If one wanted evidence that the stock market is the major driver of US policies, one need look no further than the decision yesterday by the Federal Reserve to lower interest rates by half a percentage point, a large amount.
Launching the emergency measure as a pre-emptive strike to protect the US economy after pressure from Donald Trump to act, the Fed warned: “The fundamentals of the US economy remain strong. However, the coronavirus poses evolving risks to economic activity.”
Jerome Powell, its chair, said: “Of course the ultimate solutions to this challenge will come from others, particularly health professionals. We can and will do our part, however, to keep the US economy strong as we meet this challenge.”
Normally the Federal Reserve adjusts interest rates in response to major economic factors, such as concerns about the levels unemployment or economic growth, based on its analysis of the data. But this latest move seems to have been prompted by the sharp drop in stock prices due to the fears over the impact of the coronavirus.
It is true that there are fears that the global spread of the virus could led to disruptions in trade and in the complex supply chains that companies now have. It may also be true that this drop in the interest rates, by making borrowing by businesses cheaper, may enable companies to explore way to find remedies, even though it is not clear how.
But that still leaves the suspicion that this was done primarily to boost stock prices.
Yesterday, the markets dropped sharply despite the Fed’s move. Today they rose and that is being attributed to Joe Biden’s good showing on Super Tuesday. Biden has been a loyal supporter of business interests and a presidential race between him and Donald Trump would be one that big business would favor since both would be very friendly to them. But it is always guess work as to what drives stock prices up and down on any given day, so these glib explanations should never be taken seriously.
Oh, I’ve long held that the stock market is one of the true great evils in our world. It’s no longer enough to be profitable, corporations must always show growth. When profitable companies lay off workers for no other reason than to pad their profits, something is severely broken.
There is this common miss-conception that companies directly benefit from a climbing stock price. There is a benefit to a company for a higher stock value, they find it easier to borrow money. But the stock market is a secondary market. Companies go to private lending corporations, who finance the company and purchase the company stock. These private lending corporations give the companies money at an agreed upon price. I.e. a company may want 10 million dollars to expand the business, so they sell 1,000,000 shares at an agreed upon value of $10/share to a private lending company. The private lending company then owns those shares.
At that point the private lending company will announce an public offering of those shares. If the stock has never been on the market before because it’s a new company, its an initial public offering or IPO. The private lending company will sell the shares they own at the price the market is asking. The private lending company hopes that they sell the shares for a profit (and if they can’t they generally hold on to the shares). There are a lot of regulations about this, but that’s the simple version.
The result is that the stock market is a secondary market, and more importantly a zero sum market. You can’t get any more money out of the market than the money other people have put into it. If you make money, it’s either because more money has been put into the market or because someone else is losing money. Stock market gains do not directly benefit corporations, aside from making it easier for corporations to borrow more money from the private lending companies. If the stock price goes up, a company doesn’t get the difference into it’s coffers; the investor who bought it before the price went up can now sell it for a higher price and the investor gets the profits.
As an aside, putting social security money into the stock market would immediately raise the value of all stocks in the market to accommodate the influx in cash. Then everyone who was in the market before the influx of cash would sell, taking all that cash out of the market. That’s the result of a zero-sum game. The smart players take their profits when they can. It would be the biggest transfer of public funds to the investor class the US had ever seen.
Don’t forget about the high ,corporate muckie-mucks that own tremendous amounts of their company’s stock and stock options. You can bet they know where their bread is buttered. Also, if you buy a share of stock, that purchase money goes directly to the company for their use. The higher the stock price, the more money per- share they can raise.
flex, @ #2:
True -- however, corporate executives often do directly benefit, and they’re the people actually making the decisions.
publicola, @ #3:
Not unless it’s an IPO or new stock issue, which is comparatively rare. Most times, you’re buying a share of stock in the secondary market, so the money goes to whoever sold it to you.
@Dunc #4, and @publicola, #3,
It is almost impossible for an individual to purchase stock directly from a company. An IPO always goes through a financial institution, so that the company is guaranteed to get the capital it has negotiated for. New stock issues are financed the same way, a financial company buys the entire new issue and sells it on the secondary market. Pretty much all transactions take place on the secondary market.
So what about stock options? The short explanation is that companies can own their own stock. A company may need $5 million in capital, but negotiates for $10 million in stock. The financial institution (and FTC) approves the $10 million stock issue, but the company immediately purchases $5 million of it at at the issuing rate. This allows the company to sell that $5 million on the secondary market if it needs to, or offer that stock as stock options as part of a compensation package. It is the same as if the company had purchased $5 million worth of their stock on the secondary market. In an IPO a company may negotiate for this company stock purchase prior to the IPO and immediately after the IPO sell most of their shares on the secondary market. If the punters believe the hype, a company can recover all the money it spent to purchase it’s own stock and even gain more capital for use.
When a company executes a buy-back of their stock, as many did with Trump’s tax cut, it can either retire the stock (rare) or offer it again as a compensation option for it’s executives. Thus spending corporate money to purchase more stock options for the executives who can sell it for personal gain when the value rises. And one of the best ways to make a stock rise in the market is to reduce the number of shares available. Then the executives to sell their shares, reducing the price. It’s a great way to transfer company money to individuals. Purchase stock with company money, which makes the stock price rise, give the stock to private individuals at the original price, and let them sell it for the profit, which drops the price again. Rinse and repeat.
As Dunc @4 mentioned, corporate executives often do directly benefit from the stock market, even if the company does not.
There are some regulatory checks and balances in the system, but they only work if they are enforced. Then because money made by market trading is taxed at a lower rate than other income, and you’ve created an incentive to manipulate the stock market.
There should be a disincentive to manipulate the market. I have two I recommend:
First, tax stock market capital gains at twice the level of other income rather than half, and at the same time tax dividend income at half the rate as other income. The effect of this is to encourage corporate officers to run a company to create dividends. As the only way a company generates dividends is by being profitable, it would encourage companies to invest in being profitable rather than making the stock price fluctuate. It would also provide a supplemental income for those people have small portfolios, helping to supplement other social security programs.
Second, restore the 90% tax bracket. Adjusted for inflation, of course. Maybe set it at $5 million? The effect of this would be to create a disincentive to earn more than that much in a year. Even if the government gets no additional tax revenue from setting a 90% tax bracket, it will remove the incentive to make more, stabilizing the stock market and making stock manipulation less attractive.