It amazes me the way the market can correct itself in ‘ersatz’ ways.

No banks to perform a run on to correct mal-investment? That’s fine, we’ll do it with investment banks now.

A new ending for the old tale of the king’s new clothes.

And the King decreed that from henceforth no little boys should comment upon the King’s clothes. With this decree the King was nevermore seen without clothes.

That’s a real fairy tale.

aside from the valid points mentioned by the above posters, there is the inconvenient fact that proving “insider trading” is almost impossible. most successful convictions rely on admission of guilt, or obstruction of justice, etc.

Free Jeff Skilling and pay him $50 million with taxpayers money!
As a result of the Fed’s intervention, the Bear Stearns chairman was able to cash out his worthless stock for $56.6 million! Compare this with the plight of Enron and Worldcom – here the senior officers not only lost all their stock but were also prosecuted and convicted of crimes and sentenced to huge prison terms.

“When will we learn: Stocks are pieces of paper that convey partial ownership of an earnings stream. When the debts overwhelm the earnings then the stock is worthless. When this happens there is no amount of rumour or mainipulation that can stop this.”

Actually it is less than that. It is a claim on the assets of the corporation, in reality only payable on the corporations liquidation – after the primary creditors and preferred stock holders get their money. That’s why stock prices go to zero when a company goes bankrupt – the common stock holders will get nothing in the liquidation.

The only reasons to buy a stock are the hope that it will go up in price and that it can then be sold at a profit or that the company will voluntarily grant a dividend. Often those are good reasons – but anybody buying a stock because they think it gives them some sort of claim on the companies profits aught to re-evaluate their investing strategy. There is no tangible relationship between the earnings of the company and it’s stock price – except that the market in general thinks that a stock is more valueable and will go up in price if it has higher earnings than were assumed at the last price of the stock – it’s kind of a circular argument but it seems to work most of the time.

Ownership of a stock gives you no enforceable claim on any earnings stream. Try getting the Google corporation to give you your piece of their massive profits when your stock has lost value. You will get nothing but laughed at (if that).

Back before the SEC and all the massive Wall Street regulation of the 1930′s, the best way to determine the value of a stock was not by it’s reported earnings, but by the dividend it granted. Anybody who has studied accounting knows that there are 50 different ways to report the same quarterly financial condition and come up with a different amount of net earnings. And all of them would be “correct”, just different interpretations and different methods of capitalizing assets, the timing of debts, etc.,etc,etc.

But dividends have a very limited number of ways they can be interpreted. A company cannot grant a dividend for long if it does not have the cash flow to pay it with. A larger dividend tells the world that the company’s profits have gone up, a smaller dividend tells the world that the profits have gone down. Most valuation models still incorporate dividends (and a guess about the increase in price) because they are the only tagible thing that can be measured with which to value a company’s stock.

When people on Wall Street tell you that stocks have returned something like 12% per year on average over the 20th century, what they usually neglect to tell you is that 95% of that gain came from re-invested dividends, not stock price appreciation. In fact, when accounting for inflation and excluding dividend re-invetment stock price appreciation has been extremely low over the same period, close to zero. But few on Wall Street will tell this story because it would be bad for the stock trading business. Presenting charts that go straight up over 100 years is a much more effective advertising tool.

But in the world of unintended consequences, the focus on accounting profits – regulating accounting practices and reporting as if there was “one” objective answer to “how much profit did a company make” – has distorted the market in stocks to focus on accounting earnings as if they were facts. But accounting earnings are a very subjective measure, highly open to manipulation even when using standard accounting practices.

Cash flow – as evidenced by dividend payments – is much less open to manipulation – in essense you have to lie about how much money came in and how much went out in order to fake your cash flow. That’s why the smartest Wall Street analysts spend enormous amounts of time disecting financial statements to determine the real cash flows.

This change in focus has transformed stock ownership from an investment that returned a regular cash flow in dividend payments to simply a bet on whether the price of a stock will go up. The primary way to make that bet is, unfortunately, by analyzing what the company says were its accounting profits in the past and assuming that this tells you something abut the future. We have moved from a system where the primary determinant of a stock’s value was judged by the payment of a portion of the cash flows to the stock owner, to one where the value is determined solely by opinion – what the company claims about it’s financial condition and how the investing public interprets those claims. This has been so ingrained in the investing public that nobody even thinks it’s odd anymore.

This is also a prescription for ever more regulation and oversight because the system is based on subjectivity not objectivity. In a system where the price of a stock is simply the summation of the opinions of millions of people, rumors can have a significant effect. But at the heart of it, ALL stock values are based solely on rumor – there are very few tangible facts any more on Wall Street, only opinions. How do you regulate the difference between “true” and “false” opinions? Unfortunately regulation will have to increase until the expressing of any opinion about a stock is illegal.

This from today’s Bloomberg.com: With the credit crisis entering its ninth month, Bank of England Governor Mervyn King and European Central Bank President Jean-Claude Trichet are on the verge of new steps to spur lending and increase liquidity, say economists at Lloyds TSB Group Plc and Royal Bank of Scotland Group Plc. Interest-rate cuts may be next if the crisis persists.
What will this do? It will stop the dollar’s fall against the pound and euro. The Brits and Euros will inflate their money supply, and take an inflation bullet for us, in order to mask the effects of Bernanke’s flooding the economy with dollars. The real result will be international inflation on a grander scale, much like what happened in the 1920′s.

DS: Thanks for an excellent and informative comment.