Do stock markets have social value?
Felix Salmon, among the best of the financial commentariat, at least raises the question, bless him. But then he punts, as he no doubt expects most sane folks would:
Has anybody ever tried to quantify the societal benefit of public stock markets, or the social harm that might be done if Facebook just stays private? Where would you even begin?
One should start, I suppose, by separating out equity markets from the larger capital markets in which stock trading commands far too much attention. (The bond market is vastly bigger.)
And rephrase the question: Since stock markets exist to allocate capital, are they any good at it? Better than the more staid precincts of the bond market? Uncle Sam? The Ford Foundation? The average household in its budgeting methods?
The answer should be "yes" because so much is at stake. The expression "It's only money" is for the philosophical of mind, and I'm not one of those. As with every expenditure, there is an "opportunity cost" for shareholders who could be doing something else with funds committed to the market. So there'd better be an above-average return on that stock compared with firms in the same line of business, with the broad market indexes, and investments in other asset classes.
Still, there is fantastic waste in the raising of public equity. The underwriters of Facebook, when and if that stock offering comes about, will rake off millions of dollars for handholding Mark Zuckerberg through the process of going public. It will be an obscene sum, relative to the value of services rendered, as everyday people would see it.
There are lofty transaction fees in buying and selling on public exchanges, creamed off by brokerages with mark-ups to make any grocer blush with envy or outrage. Such fees are especially accumulated by mutual fund managers, who with their over-frequent trading of clients' portfolios (a.ka. "churning"), pass that dubious cost, along with their own steep transaction fees, to the client. Which cuts deeply into the returns of Main Street investors. (It would help if more than half of money managers could at least beat monkeys with dartboards in their stock-picking prowess.)
Exchanges, of course, rake in annual listing fees from each company privileged to trade on the exchange. Fees are exacted, too, by self-financing federal, provincial, state and territorial regulators in return for blessing what a listed company has to say for itself public notices - a benediction too easily granted more than half the time. They also pocket a nice sum for vetting initial-offering and secondary-offering prospectuses.
You can see, I hope, a great deal of money here that is not going into running the business that's raising the funds.
Salmon and I could benefit from a thorough, dispassionate examination of all the money collected in stock-market operations, and where it goes. We now do this with charities: How much of the funds raised helps the cause, and how much goes to administration and fundraising?
In normal times, and we've seen too few of those lately, there will be waste, as in all enterprises, public and private. But if in normal times it costs a nickel or less to raise a dollar, in an arena where Keynes' animal spirits decide the exact current value of a stock (and thus an entire company), I suppose that's of sufficient social value. Investors, given the benefit of transparency and equal knowledge to that of other investors, voluntarily finance the start-up of a McDonald's or the $1-billion cost of a new Intel foundry (silicon-chip factory). And that's a good thing, rather than Saddam Hussein deciding out of pique to starve Iraq's under-developed state-owned oil reserves of capital for two decades.
The problem, in addition to simply too much waste sloshing around in a process not efficient or disciplined enough, is that the markets collectively are given to buying and selling "panics" in which capital is wildly misallocated, in staggering sums that make the hijinks at City Hall or the statehouse seem trival. (Which they comparatively are.)
Investors, driven by the madness of crowds documented so long ago by Charles Mckay, have in the past decade alone run up the price (not the true value) of dot-com, pharmaceutical, telecom and financial stocks, then abandoned them, lemming-style, erasing about $8 trillion in shareholder value twice since 2000-01.
No one dare call that efficient allocation of capital. The average district school board does a better job. But then, school administrators talk among themselves, while solo operators like Nick Leeson, based in Hong Kong, takes the two-century old Barings Brothers of London out for a joyride that ends with the venerable brokerage being totalled.
Which raises another problem, the inability of market participants - investors, traders, exchange operators - to learn from mistakes. Leeson begat the rogue trader who nearly brought down Societe Generale, one of France's largest banks; and the derivatives "innovator," also unsupervised, who from his knothole in London dragged down New York-based AIG, world's biggest insurer, now on U.S. government-provided life support.
We duck this question because once you pull that string, you soon find yourself asking if a company proposing to distribute gummi bears or launch yet another online dating service is an appropriate use of the planet's limited resources. Such decisions will be arbitrary, of course, opening the door to Ayn Rand & Co. to inveigh against those who presume to know what's best for us.
So, is dervatives trading of social value? The exchange of common shares of Exxon Mobil? The start-up equity in a wannabe wind-farm operator?
The answer again is yes, of course it has social value. Investors with their own money on the line, and with more to lose than a bureaucrat in making that same capital-allocation call, must be counted on to act in their best interests. Which, Adam Smith tells us, collectively align with those of society.
But my answer of a qualified "yes" is conditional on supervisory reforms, among exchange operators and state regulators, to ensure that issuers, traders, brokers and everyone else at the party is no longer groping someone else's partner, or taking flight from the roof just because everyone else is suddenly convinced they can fly without benefit of an airplane. And are denied entrance to the dance hall because their chatter, grooming, body language and long list of "priors" suggests that their presence might spoil the party for everyone.
Because you know who pays for calling out the police, fire and public health departments in the aftermath if it all goes wrong. That would be me, with a tax hike for emergency services that offsets my enjoyment from waltzing with Sandra Bullock and Annette Bening earlier in the evening.
Obama and Congressional Dems failed to deliver promised tough reforms. And that's what gives Salmon and others just cause in raising such a fundamental question.