Financial Markets Made Simple

There have been two significant pieces of financial news lately. One received significant attention, the other received relatively little. Together, they illustrate an important lesson about how money works: Reasonable risk taking is usually rewarded, greed is often ultimately punished.

We have heard a lot lately about the downfall of Bear Stearns as a symptom of the national “Credit Crisis”.  A year ago, this huge financial institution had a “value” in the neighborhood of $170 per share, and two weeks ago had to be propped up to $10 per share by a federal bail-out. How can a company have such a dramatic loss of value over such a short time?

The value of a company is based on the perceived worth of its assets and business activities. When a company attempts to create value by making highly speculative investments, chances are that those investments might lose value instead of gaining.

Meanwhile, Oakland County had its AAA bond rating renewed.  The folks who rate the quality of investments were willing to do this because they are virtually certain that if Oakland is backing financial instruments, the payments will be made. As a result, Oakland County will have an easy time selling its bonds, and can keep its costs down

The point is that there is no shortage of money available to be loaned or invested. Indeed, while it will take a few months for the effects to show in the market, the actions of the Federal Reserve appear to have freed up a lot of money. The question is; Where will the money go?  I suspect that it will be much more willing to accept a reasonable return on a relatively secure investment, as opposed to chasing a unrealistically high return on speculative investments that are not based on sound underlying value.