Stock Market

Wall Street Lays an Egg," a headline in Variety announced in October 1929. In that understated sentence the show-business newspaper was saying that the New York stock market had collapsed. Beginning on October 24--remembered as Black Thursday--and culminating in an even blacker Tuesday, October 29, the value of securities dropped more than 26 billion dollars. Before the end of November 1929 the nationwide loss exceeded 100 billion dollars. Over the next few years the nation, and the rest of the world, slowly sank into the Great Depression (see Great Depression).

The crash of 1929 was never far from the minds of those who had experienced it. Although governmental safeguards had been erected, there was always the fear that a crash could happen again. On Monday, Oct. 19, 1987, it did. The 1987 stock market collapse, a fall of 508 points in the Dow Jones industrial average, cut the value of securities by more than half a trillion dollars. The total decline for October 1987 was 769 points. Although the point and dollar drops were far larger than those of 1929, the loss in terms of percentage of the market was smaller.

A few days after the crash of 1987, the journalist James J. Kilpatrick told his readers: "Those of us who know nothing about the stock market will never understand it. That puts us right in the same class with economists and brokers who know all about the stock market." He was not exaggerating. The stock market--or, more broadly, the securities industry--is far more complex than the markets for products and services. The stock market has been called the paper economy because it deals in money, certificates of ownership, and certificates of debt. The business of the market is the buying and selling of both types of certificates, normally called stocks and bonds. What complicates the market are all the devices that have been introduced into what was originally a simple business transaction. This article deals only with the most general features of the market.

The Function of Securities

Governments and corporations need money in order to operate. Governments get money in two ways: through taxation and through borrowing. When governments borrow, they issue bonds, or certificates of debt. These certificates pay interest to the people or institutions that buy them. Thus, a person who buys a bond expects, over a specific period of time, to recover the principal--the amount of the loan--plus the interest--the fee the government pays the lender for the use of the money. Corporations likewise have two means of raising money (apart from their own profits). They may borrow it, and in doing so they may also issue certificates of debt. These certificates are called debentures, or, more commonly, bonds. Like government bonds, they pay interest to the buyers.

The second way for companies to raise money is to issue stocks, which represent ownership in a corporation. A company is literally selling part of itself to raise money. (The terminology varies between Great Britain and the United States. In Great Britain a company is said to issue shares, while in the United States a company issues stock. In the United States stock is divided into shares--100 shares of IBM stock, for example; in Great Britain "stock" has the same meaning as "bond" does in the United States. This article uses the American terminology.) Bonds and stocks are together called securities. The term stock market, though somewhat imprecise, is used to name the industry in which stocks and bonds are bought and sold.

Just as governments must weigh the merits of higher taxes versus the merits of borrowing, so corporations must decide whether to raise money by borrowing or by issuing stocks. There is a greater risk in borrowing because the company puts itself in debt to someone else. If the debt cannot be repaid, bankruptcy may result. By borrowing, however, management has more control over the operations of the company, whereas when a corporation offers stock to the public, a degree of control is lost. Management becomes responsible to the ownership--those who hold the stock. Stock issues also decrease company income because dividends must be paid out to stockholders from company profits. New companies are quite likely to issue stock, since they are seeking venture capital, or start-up money.

Primary and Secondary Markets

Securities are traded in two kinds of markets: primary and secondary. When a corporation decides to issue stock to the public, it is undertaking a primary distribution. This first sale of stock is in the primary market, and the money received goes to the company.

If everyone who bought stock simply kept it and waited to collect dividends, there would be no secondary market. The main reason for buying stock, however, is speculation--the hope that the value of the stock will increase so it can be sold at a profit. A secondary market--by far the larger of the two markets--comes into existence because a share of stock, once it has been sold by a corporation, takes on a life of its own. It becomes a piece of property in itself. Like a work of art or a hoard of gold, a share of stock is regarded as something with a potential for increased value.

Owners of stocks (and bonds, as well) are continually in the business of trying to better their fortunes by selling and buying stock in the secondary market. A stock increases or decreases in value for a variety of reasons: the general business climate, the type of industry represented by the stock, the success of the issuing company, and more. Those who trade in the secondary market are basically speculators--they are betting that the stock they buy will increase in value and that the stock they sell will decline or level off. Shortly after the crash of 1987, the economic journalist William R. Neikirk stated: "It is not too strong to call our financial markets casinos." When stocks are traded in the secondary market, none of the money goes to the company that originally issued it. It goes to the seller, minus a commission for the broker.

When a market crashes, the fall occurs in the values of stocks traded in the secondary market. The values of company assets remain the same. In a secondary market a stock value may react to many factors that are completely unconnected to the company that issued the stock. The company itself may be perfectly healthy even as its stock decreases in worth.