Security in Securities?

Bill Gates has $72 billion. Mark Zuckerberg is worth $9.4 billion. Chase Bank's value is $212 billion. We hear these numbers thrown around the financial media. Is it actual money, as in currency, that those people possess? In theory, yes: they could sell the shares of the company and have that much in cash. However, the act of those two individuals selling their shares would cause the price to go down – perhaps Gates less so now that he is no longer CEO of Microsoft, but Zuckerberg very much still IS Facebook. Gates, by the way, has sold around $2.5 billion worth of Microsoft shares in the last year. Even if he did the same thing every year, he would need 30 years to sell it all.

Securities form a central pillar of America's economy. The corporation may have been born in Britain, but the New York stock exchange brought the idea of sharing corporate wealth with the public. We have gotten closer and closer to the idea of a free and fair market where instead of goods or commodities, companies are bought and sold.

We previously discussed currency, real estate, and intellectual property as being part of America's assets. A great deal of those three asset classes are owned by corporations. We don't want to dive into the deep end of corporate law, but for most purposes, corporations can act just like an individual. It can buy and sell property, physical assets, and patents and hold all forms of currency. One can even sell percentages, or shares, of itself to others that have no involvement with the day to day operation of the company's business.

Sidebar here: the federal government has been very kind to corporations as far as laws regulating them. We have one of the most lenient bankruptcy systems in the world. If a corporation goes bankrupt, the individuals holding shares are not personally liable for those debts outstanding. So, the risk of going out of business is spread outside of the corporation to those who lend to it. At the same time, individuals profiting from corporate dividends or selling a stock at an increased price currently pay a 20% tax rate, well below that of real “income” for most people. Large corporations also receive favorable treatment by state and local governments who want those manufacturing jobs in their area. Washington and Seattle governments continue to woo Boeing to leave its manufacturing facility in the Seattle area while Boeing continues to leverage the power that comes from employing 168,000 workers, many of them well paid skilled engineers and specialized tradesmen. To be fair, those workers spend money in the local economy, so their continued presence in Seattle benefits the entire population there, Furthermore, a recent Supreme Court decision allows corporations to give directly to political campaigns, including through an anonymous scheme through non-profits to SuperPACs, so corporations have a way to influence government regulations that will continue to favor them.

Ok, let's jump back to Facebook. As of Friday, the company's stock is valued in total at $132 billion with a share price of $54.25. Facebook's business model is that of an advertising platform – companies purchase ads or information from Facebook for the purposes of marketing to a specific group. The entire advertising economy, including billboards, radio, print, etc., is estimated to reach $177 billion in 2014, with the internet gobbling up about a fourth at $47 billion. Facebook releases its 2013 numbers soon, but in 2012 they made around $4.5 billion. Somehow, Facebook is worth its annual revenue 24 times over. One might argue that Facebook is a disruptive technology that changes the way we live and work. Indeed, people use the network to communicate with one another. But, unless they start a dramatic fee for service structure (which would likely lead to the mass exodus of their users), they are still only an advertising company. Forecasts show a healthy increase in the online media ad spending from $47 billion to $60 billion by 2017. If Facebook continues to receive around 10% of that total, they will still only be bringing in $6 billion in revenue each year. By comparison, McDonald's corporation is valued at $96 billion on 2012 revenues of $27 billion. Somehow, with revenue less than a fifth of McDonald's, Facebook is worth $20 billion more.

My point here is that there isn't hard data to support why Facebook is valued so highly. They have gotten by with good justifications up to now that the internet is the future of advertising, people want to buy things their friends have, so on and so forth. It's just hype though. People assume that, hey, I have a facebook page, and everyone I know does too. That's gotta be worth something, right? They are now a couple of years old as a public company, and investors will want to see some hard cash. Facebook earned a penny per share in 2012, whereas McDonalds earned $5.36. Considering there are half as many shares of McDonald's out there as Facebook, you have to wonder why I would want to own part of Facebook instead of part of McDonald's. You heard it here first – Facebook's share price will fall, dramatically, and most likely settle in around $20 per share or less. And if they are very successful at what they do, they might continue to serve the role they currently do 10 years from now, maybe 20. This is assuming the next big thing in social media doesn't clobber Facebook and figure out how to monetize this industry. The Internet economy is only one piece of the pie, and strangely it seems that this particular piece is like a lost boys' dessert.

The dollar value of these companies goes up and down on a daily basis. But the shares are only worth something when there's a buyer to purchase them. Let's back the lens off a bit and think back to 2008. This timeline is very helpful to recall the events, and remember that most of the U.S. public wasn't paying attention to this until September 2008. When the public was brought in through the news of Lehman brothers, faith in corporate wealth plummeted, and people issued sell orders essentially regardless of price: show the U.S. the money! The Dow lost about half of its value, and America millions of jobs, in 6 months. The crazy thing is that some companies were trading below the price of their cash on hand – they could just liquidate the company and make more money than their shares were worth! At that point, there was no way to go but up, and for the last 5 years, it basically has.

We come to realize that not only are these corporations important to America, these corporations ARE America. When you read down the list of the Dow 30, these are the brands we recognize, household names. We work for corporations, and we retire based on the money we have put into IRAs which invest in them. You could invest in local, privately owned companies. Then, you are trusting that those people are giving you the right information and an honest return on your investment. The public stock market requires honest information, and there are people whose job it is to check up on the info they provide and make sure it's accurate and the companies are following the law. By “going public”, those companies are opening their accounting books to public auditors who make sure the money is actually there. We trust this system – indeed in 2012 we had $18.7 trillion tied up in it. On first glance, it might worry us that this number is higher than the entire M2 money supply we discussed in week one, but these companies will be around tomorrow. Indeed, they have a good portion of that M2 money themselves. They will probably be around next year, and it's pretty likely a lot of them will be around five years from now. We can put our money to use by investing in those companies – they will take the money and attempt to make more from it. And we don't need all of that money this year – we will gradually sell some shares in companies in exchange for money that we will purchase goods with, which will be sold to us by corporations which then pass that money down the chain to investors.

The stock market is open to more people than ever in history. Gone are the days when you need to work through a middleman to buy and sell stocks. Online brokerage firms allow someone to trade in their pajamas at home. Company 401K's and IRA's allow workers to put a portion of their paycheck into investments to save for future real estate purchases or retirement, tax free. Other than real estate, the stock market and public ownership of corporations is where we put our money. You make 0% interest with money in the mattress, less than 1% (currently) on a savings account, and potentially 5-10% on stocks. Of course, there's significant risk putting money into stocks, but in the long run, they've been a fantastic investment over the previous 80 years, basically since 1933. The big question is how good of an investment are they for the future? Will we continue to see 4-5% average growth in our economy like we did for years? Or will we continue in the stagflationary period of the last 5 years? Which will dominate – fear or greed?

Finally, back to government intervention, we've seen unprecedented government involvement with the stock market since the 2008 crash. Bear Stearns, Fannie and Freddie, AIG, the auto industry, many other smaller scale investments: all of these were enormous government bailouts that have made Wall Street very unpopular with average Joes. The idea of companies that are too big to fail continues to perplex both corporations about where their limits are and regulators about how far they can push companies to follow the law. Politically, the Tea Party hammered politicians over government bailouts, and we haven't seen them since 2009. Instead, beginning in 2010, we've seen instead of direct government investment, the Federal Reserve has provided trillions to banks through quantitative easing. All of those bad loans banks made? They still have them. Except the Fed has been purchasing them, in exchange for newly “printed” money. What do the banks do with the money? They are loaning as much as they can, but since they are allowed to, they invest in the stock market. So, the stock market which has been pushed up by the banks which are pushed up by the Fed has been on a tear ever since. The big question will be how long can this bubble last? Will the rising tide of bank investment bring back millions of investors who fled stocks for safer investments? Tax free contributions are still going in, many times because those contributions are automatic.