In general, I believe that free markets are the best way to determine the value of goods, services or skills. Of course, capitalism isn't magic. Realities such as hidden costs or captive markets or the effects of unearned wealth are too often ignored by laissez-fair zealots, but similar or equivalent problems exist under any system and so far nothing has proven superior to good old supply-and-demand capitalism.

However, the free market - at least as it exists here in the US - seems to be singularly bad at determining the value of companies. All of those problems with hidden costs and captive markets get magnified, and there's also an unavoidable element of speculation. The value of a company is largely based on its future prospects, but even professional analysts and financiers often struggle with evaluating those prospects. Venture capitalists expect that 80% of the companies they fund will fail, and they're prepared for it, but in the stock market there are enough suckers to bid up every single stock in a new sector as though it will be one of the few winners...inevitably leading to failures and crises of confidence such as we saw with the dot-coms.

Are stock markets necessary to capitalism? Of course not. It's entirely possible to let the market determine the value of products but not companies. The debate question, then, is: would capitalism be better off without stock markets (and similar institutions)? Alternatively, is there some way that the stock market could be limited or regulated to preserve the benefits while eliminating the unfortunate side effects?

Stock markets are necessary for industrial capitalism, and in fact any "capitalism" which did not have a mechanism for determining the value of corporate (as in more than simply individual) efforts would be incredibly inefficient, and would therefore fail to produce the benefits of capitalism.

It may be possible, but it would be very inefficient.

No, capitalism as applied to an economy larger than a village could not exist without equity markets. Equity markets are the most efficient means of allocating resources to production on a large scale, AND equity markets are far and away the best means of reinvesting 'profit', i.e. that human effort which is freed up as a result of greater efficiencies.

It is not perfect, it is simply the best possible means of "allocating" human effort.

That sounds like a lot of opinion stated as fact. Would you like to explain the reasons behind your belief?

I think the concept of allowing individuals to share the profits and finance of a business is a pretty good one.

There wasn’t this sort of volatility when transaction fees were a hundred dollars a trade (and a hundred dollars was a lot back then…I believe that was around the 1970s). Virtually free transactions coupled with internet technology have escalated day trading and frivolous transactions. Of course, there’s a minus side to escalating those prices. People unable to buy large transactions would be disproportionally charged, and couldn’t take advantage of the dollar cost averaging method. A proportionate fee (I don't like to use the word sales tax) for buying equities would probably stifle volatility.

Limiting the number of shares a company is permitted to issue would also ameliorate the problem. Companies which dilute the value of their shares by arbitrarily issuing more at any time don’t have a stabilizing impact.

I can't think of anything else at the moment. I'll sleep on it tonight. It's a welcome diversion from the presidential address

99% of the problems can be solved by the individual not being a sucker. The best way to invest in the stock market is to set a certain amount of dollars every month into an index fund. Don't try to time the market, dont jump on the newest fad investment.

There needs to be no increase in the minimum commission. If people wish to go to Vegas that is their choice, the stock market odds are much better, providing you do just a bit of research and have a tad of common sense. Don't put all your eggs in one basket, or one market sector.

If you don't wish to do any research, take my earlier advise: buy index funds or their equivalent.

If you have a 401K put a minimum in company stock. Having your job and your savings all depending on ones company's status is taking on a huge risk.

Stricter laws against fraud and increased penalties is the answer to most of the stock market charades of the last few years.

If you really wish to discourage short term investing a highly variable capital gains tax, depending upon the time stocks are held, would be fairer to the small investor.

Well, with all the recent scandals and what-not, it's easy to see how the stock market can seem like a blunder sometimes.

Insider trading for example... thats almost impossible to regulate. What is preventing one friend in a company to tell his other friend to sell out?

Stupid stockholders, by far, are the worst part. I did a bit of investing (just before the scandals) and eagerly waited to see if my stock would rise or fall. Well, once the corporate scandals came underway, all stocks took a hit.

When one minor detail goes wrong, and even if it doesn't directly affect that person, a stockholder is likely to sell out ASAP. Everybody is so afraid that one rupture in the market will scare other people into pulling out, so they pull out as well. It's one crazy chain reaction.

Although, a week or two after the scandals, it was a perfect time to buy!

No. The only way to determine the value of a company, IMO, is if they make a profit every quarter. Also, the stock market makes the majority of it's value off the economic stats (consumer spending, consumer confidence, unemployment numbers, Company Profits etc). The consumer confidence level measures the confidence in the economy in the way i described on how the stock market goes and company profits. The stock market is just a building full of numbers that mean nothing.

Not true, and I'll give you a very real life example. EDS's crooked CEO made a contract with the Navy which actually will lose the company money in the long run. He doesn't care, because it looks good on the books now (short term profit wise, which is the only thing the balance sheet will indicate), and he intended to quit before the loss became evident and effected his personal bottom line. He was fired recently, with something like a 30 million dollar compensation package. Beware shareholders of EDS!

Actually, profit every month isn't much of an indication of a company's worth at all. What if they spent money by investing it into the company? When you buy shares, you should be looking at the potential future earnings, which is a pretty difficult endeavor.

I second that one.

Edited to add:
Actually, the decline continued. A year after the scandals (around November of 2002) the S & P 500, Dow, and Nasdaq were all considerably lower.

Yes, and communism would work if everyone became all altruistic. Human nature just ain't gonna change any time soon, and people being suckers is part of human nature.



Do you really think fraud was the major factor in the dot-com bubble? Does that explain why Akamai and CMGI were supposedly worth more than Ford and GM at one point? Does it explain investors throwing $150M at boo.com? I think stupidity and wishful thinking have far more to do with these phenomena than any wilful attempt to deceive. The Enrons and Worldcoms came to light after the tide had gone out.



I think short-term investing is a significant but not dominant contributor to the kinds of rampant speculation we saw in the dot-com era, and your suggestion seems like a good way to rein it in.

You are right human nature change won't anytime soon. Though the dotcom bubble burst definitely has a positive effect of making people more wary next time. The stock market is no different than buying other investment opportunities, i.e. housing, gold, silver, junk bonds, etc. It is certainly safer than the commodities market. The fact is most people get 12 years of free education in this country, they need to take advantage of it. We can protect people from poor investment decisions, but only by imposing extra costs on the investment of capital and/or restricting the flow of capital. Not a good idea.

Ouch. Well, I'm glad I didn't put any money back in! I thought stocks would have hit rock bottom pretty fast...

Aren't the problems you see with the market completely self-correcting? All those who make inefficient decisions will soon be out of money, and thereby excluded from further participation. This is, in fact, why the market is actually very efficient--it quickly, ruthlessly, and inexplorably transfers money from those who make poor decisions to those who don't. This is the strength of the system, but you seem to view it as a weakness. Capitalism was never meant to be pretty, only efficient. And it through this efficiency that almost everyone benefits in the long run.

Nope. Not when such a high percentage of investing is done through payroll deductions in one form or another, or when brokers and fund managers reap huge profits regardless of how well they perform. Also, the "inefficient decisions" are often due to inequity, not incompetence. Insider trading and illegal after-hours trading are just extreme examples of the already rich taking advantage of flaws in how the market works; lesser and perfectly legal variants occur with even greater frequency.

If the market did function as a meritocracy, if information and access were equal enough that the smart investors could reap the rewards of being smart, it would indeed be a great capitalist tool. But that's an ideal. The reality is that it doesn't work that way, and it's often the case that a potentially valuable tool can become a great hazard when it doesn't work as intended.

The market is already correcting these problems (have you checked Enron's or Arthur Anderson's stock price lately)? Agreed about the inequity, but then these people should either learn more or invest less--it's a sad fact that most people spend less than 5 hours/years researching their investment choices, despite the fact that over their lifetimes this will probably account for 1/2 of all of the their earnings. This isn't the system's fault--all it does is put a mechanism in place. It's up to each individual to put themselves in the best possible position to take advantage of it. As for the brokers and fund managers, this is also self-correcting. And this same people would figure out how to exploit any other system as well--there isn't any system that can eliminate basic greed. In fact, it is that very greed to gives these people such followings--everyone looking to make a quick buck by beating the system, rather than investing for the long haul.



What is a better alternative, then? Every other market mechanism has shown itself to be exteremely inferior--thereby bringing everyone down with it. I feel sorry for those that get got in the cracks, but that doesn't deny the simple fact that we're all much better off this way than any other. Things at places such as Enron point to the flaws of human nature, not to the inadequacies of the market system. To think that these same flaws wouldn't exist in any other system is ignoring the true problem, IMHO.

Is that really the market at work? Seems to me that the market got a little bit of a nudge from regulators. The stocks tanked because they ran afoul of regulations; if those regulations had not even existed would the effect have been the same? Is it the same on companies that carefully tread the line just this side of getting busted themselves? Are there not new companies being investigated for similar behavior almost every week? It doesn't matter if the cast changes; the play remains the same. The people who run companies obviously feel it's worth the risk to engage in these behaviors even though it's illegal, so if the limitations were removed there's no question that we'd be seeing even more of them.



It's not always about learning. No matter how much I learn, I don't have the same access to information as an insider or even someone working on Wall Street. I don't have the same access to the trading floor either. If I'm on the phone with a real player, and we deliberately submit the exact same orders at the exact same time, the player's order will be processed first. Always. That's just the way the system works; orders from certain sources are processed immediately, while orders from other sources are subject to unnecessary delays ranging from seconds to minutes. When you're trying to take advantage of a short-lived anomaly in option prices, time matters. If you don't jump on such an opportunity someone else will beat you to it and then it'll be gone.

No, I'm not a day trader. I'm actually a buy-and-hold kinda guy. However, I know people who've written the software that traders use and my current company targets the financial-services market (including the back-room folks that most people never heard of). The system is definitely not set up so that Joe Average is on the same footing as the big guys.



Then why has this phenomenon persisted, and even become more pronounced, over decades? That doesn't seem very self-correcting to me.

What you're describing is an ideal of a self-correcting meritocracy, but it's an ideal that I just pointed out does not exist in reality. I already know what the ideal should be; the debate question has more to do with the effect of capital markets as they actually exist and are likely always to exist.



I don't actually have an answer to that. Is that OK? I suspect that tax/fee regimes that encourage more long-term and less short-term (especially extreme short-term) investing might help. Limits on the amount of cash a company can raise via stock, relative to asset value and/or revenue and/or debt might help too, just as liquidity requirements for banks do. I don't have a complete formula, though, and recognize that some measures would merely change the problem instead of solving it.



Capitalism itself is based on the recognition that these human tendencies exist but can be channeled in constructive directions. I don't see why that assumption should change when applied to markets for capital instead of products.

I certainly agree with this. Although I don't like it, and wish it weren't true (it's becoming less so), I don't see how this impacts the lives of 99.9% of the investors out there. They can still buy and sell the same stocks at the same prices that they would get if the system were completely fair and equitable--they just don't have access to some of the 'sweet deals' that others do. But these deals don't really do anything to hurt the other investors, they're just opportunities not everyone has access to.



No disagreements here (although I would add that current tax policies are set up to do just that--which was one of the major points of the recent capital gains legislation). I would throw out another solution, although I'm not sure how this would ever get implemented. Have companies include cash flow in their earnings statement. Almost all of the manipulations corporations do to effect their stock price have to do with earnings, which can be manipulated. Cash flow is a much better indication of corporate health, and much harder to manipulate. If you looked at Enron, WorldCom, and almost every other company that has had a spectacular rise and subsequent fall, their earnings told a misleading story, but their cash flow would have clearly pointed out that they were in trouble.

As for the trading rules themselves, I think this will eventually even out as more investors become aware of the problem and a groundswell develops to remove these inequities. For example, with so many trades being initiated online now, this has driven down margins, and squeezed out many of the differences between markets (which insiders used to use to get significant earnings). Margins in these types of trades used to be on the order of 25 or 30 cents per share, now they're down to a penny or so. So, the problems are being addressed. Would I be opposed to legislation or regulation that improved upon/sped up this process? Absolutely not. Do I feel that these inequities indicate a sweeping overhaul of the system is needed, or that stock markets are so bad they shouldn't exist? Again, absolutely not. (sounds like we may agree here--just arriving at this point from opposite directions).

I'm reviving this thread because i had a thought:

The stock market basically is used to put your money into something and see if you can get rich on it. BUT....if the stock goes down severely for some reason (I.E. Aftermath of a terrorist attack on US soil), you lose money. You lose money, you lose your house. You lose your house, your out on the streets. Is that fair???

Also, the stock market creates a level of bureacracy (the SEC) to keep tabs on investors and it wastes government spending and time. Look at the SEC budget and you will see a huge number.SEC Budget: $842 Million What can that SEC budget be used for? Domestic things like roads, HealthCare, a new energy plan to prevent another "Blackout of 2003", welfare or EDUCATION!!

GA, you're not understanding the market, I think.

If you invest cash into the market, it's like investing in a new car expecting it to become a classic. If it doesn't, you're out the money you but into the car, but nothing else.

If, on the other hand, you BORROW money to purchase the car, then you're spending money you don't have. People borrow too much money all the time: they get in over their head on their house, they run up credit cards, etc. I don't see any movement afoot to do away with mortgages or credit cards.

Same with the market: if you invest cash, you're only risking that cash. If you BORROW money -- purchase on margin, sell short, etc. -- you are spending money you don't have and can run into trouble.

All this seems completely "fair" to me, since it's human choice involved in a somewhat monitored transaction.

As for the SEC, considering that they are trying to monitor a multi-trillion dollar enterprise -- the markets for securities -- I'd say having less than $1 billion is a pittance and wholly inadequate. As witnessed by their lack of ability to spot the frauds of Enron, WorldCom, half of all mutual fund companies, etc.