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You see, it's all actually very simple. But everything was simple in Leave-It-To-Beaver Land, and we don't live there anymore, in fact, we're not in Kansas anymore either.

There was a time – and there are some places – in which banking was a conservative, prudent, and cautious business. Banking was local for the most part. The bankers knew their clients, knew about their work and family relationships and assessed the risk of any of their loans, for example, based on this knowledge. A person with a steady job and without a lot of other debt was a pretty safe risk for a mortgage on a house suitable for his or her family. Yes, the house itself was used as collateral for the loan (that is, if you couldn't pay off the loan, the bank would end up with your house), but the bank really didn't want the house, it wanted the money you made in payments. Why? Because it could take that money that you paid in an loan it out to other loan seekers, or invest it somewhere they could expect a reasonable return. The key to the whole system was reason: the bank knew its customers, knew its strengths and weaknesses, knew its capabilities and acted accordingly.

All the while, outside the banking system as just described – the commercial banking system, there was another system for another set of clients and customers. This was called investment banking. Here, the stakes were higher and the returns were higher. It's called investment banking, but it really isn't investing in the same sense that we might have put our money in a savings bond or such. No, here more volatile things were involved: stocks and futures (the infamous "pork bellies" one often heard about), and more. Here, however, I need to make a small detour before moving on.

In the world of business, there are three ways for an organization to generate extra cash. Extra? Yes, that is, money that is not generated through regular operations. Money the organization wants to invest. We all know that it is wiser to save up for a large purchase before buying it, but in the go-go-go, consumer-driven world today, we too often resort to credit to satisfy our impulses. Some things, like a home, of course, are really too significant a purchase to save up for, but cars and stereos and smart phones and refrigerators are in fact manageable.

The savings of business are called retained earnings, and sometimes these reserves are not enough to finance the next step forward for a business, so they have to get the money elsewhere. The three avenues open to them are, as in everyday life, to beg, borrow or steal. Really? Let me explain what I mean.

Let's start with borrowing since it is the most familiar to most of us. You go to a bank (usually) or other financial institution (could be a credit union, or Aunt Marge) and you negotiate a sum to be paid back over a specified period of time, and at a certain rate of interest. The riskier the bank feels this lending is, the higher the interest rate you end up paying. (It was once rating agencies which made such decisions, but they managed to tarnish their own reputations lately.)

The second way is to beg. Actually, the organization itself offers promissory notes (in everyday speak: IOUs) called bonds. The organization is, within certain limits of course, free to say when and how the bonds will be paid out, but there are several agreed on standards. Perhaps the most commonly known type of bond is the savings bond. When you buy a bond today for $37.00, in seven years the government promises to pay you back $50. The organization is basically saying, "trust me", and if you do, you can lend it money.

Whimsical as I am, I listed "stealing" as the third way, but that's obviously not 100% accurate. The third way of generating cash is to issue shares of stock. These shares represent ownership, so the percentage of shares you hold determines your "share" of the business. Such an issuing can be private, that is, you offer a part of your business to someone else and you negotiate between yourselves how many shares and what they are worth. We don't often hear about these kinds of transactions in the news. But, such offerings can also be public. These are the infamous (if at times not notorious) IPOs or "initial public offerings" that get lots of media coverage if they are big enough. In this case, the company decides to sell shares of ownership to the public, in the hopes that the demand for the new stock will raise the share price and thereby generate more cash.

A few years ago, a German low-cost airline went "public" and sold €1,000,000,000 worth of stock on the first day! Not bad, eh? But this is where the "stealing" comes in. They didn't take all that cash home with them. After paying fees and premiums and costs for staging the sale, they had a mere €400,000,000 to take home. I don't think it is out of line to wonder why the people who put on a sale earn more than the folks for whom the sale takes place, but that's another story.

What's worth noting, though, is that this is a one-time deal. Once those shares are in the public domain (on the stock market), they can be bought and sold and speculated with and the issuing company receives no money whatsoever when these shares change hands. If I buy some stock at the beginning, then the company takes home some of that money. If I sell them to my friend Tom a week later, I get money from Tom, but I don't have to give anything to the issuing company. They don't own those shares anymore: I did, and now Tom does.

This is the point, unfortunately, that most people miss. The issue company only has so much to do with its stock as it is concerned to keep its value reasonably high, but this is more for image than financial reasons. People who buy and sell stock do so to make money. Anyone who "plays the market", as it is most accurately described, buys stock in the hopes that the price will rise so that they can sell it later for a profit. In other words, the company should do well enough that the share price rises so they can make money. Since the issuing company's only obligation is to increase it's share price so that others can generate income, it is not truly accurate to call the stock buyers "investors". They aren't investing in the company, they are investing in themselves. Technically, the shareholders are "owners" but for the most part they are only concerned about the share price, not the working conditions, the employees, the customers, or the products or services themselves ... or only insofar as these things have a positive influence on the share price

The stock market, then, is really more like a casino than an investment, as one chief financial officer told me. What amazes me the most, though, is the amount of media coverage this particular casino gets. Fluctuations in the stock market are more often than not market players' emotional reactions to all kinds of events, but not really a sound indication of the health of the economy. I don't think it's ever a good idea to take your temperature in a casino.

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Comment Preferences

  •  Tip Jar (2+ / 0-)
    Recommended by:
    Words In Action, Steven D

    None are so hopelessly enslaved as those who falsely believe they are free. -Johann Wolfgang von Goethe

    by achronon on Wed Apr 03, 2013 at 06:09:57 AM PDT

  •  Forty years ago, banking was the "3-6-3 business" (2+ / 0-)
    Recommended by:
    Words In Action, achronon

    Take in passbook savings at 3%, loan it out at 6%, and close the doors at 3:00 PM. A buddy of mine majoring in business said that banks were notorious for hiring average students because they didn't want executives who would get too bored by this profitable drudgery.

    I voted with my feet. Good Bye and Good Luck America!!

    by shann on Wed Apr 03, 2013 at 07:01:42 AM PDT

  •  Pluto-Dems love it. (2+ / 0-)
    Recommended by:
    radmul, achronon

    They love Rahm, too.

    What's the point of letting neoliberals into the tent when neoliberalism is burning down the campground?

    by Words In Action on Wed Apr 03, 2013 at 07:23:25 AM PDT

  •  That was long ago (0+ / 0-)

    and far away.  

    Reagan started the ball rolling toward our present endless financial mess with his deregulation of the Savings and Loans.  Naturally, when that led to the biggest financial crisis since the Depression the only legitimate option considered by our politicians was to deregulate all banks.  Because - Free Markets!  Invisible Hand!

    "If you tell the truth, you'll eventually be found out." Mark Twain

    by Steven D on Wed Apr 03, 2013 at 07:39:27 AM PDT

    •  That's why I wanted to provide (0+ / 0-)

      a bit of background.

      The whole scene and our understanding of it has changed. The other evening I heard one person in a discussion round call people who take their money to the bank, "investors", and just this morning I read that in NZ the moment your money is deposited, it is no longer "yours". You get essentially an IOU that, should things go wrong, be converted into "bank equity", which is what they are doing via the Basel Accords and tried sneaking through in Cyprus.

      There will be interesting times ahead, that's for sure.

      None are so hopelessly enslaved as those who falsely believe they are free. -Johann Wolfgang von Goethe

      by achronon on Thu Apr 04, 2013 at 03:54:48 AM PDT

      [ Parent ]

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