I always wondered why the heck we really want securities markets to begin with. I mean, what can stocks and bonds do that a bank can't? Germany and Japan, for example, built thriving and modern economies without them. Case in point -- Germany didn't have a modern stock market until the 1990s. Instead, financing comes through loans from other corporations and from the Hausbank -- the company's long-term banking business partner.
But assuming, arguendo, that public issues of equity and debt is an efficient way to raise money, at least a viable option to bank-based finance... what, exactly, is the purpose of secondary markets -- which don't really raise any money for the "user" of the funds?
In America, a corporate borrower wanting to raise money for capital investment has a few options: (1) It can get a bank loan from a commercial bank; (2) it can sell equity or debt to non-public markets (the province of hedge funds and... Facebook); or (3) it can issue and sell stock or bonds on public markets.
For those chosing option #3, it's called an IPO ("Initial Public Offering"). So the company will create stock from thin air (with the aid of an underwriter, an investment bank) and sell it on the NYSE. But... that stock doesn't just disappear. It continues to change hands over and over and over again. This is the "Secondary Market."
The sale of stock and bonds on the secondary market doesn't actually make any money for the issuer, the corpoation that wanted to raise funds to begin with.
So what's the point of them??
I understand that these secondary market stocks can perhaps serve collateral for other debt obligations of the issuer -- they can redeem shares and take advantage if the price goes up. Sort of like borrowing on your house that appreciates in value. And they provide liquidity for initial IPO investors who would otherwise be too afraid to invest in stock they could never unload.
But.... given the SIZE of the markets, how much is actually serving a liquidity and/or collateral purpose, i.e., an actual useful purpose, and how much is just.... gambling? Has anyone ever tried to measure this?
Paul Krugman pointed me to an answer: it's gambling. Per an economist at the NY Fed Reserve -- a bastion of progressivism, of course.Krugman references the following Paper by Charles Steindel.
Growth in the Naughties
Yesterday I posted a brief note about how to think about the 2000-2007 expansion, now that we know that there was an unsustainable housing-and-debt bubble. My point was that this doesn’t mean that the growth was somehow fake; real output of goods and services did indeed rise, even if the legacy of that growth was debt that create macroeconomic problems now.
Charles Steindel emails to remind me that he actually did a quantitative assessment (pdf). In that analysis, he asked how much our estimates of actual growth are affected if we consider the possibility that (a) what Wall Street was doing wasn’t actually productive (b) much of the housing will end up being less useful than expected (e.g. ghost towns at the edge of urban areas).
What he finds is that even with fairly strong assumptions about phony financials and wasted investment, you can’t make more than a minor dent in growth estimates. On the financial side, the point is that we measure growth by output of final goods and services, and fancy finance is an intermediate good; so if you think Wall Street was wasting resources, that just says that more of the actual growth was created by manufacturers etc., and less by Goldman Sachs, than previously estimated. On the housing side, the point is that residential construction, even though it was at high levels, never got much above 6 percent of GDP. So even if you believe that a large part of the construction taking place late in the housing boom had very low usefulness, it only subtracts slightly from growth over the course of the whole period.
Meanwhile, Mike Konczal points us to new work at the SF Fed on the role of household debt in the slump, further reinforcing the case that stressed household balance sheets are at the core of our problem. Indeed. What this says, however, is not that the economy couldn’t and shouldn’t be producing more; it just says that we should be pushing harder on unconventional monetary and fiscal policies.
