responsibility and the essential sense by both leaders and followers of a connection to consequences.

    I also believe this account forms a vital core for an evolving internet landscape and questions re ownership of user data.

    Stop making cows. Quit being calves.

  6. billwilson

    Interesting times:
    1. Rapid change (social and technological) means that in many cases I don’t know what a company will be doing in 5 years … so why should I pay 20 times earnings.
    2. Many new companies are of the hit/miss variety (a new drug, a new software program) where you need high upfront money to produce a product/service but if it does not work/catch on then it has a value of 0 (unlike say building a manufacturing plant, which would still have some value to another firm even if the original plans did not work).
    3. HFT is destroying the golden goose of the market. Combined with demographic changes (retirees pulling out money) we are seeing a move to wards the public leaving the equity market. The only ones left for HFT to scam are other HFT algorithms. No one with half a brain wants to go anywhere near these markets. (just computers trading with computers). One alternative would be to put in a transaction tax to increase trading costs and reduce the stupidity going on now, and encourage longer term holdings.
    4. We are seeing the decimation of middle sized companies – kind of a bi modal world – with either very large companies or much smaller niche ones. Any time a niche player starts to grow it is either bought by a bigger company or picked off by a private equity mob. It is symptomatic of our world which seems to be going bi modal. Even my professor friends say that the normal distribution of grades is being replaced with a bi modal distribution (either they get it … or they don’t).

    1. alex

      “Rapid change (social and technological) means that in many cases …”

      Rapid change is nothing new. We’ve had that since the 19th century. The Internet and cell phones are nothing compared to the upheaval caused by the introduction of railroads and the factory system.

      “Many new companies are of the hit/miss variety … where you need high upfront money to produce a product/service but if it does not work/catch on then it has a value of 0 (unlike say building a manufacturing plant, which would still have some value to another firm even if the original plans did not work).”

      The same was true of railroads, which got overbuilt by investing crazes in the 19th century and led to financial panics. Or the overbuilding of factory capacity in the 1920′s. The liquidation value of a radio factory in the Great Depression was close to zero.

      “HFT is destroying the golden goose of the market.”

      Agreed. It’s a scam practiced by a few well placed firms.

      “We are seeing the decimation of middle sized companies”

      Also true, and in many cases it can’t be explained by efficiencies of scale. For example, as Yves has stated, large banks are _less_ efficient than medium ones. The only “efficiencies” are concentrations of power, or in other words rent seeking.

  7. papicek

    I don’t know that stock markets distribute wealth much at all, while I can think of myriad ways they tend to absorb wealth. One man’s sell price is always another’s buy, after all, and wealth is “created” only when a transaction is completed and it may very well be that the net effect of even an up market is to absorb wealth created elsewhere.

    We know that wealth mined from equities goes disproportionately to those already wealthy, and indeed, this is a question with enormous political ramifications.

    I haven’t seen any data on the levels of capital available to the financial markets versus that available to Main Street businesses and to individuals, and exactly where all the capital originated, but I suspect a well functioning stock market (ex-algo traders and their ilk, of course) is a fairly reliable barometer of confidence more than anything else.

    1. alex

      ‘wealth is “created” only when a transaction is completed’

      Once upon a time corporations used to pay something called dividends.

      1. Art Bitrage

        Alex, dividends are at their highest levels in decades… Which companies don’t pay dividends? Facebook, Linked-in, Tumi, Zynga?!? These and countless others are astronomically valued crapshoots. People should be buying REITS, Utilities, Pharmaceuticals and Consumer Staples companies; they all pay very high dividend rates. Why don’t “investors” do that? Because they don’t want to invest, they want to gamble and get rich quick.

        1. LucyLulu

          I’ve had quite a few dividend stocks since my parents gave me my first stock of ATT (pre-divestiture) back in 1980. Today, one must choose between dividends and growth. In other words, if one buys a stock with a good dividend, it is expected that it will underperform the market. Since the GFC, even with the dividends, the dividend paying stocks have frequently been net losers. In the past, while unlikely to be an MSFT or AAPL, the dividend stocks also showed healthy appreciation. I don’t have authorities to cite but it seems the rise in share prices outpaced inflation.

      2. F. Beard

        Once upon a time corporations used to pay something called dividends. alex

        Dividends are dumb. Why would you want to take profit out of your own business?

        Also, dividends are un-Biblical since they amount to “profit taking.” Profits in the Bible are good, “profit taking” isn’t.

        1. alex

          “Why would you want to take profit out of your own business?”

          Because that is how the owners make money. Depending on the time and company, there are limits to how much money it makes sense to re-invest in a company.

          1. F. Beard

            Because that is how the owners make money. alex

            If the owners need money, they can sell some of the stock. Taking dividends defeats the whole idea of pooling capital for economies of scale. It’s a vote of no confidence in the company’s ability to wisely invest.

          2. different clue

            Reply to F. Beard actually . . .

            Isn’t saying “if the company owners want some money they can sell some of their stock” somewhat like saying if a farmer wants money, he can sell some of his farmland?

          3. F. Beard

            somewhat like saying if a farmer wants money, he can sell some of his farmland? different clue

            Well, that’s what some farmers do when they retire, isn’t it?

            Also, if one sells his stock at a rate less than or equal to the appreciation rate of the stock then the value of his share holding would never decline.

            The equivalent in farming would be if the soil fertility of a farm increased every year such that the farmer could sell some of his land but still be able to grow the same amount on the remaining land.

          4. different clue

            F.Beard,

            Raise fertility on some land to sell off some other land?
            How far can that process go? Till Mr. Farmer is left with infinitely little land of infinite fertility?

            I thought my analogy would show the “owners don’t get paid unless they sell their ownership” to be nonsense. What sensible farmer or anyone else would do the work on his owner-operated bussiness for free until he sold the farm? How would he even meet his farming expenses? Sell it when he retires? Well fine, if he wants. Meanwhile he should pay all the expenses involved in farming while making no money farming for the several decades before he retires? How does he stay farming or retain ownership long enough to retire then?

          5. F. Beard

            Raise fertility on some land to sell off some other land?
            How far can that process go? Till Mr. Farmer is left with infinitely little land of infinite fertility?
            different clue

            Your analogy was flawed to begin with since a common stock company is jointly owned. Thus individual owners do NOT own individual pieces of the company but ALL of the pieces jointly. Example: You and I own a cow. Do you own the right half and me the left? Obviously not since to divide the cow is to destroy its value as a cow.

        2. LucyLulu

          Dividends are temporary and can be revised down or suspended/terminated. Selling shares of equity is permanent. One is short term, one is long term. If I have a business, would I rather give up some of this year’s profits or would I rather give somebody a percentage of my company? By the large increase in recent years of frequency of yearly bonuses being paid rather than raises given, apparently business thinks the dividend analogy makes better sense.

          I don’t know the history behind the stock market but my understanding from way back when was that it provides the “American entrepreneur” a means to fund his latest innovation. Typically these ventures were riskier debt than banks wanted, and stocks provided savers with a means to increase their returns. I could be wrong, but I think stock ownership used to be more popular with the middle class (small amounts) than it is now. Perhaps not necessarily common, but not unusual for a couple to have certificates for a few shares stored somewhere for safekeeping.

        3. ChrisPacific

          Dividends are dumb. Why would you want to take profit out of your own business?

          What’s the discounted cash flow valuation of a financial instrument that never actually produces any cash?

      3. papicek

        Like I said, I’d love to see data. It would be one helluva study. Do stocks create wealth? Certainly over history prices have risen, Hence new wealth. However, those prices reflect a buyer putting some cash into the purchase (lets avoid the existence of buying on the margin for now), hence wealth is absorbed.

        As for dividends, they’ve always been a tiny fraction compared to the initial investment of a dividend bearing issue.

        I wonder if anyone really knows. Like I tried to emphasize, where the capital originated (retirement plan contributions, for example – IIRC somewhere around $4-5 trillion) makes all the difference to the answer of whether net absorption or extraction occurs. Caution tells me that like other systems, input versus output levels tend to oscillate.

        I don’t take it as a given that trading generates wealth, however. I’d like to see money flows data.

        1. enouf

          … Certainly over history prices have risen, Hence new wealth. …

          Dare i suggest that it’s not that ‘prices have risen’, but that the ‘value of the dollar has fallen’ (been stolen, slowly, via a maniacal Debt-based and Usury-based FRB system); i.e; Inflation (more dollars needed to purchase same amount/quantity of goods/services). I certainly wouldn’t give inflation the attribution of creating new wealth.

          If we take the most positive views/estimates, the 1.00 USD of 1913 is today worth ~ 0.04 cents. YMMV

          Love

        2. enouf

          … Certainly over history prices have risen, Hence new wealth. …

          Dare i suggest that it’s not that ‘prices have risen’, but that the ‘value of the dollar has fallen’ (been stolen, slowly, via a maniacal Debt-based and Usury-based FRB system); i.e; Inflation (more dollars needed to purchase same amount/quantity of goods/services). I certainly wouldn’t give inflation the attribution of creating new wealth.

          If we take the most positive views/estimates, the 1.00 USD of 1913 is today worth ~ 0.04 cents. YMMV

          Love

          1. papicek

            Indeed, and I can be more specific. Capital inflows from retirement plan contributions into financial markets present a good argument for a classic inflation scenario for stocks. All that money flowing into a closed system . . . .

            As for the dollar’s real value, who knows what it is now?

  8. K Ackermann

    This is kind of a funny post for me. I can understand the utility of broad equity markets, but I have to say, the modern behavior of the publically traded company so often makes for a lousy citizen.

    Did Zuckerberg need to take Facebook public because it would die otherwise? So the company gets a huge chunk of money but I haven’t heard any business plans that require it.

    He’s already got a mess on his hands, and now it’s going to be all short term thinking from here. Because their revenue model is on the edge to begin with, they are already under pressure, and if they don’t turn it around quickly, the pressure will mount and the perception of failure will intensify. They don’t need to buy market share – they already have a huge market.

    It was probably not the most efficient allocation of $100 billion dollars, and now they are constrained to the short term, and short term thinking is killing us.

  9. Hugh

    In praise of equity. Why?

    The top 1% own 50.9% of US stock, bond, and mutual funds. The bottom 50% own 0.5%. The top 10% own 90.3% of them.

    http://www.businessinsider.com/facts-about-inequality-in-america-2011-11#half-of-america-owns-25-of-countrys-wealth-the-top-1-owns-a-third-of-it-2

    Instead of a few wealthy families, we have a relatively small wealthy class. I fail to see any significant difference between the two.

    As for Facebook, I have no sympathy for those whining about being “misled”. IPOs are not something I follow. Yet even I knew months before the IPO that it was overpriced air.

    1. alex

      “Instead of a few wealthy families, we have a relatively small wealthy class. I fail to see any significant difference between the two.”

      Considering your link, the 90-99 percentile owns 39.4%. That’s 9% of the population, which is much too large of a group to be an oligarchy. We’re talking about people who are obviously better off than the bottom 90 percentile, but far from rich. While it should go further, it still serves as a useful distribution of power. Compare the US to, for example, to Brazil.

      1. Hugh

        Kleptocracy, that is systemic looting, needs considerable machinery to enable, carry out, and defend it. This service is performed by our elites who comprise most of the 90-99 percentile you reference. It is bizarre to qualify as a useful division of power precisely the class that drove the economy over the cliff in 2008 and has placed so many of us in the non-elites in debt peonage. It is rather like defending feudalism on the grounds that it wasn’t just a few great lords, that is was actually quite a useful division of power if we counted in all the knights, minor nobility, and prelates.

        1. alex

          “elites who comprise most of the 90-99 percentile”

          You’re kidding, right? Someone in the 90th percentile ($64,858/yr in 2011 for a single person) is an “elite”? You’re blaming the kulaks for the sins of the aristocracy.

          http://en.wikipedia.org/wiki/Kulaks

          1. Hugh

            They’re called footsoldiers, and of course many of those in that group make considerably more than what you cite. It is a decile after all. And consider too how much a professor of economics or some other kleptocracy enabling discipline is paid.

    2. chris murphy

      And this top 1% is comprised largely of the senior management of public corporations. As the last 15 years of corporate governance scandals have proven and as Berle and Means pointed out half a century ago this management does not represent the interests of even the 10% class of shareholders. This effectively results in the same sort of oligarchical control the author asserts exists in countries without broad and deep equity markets.

  10. Jack Straw

    Corporate governance seems like an afterthought since the real shareholder power is the buy/sell decision. Or another way of putting it is that corporate governance seems only to really matter when the shares themselves are not liquid, or explicitly restricted from ordinary buy/sell marketability. Or another way of putting it is that the corollary of the phenomenon that equities outperform bonds is that equity is relatively expensive finance (for the issuer) compared to debt – the exceptions being those IPOs that end up being SEC investigations.

  11. Moneta

    The thing is that while the burden of investing for retirement is beind dumped on the individual’s shoulders, investment opportunities are being snatched up by large defnined benefit pension plans.

  12. Jack M. Hoff

    “”The reasons given for the concern are that public companies create jobs, they “let in daylight” and they allow the public to invest in companies.”"

    Dear Economist, tell us what you really think. Isn’t it that you perceive the problem to belong to the 1%’ers? Why after all, if there are no public companies coming online and no private equity investors to buy that stock, how in the world are the 1%’ers going to end up with all the money?

    1. Art Bitrage

      Jack, You sound jaded. Using buzz terms like “1%-er” and “private equity” may seem intelligent but you clearly dont understand what youre commenting on. Before you get angry you should get educated.

      “private equity” firms don’t buy ipo’s, (which are PUBLIC equity) they only buy public companies when they intend to take them private (de-list).

      “1%-ers” are, obviously the richest 1%. Not everyone in this “group” puts their money into private equity funds, or even hedge funds. Not only that, private equity money comes from a vast array of sources, including endowments, municipalities, and retirement funds. Your retirement plan may actually have small amounts of capital allocated to private equity somewhere.

  13. Face Eatin'

    Technology always threatens the oligarchy which is why they are the first to seize it and abuse it. Laws coming through congress are half an attempt to secure rental income on old information and tyrannical new forms of censorship. The masses feel it’s all reasonable in some lazy, thought controlled sense of numbness. Stunning numbers of our great populace still feel the wacky web isn’t a corporate tyranny, which it is almost completely. Drink your “progressive” propaganda deeply, but don’t question too much or raise a fuss.
    HFT is a crooked rip off – the hand wringing from FakeBook investors and their lawsuits is because they didn’t score in what they thought was a guranteed fix. Let’s seize their houses, then they won’t complain.

  14. be'emet

    The money lenders invent capital freely. How can accumulated wealth compete with that?

  15. pwelder

    Excellent piece by sell on news and a nice find by Lambert. I don’t understand why we don’t see a lot more of this critique from the politically active left. Reform in US history has always got a lot of traction by contrasting the theory – rhetoric and justifications – around a system with results in practice.

    As to why equities seem to be an Anglophone thing, part of the answer may lie in where investors first found their pot of gold at the end of the rainbow. I would look into how the triangle trade was financed – were they selling shares in those lucrative voyages? Also, if memory serves, the East India Company made out like bandits. Human nature being what it is, it doesn’t take the memory of many big wins to keep speculative juices flowing.

  16. Mel

    “First, big stock markets tend to distribute economic power. This is more of a political point, but in countries with large stock markets, the extremely rich are not as powerful.”

    Seems true, but I think there’s a causeeffect problem. Initially, limited companies, stocks and stock markets arose when people who wanted to make huge initiatives couldn’t find the huge quantities of capital they would need to set out. They had to whip-round to many other people to accumulate the money. Extremely rich powerful people don’t need to whip-round to anybody. They already have everything, and there’s nobody else who has anything to contribute.

    Corporations with huge cash reserves don’t need to sell more stock to get — what — more cash?

    1. F. Beard

      It all goes back to the banks.

      Who-could-a-node that usury for freshly created money would lead to unjust wealth concentration? Just about every famous man in history is who.

      Ah, the evil brilliance of creating an asset from nothing by enticing someone to borrow! And the process is self-reinforcing since the more people borrow, the more they need to borrow!

  17. ess emm

    On the short-selling thing, I was hoping for some insight.

    Why would a shareholder countenance his brokerage firm letting somebody “borrow” his shares to do something that will immediately have a negative impact on the price? It seems counter to the natural inclination to protect your asset; if the asset was a car you would drive it yourself, rather than letting somebody else drive it who wants to damage it.

  18. McWatt

    The bottom line in all of these threads, under all these different headlines, on all web sites like this one, is that a great number of people are daily being taken advantage of by a small number of people. That’s not fair. Until someone at the helm understands this we are nothing but prey.

    You can take all of these issues, and all of these threads, and all of your thoughts and all of your comments and throw them out the window as far as I am concerned.

    Right now, the only thing I want for me and my family, is to be put on the “do not kill list”.

    “Catch-22 says they can do anything we can’t stop them from doing”.

    1. different clue

      Is there a way to change ourselves from “prey” to “inedible”? Is there a way for members of the prey-item majority to grow poison spines, claws, and so forth so as to become a little more predation-resistant?

      Is there a way for a hundred million little prey-items to change some of their wealth to un-monetized forms which would be invisible to the OverClass moneydar and thereby less subject to drainage and/or seizure?

  19. Jonathan Bernstein

    Regarding your interest in the early history of the London capital markets, you might start with “The Financial Revolution in England, 1694-1720″ by PGM Dickson. Long story short: London got going (after many false starts) with the foundation of the BOE in 1694. In additon, to finance the War of the Spanish Secession (1707-1713 if memory serves) England borrowed money but levied specific, dedicated excised taxes to insure repayment. This establishment of sound government finance helped enable England to unseat France as the No. 1 European power.

    Meanwhile, equities (primarily the royally sponsored trading companies such as the East India Company — and of course the unfortunate South-Sea Company) traded in the coffeehouses at London’s Exchange Alley. As has often happened, a sound market for government debt underpinned and made possible the more vibrant market for stocks.

    1. gordon

      I don’t know if Dickson covers it, but I have a memory that the English learned a lot from the Dutch about finance in the aftermath of William & Mary’s accession. A lot of Dutchmen came over then. The English also learned a lot about land drainage about this time, also from the Dutch.

  20. Jim in SC

    On the short selling thing: short selling is not ‘financial trickery.’ Financial trickery is promoting stock with lousy balance sheets based on the promise of future results: fads, frauds, and failures. These are exactly the sorts of companies that short sellers go after.

    Short selling in the context of a long short portfolio has the social benefit of allowing the portfolio manager to invest in riskier companies than would otherwise be possible, since the presence of short positions generally reduces volatility for the portfolio as a whole.

    I recommend Richard Sauers’ book:

    http://www.amazon.com/Selling-America-Short-Contrarians-Absurdity/dp/0470582111

    and Kathryn Staley’s, though the examples are somewhat dated: http://www.amazon.com/The-Short-Selling-Marketplace-Book/dp/0471146323

    Finally, Marc Cohodes (who was Richard Sauer’s partner at Rocker Partners and Copper River), gives a deposition here that describes the practice of short selling very accurately, though as the NYTimes indicates, you have to wade through some salty language.

    http://www.nytimes.com/interactive/2012/03/26/business/20120326Goldman-Documents.html

    The most honest people I have met in finance have been short sellers.

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