Friday, October 17, 2008

Why do we need stock markets?

Traders in London

The Magazine answers...

Share values have dominated the news for weeks yet for many of us they seem a world away from our day-to-day life. Professor Alec Chrystal explains why stock markets exist.

It is easiest to answer this question with another question which is: why do we need companies?

Companies are legal entities which exist to co-ordinate the production of the goods and services that a modern economy delivers, and in the process provide employment to large numbers of people.

They are where many of us work and from which we buy many of the products we consume. They are not the only form a business organisation can take. Government-owned companies would be called public corporations. Small businesses may be "sole traders" or partnerships, which are not companies.

Whenever a company is formed, its owners are the shareholders. Some companies may have only one shareholder and if that is a single person then it will be a private company. If there is more than one shareholder, they own the company jointly, and the size of each share of ownership depends on the proportion held of the total number of shares in existence. So if a company had 100 shares issued then the owner of 10 shares would own 10% of the company.

Why sell shares?

A key reason for forming a company is that the shareholders of a modern company have "limited liability". This means that a shareholder can lose what they paid for their shares in a company but they are not liable for the debts of the company beyond that. This is not true in, for example, a partnership, where partners are jointly liable for all the debts incurred.

Investing in company shares is thus potentially attractive, as shareholders get a share of the profit of the business but know that the worst that can happen is that they lose the value of the original investment.

Many shares are not very volatile at all in normal times, but the recent past has been a very abnormal time

Thus, wherever we have companies we must also have shareholders. Does this also mean we must have markets in shares?

The answer here is no. The Bank of England is a company and its only shareholder is HM Treasury but there is no market in its shares. Virgin is a private company so its shares are not for sale.

It is entirely up to the existing owners of such companies to decide if they want to sell shares to others or not. However, many companies have taken the decision in the past that they do want to sell shares on an open market and the largest of these companies will have their shares traded on an organised stock exchange.

These are known as "quoted companies" and the prices of their shares can be read in the financial press each day. Anyone who wants to can buy these shares, though most are held by big investment institutions such as pension funds and life assurance companies, which hold these on behalf of their members or customers.

Billboard in London
Do we all feel the pain?

The benefit to companies from having their shares publicly traded is that they can issue new shares to raise capital for future investment. The only alternative source of funding would be to increase debt (by borrowing more from banks or issuing bonds).

The benefit to investors from having shares traded is that they are not locked into the investment for an indefinite period. Shares held can be sold at their current market price whenever the markets are open.

So why are share prices so volatile? A partial answer is that many shares are not very volatile at all in normal times, but the recent past has been a very abnormal time.

And share prices are determined by the balance of demand and supply in the market at any point in time. If there are more sellers than buyers, prices will fall and vice versa. Share prices will move most when there are big news events affecting investors' perceptions of the future prospects for the company concerned.

A regular feature in the BBC News Magazine - aiming to answer some of the questions behind the headlines

The value of all shares outstanding in a company (the "market cap") is the current market value of the future profit stream that that company is expected to generate. For example, when oil prices rise sharply, investors will calculate that profits of oil companies are likely to rise in future, so prices of shares in companies like Shell and BP will jump up.

There are times when waves of excessive optimism drive share prices up, such as during the dotcom bubble. The recent episode of share price falls has been a product of pessimism about the prospects for survival of many banks, followed by pessimism for the immediate prospects for many other sectors of the economy in a global slowdown.

Share prices convey the message but the existence of traded shares is not the cause of the problem. The problem is the mistaken investment lending decisions of the many financial institutions that forgot that house prices can fall and that most loans are risky.

Shared pain

For individuals who own shares, a price fall represents of real loss of wealth. This may recover over time, but the recovery may be slow and cannot be guaranteed.

For those who are close to retirement and have pensions with a significant proportion of the funds invested in shares, or mutual funds, the effect could be especially significant. The value of their pension pot at current valuations will be significantly lower than earlier in the year.

The best strategy is probably to postpone retirement (where possible) and certainly to postpone cashing in the pension pot and converting it into an annuity. If in any doubt as to the best course, seek independent professional advice. There can be no guarantees that the worst is over, and even if it is, the recovery may be slow and measured in months and years, rather than days or weeks.

Alec Chrystal is head of Faculty of Finance, Cass Business School, City University, London.

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Wells Fargo Profit Falls as Credit Weighs

Wells Fargo, whose planned purchase of Wachovia Corp will create the largest U.S. retail branch banking network, said on Wednesday third-quarter profit fell 25 percent, hurt by higher credit losses and investment write-downs.

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Net income dropped to $1.64 billion, or 49 cents per share, from $2.17 billion, or 64 cents, a year earlier, the fourth straight quarterly decline.

Revenue rose 5 percent to $10.38 billion, while expenses fell 3 percent.

Analysts on average expected a profit of 34 cents per share on revenue of $11.08 billion, according to Reuters Estimates.

San Francisco-based Wells Fargo [WFC 32.06 -1.84 (-5.43%) ] was able to wrest Wachovia from the arms of Citigroup [C 14.88 -1.02 (-6.42%) ] with a $15.1 billion all-stock takeover, largely because it never dove deeply into the risky mortgages and exotic debt that strangled Wachovia and rivals such as Washington Mutual, Countrywide Financial and IndyMac.

The merger has won federal regulatory approval and is expected to close this quarter. It would create the nation's fourth-largest bank, with more than $1.4 trillion of assets, close to $800 billion of deposits, about 6,600 branches, 48 million customers and 280,000 employees.

In buying Wachovia, Wells Fargo is expanding east of the Mississippi River, a big change for a lender known for a stagecoach that evokes 19th century westward migration. Wells Fargo said it saw a "tremendous inflow" of deposits late in the third quarter as nervous depositors fled rivals.

"We're known and admired for our conservative financial position and a disciplined acquisition strategy that will not change," Chief Executive John Stumpf said in a statement.

Wachovia, based in Charlotte, North Carolina, was pummeled by a $122 billion adjustable-rate mortgage portfolio it took on when it bought California lender Golden West Financial Corp in October 2006.

Wells Fargo expects new federal tax deductions to cushion a $74 billion write-down tied to Wachovia's lending.

Shares of Wells Fargo rose 3.6 percent to $34.74 in pre-market trading.

Home Equity Losses Elevated

In the third quarter, Wells Fargo added $500 million to loan loss reserves, or 10 cents per share, largely for expected increases in credit losses in several consumer businesses.

The bank set aside $2.5 billion for credit losses, while net charge-offs more than doubled to $2 billion.

Chief Credit Officer Mike Loughlin said home equity loan losses will be "higher than normal" until home prices stabilize.

Results also included $646 million of charges for exposure to Fannie Mae and Freddie Mac preferred stock and Lehman Brothers [LEHMQ 0.07 -0.01 (-12.5%) ] bankruptcy.

Profit rose 10 percent to $1.59 billion from retail banking, and fell 86 percent to $83 million in wholesale business banking.

Wells Fargo Financial, which lends to less credit-worthy people, had a $33 million loss. Net interest margin was 4.79 percent, compared with the second quarter's 4.92 percent and 4.55 percent a year earlier.

Adding Wachovia would allow Wells Fargo's branch network to surpass those of Bank of America [BAC 23.24 -1.01 (-4.16%) ] and JPMorgan Chase [JPM 39.33 -1.16 (-2.86%) ].

Wells Fargo would trail Citigroup, JPMorgan and Bank of America in assets, though the latter will regain the top spot when it buys Merrill Lynch [MER 18.15 -0.20 (-1.09%) ].

Billionaire Warren Buffett's Berkshire Hathaway [BRK 119800.0 6650.00 (+5.88%) ] is Wells Fargo's largest investor, owning 8.8 percent of its stock on June 30, Thomson ShareWatch said.

Wells Fargo shares closed Tuesday at $33.52 on the New York Stock Exchange. They have risen 11 percent this year, compared with a 30 percent drop in the KBW Bank Index.

Copyright 2008 Reuters.

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Bid to create world's largest sandwich in Iran fails after crowd eats it before it can be measured

By Niall Firth

The meat had been cooked, the sandwich almost assembled and assorted Guinness Book of Records dignitaries were patiently waiting by to give it their official stamp of approval.

But cooks in Iran were left in despair after their bid to create the world's longest sandwich failed when the crowd started eating it before it could be measured.

Event organisers had planned to stuff the 1,500-metre-long sandwich with 700 kg of ostrich meat and 700 kg of chicken, and display it in a park in the capital Tehran.

ostrich meat sandwich

Iranian workers prepare a giant ostrich meat sandwich in an attempt to achieve a Guinness World Record

But as the sandwich was being measured, chaos ensued.

The giant snack was gone in minutes, leaving the three Guinness representatives with a problem.

One of the event’s organisers said video footage of the sandwich would be sent to Guinness officials.

"We still think the sandwich will be recorded in the Guinness book because of all the evidence and footage that we will send them," claimed Parvin Shariati.

The stunt had been organised to encourage Iranians to eat a healthier diet.

Ostrich meat is far leaner than much of the Iranian diet with as half as much fat as chicken, lots of iron, and very little cholesterol - as well as being extremely tasty.


Iranians tuck into a giant ostrich meat sandwich - but they started eating before it could be officially measured

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Gitmo prosecutor consulted priest for help

SAN JUAN, Puerto Rico - Struggling with orders to prosecute a young detainee at Guantanamo Bay, U.S. Army Lt. Col. Darrel Vandeveld went online and consulted a well-known Jesuit priest for help with his concerns about the fairness of the military tribunals.

Vandeveld described a crisis of conscience over the prisoners' treatment and the ethical handling of cases that led him to quit last month as prosecutor.

"I am beginning to have grave misgivings about what I am doing, and what we are doing as a country," he wrote in the Aug. 5 e-mail, which the priest shared with The Associated Press on Monday night. "I no longer want to participate in the system, but I lack the courage to quit. I am married, with four children, and not only will they suffer, I'll lose a lot of friends."

Vandeveld's claims that the government withheld evidence from detainees has sparked criticism of the tribunals. But his correspondence with the priest and other statements suggest his defection was driven also by discomfort with the unforgiving treatment of detainees at the isolated U.S. Navy base in Cuba.

A 48-year-old veteran of the conflicts in Iraq and Afghanistan, Vandeveld has testified he went to Guantanamo in 2007 as a "true believer" in the Pentagon's specially designed system for prosecuting terror suspects.

He was assigned to lead the case against Mohammed Jawad, an Afghan accused of throwing a grenade that injured two American soldiers and their interpreter in Kabul in 2002. But he said the evidence he saw — some of which was withheld from defense attorneys — suggested the defendant was under 18 and may have been drugged before the attack. He saw other documents indicating Jawad was subjected to sleep-deprivation at Guantanamo.

Priest: Gitmo 'a sham'
In his e-mail to the priest, which was first reported Sunday by the Los Angeles Times, the Catholic said that while the detainees may be guilty, minimal thought was being given to their rehabilitation. He said he believed teaching tolerance would "end the hatred" of the Guantanamo prisoners.

The Rev. John Dear, a Jesuit priest and social activist, encouraged Vandeveld to quit, telling him the U.S. operation at Guantanamo is "a sham."

"God does not want you to participate in any injustice, and GITMO is so bad, I hope and pray you will quietly, peacefully, prayerfully, just resign, and start your life over," Dear wrote in his e-mail.

Dear has written several books on nonviolence and has been arrested dozens of times in protests. He was nominated for the 2008 Nobel Peace Prize by Archbishop Desmond Tutu.

The chief prosecutor at Guantanamo, Army Col. Lawrence Morris, said Vandeveld never raised any concerns with him. Morris also denied that the government withholds evidence, saying his office goes beyond what the rules require in turning over material to defense lawyers.

Vandeveld quit in September, but he did not go quietly. Instead he reached out to his opponent in the Jawad case, defense attorney Air Force Maj. David Frakt, and provided a declaration and sworn testimony describing breakdowns in the system for providing evidence to detainees.

He is at least the fourth prosecutor to resign from the tribunals. Others have accused superiors of political meddling or deliberately misleading senior civilian Pentagon officials about the quality of evidence against defendants.

Defining justice
In his Sept. 26 testimony, Vandeveld said his change of heart was influenced by details of Jawad's story and his own evolving view of justice.

"I seek more restorative or reparative justice, rather than the rote application of the law," said Vandeveld, who resigned after his superiors rejected his recommendation to pursue a plea deal with a light sentence for Jawad.

Jawad, now about 23, instead faces a life sentence if convicted of war crimes charges, including murder, at trial in January.

Vandeveld also testified that defense attorneys are unlikely to receive all the possible evidence in their cases because of disorganization in the prosecutors' office and the difficulty in obtaining documents from the military, the CIA, the FBI and other agencies.

"They have an impossible task of attempting to reconstruct six years after the fact all the evidence that has been collected in these cases," he testified.

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