Does the public stock market actually serve a purpose? To some free-market zealots, the answer is obvious: The public markets increase liquidity, and this enables fledgling businesses to get off the ground by allowing them access to capital. Moreover, we can all reap the benefits of capitalism’s “creative destruction” and become a nation of investors (as opposed to one of actual producers). For well over a decade, the public bought this line with increasing gullibility. New research, however, suggests that the only institutions public financing helps are those which arrange the financing. That is to say, public equity finance is a business whose greatest beneficiaries are its salesmen.
Lawrence E. Mitchell, a professor of business law at George Washington University, argues in a recent paper that the “empirical evidence is clear that the American public stock market rarely has been a significant factor in financing industrial enterprises in the United States. The only American business sector to rely upon public stock issuances as an important source of financing public activity is the financial industry itself.” Based on data going back to 1955 and in some cases even earlier, Mitchell finds that “America’s economy is increasingly based on finance, and our public financial markets principally are financing finance.” In fact, he concludes, “the data raises the question of why we incur the very substantial economic and social costs of a public stock market in the first place.”
It is a question worth asking in light of the large-scale collapse of the stock market—precipitated in significant part by the even larger collapse of the mortgage and credit markets. The “market”—by which nearly everyone means the stock market—was supposed to make us all rich, but we seem to have forgotten that there should be some real value behind all that common stock. The crisis indicates that when you build a market on value that everyone merely believes to be worth something—until they don’t—that market may not provide long-term stability.
It seems that when people have wanted to build a business that produces something—food, materials, other goods—they have had little need historically for the public markets. When you want to sell financial snake oil, however, you “go public” and get investments from average Americans and their pension-fund managers seeking a quick profit. Worse, obsessions with quarterly results and no-strings profits have made the market more volatile than ever before; most “investors” should be called “traders,” as the reason for holding stock is no longer to increase wealth over time at a rate greater than inflation but to turn it over quickly by selling as soon as the price rises.
Mitchell’s research comes out at a fortuitous time, as the federal government is pumping money into financial institutions to keep the markets going, in order to “avoid chaos.” The major investment banks have either folded or turned themselves into normal, staid commercial banks. As Mitchell’s paper implies, the government might have been better off lending our tax dollars to companies that actually build something—or, better yet, reducing our tax burden.
This article first appeared in the January 2009 issue of Chronicles: A Magazine of American Culture (Cultural Revolutions).