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Money Money Money

May 29th, 2009 - 8:37 am

That’s my favorite headline above. Stole it from Dr. Johnson, an econ professor at Mizzou way back when. He worked in the Johnson (no relation) Administration and was a dyed-in-the-wool liberal, but he was always saying, “Money, money, money — I love it!” Great teacher, too.

I bring him up because one of my regular readers – and a smart guy, too – had this to say about GM’s bondholders getting screwed by the President:

Someone is going to get screwed, but I have a hard time coming up with a whole lot of sympathy for those bondholders. All those years of hearing about how they shouldn’t be taxed for capital gains at the same rate as people who work for a living has made me realize that it’s about fucking time that that “risk” they used to justify that difference probably should bite them on the ass in this instance. GM was a bad investment, and the government is being told that millions of jobs are less important than bond portfolios?

I’m empathetic to their plight, but I’m not sympathetic. Yeah, yeah, I’ll hear about confidence in the markets. But I think saving literally millions of jobs is a bigger confidence-builder than bailing out billionaires. It would be nice if we could do both, but it was the billionaires that got themselves into this mess. Bad investments have consequences.

Evil speculators, blah blah blah. Actually, most GM bondholders (or anyone’s) aren’t billionaires, they’re regular folks looking to save and make a buck. Although even if they were all billionaires, the point would remain the same. And I’ll make that point right now. Two points, actually, but they’re related.

1. All investment is speculation.

2. The secondary market makes the primary market possible.

The first point is easy. You invest, but there’s risk. The higher the risk, the higher the reward sought. Everybody knows that one. You also should bear in mind that no matter how risky (or safe) an investment might be, you always always always seek to minimize that risk. That’s not just the invisible hand or whatever, that’s human nature. And it’s a good thing.

The second point is a little more subtle, but nothing difficult to understand. And it applies to both stocks and bonds. When you buy a newly-issued bond from GM, you’re the primary market. If I buy that bond from you, I’m the secondary market. And if I didn’t exist, you would never buy bonds from anyone.

When you buy a bond in the primary market, whether it’s AAA stuff from the US Treasury or junk from GM, you seek to minimize your risk. You want the best price and return you can get, but just as importantly, you want to know that if you ever need or want to sell that bond, there will be a market for it. That’s the secondary market. In other words, if you change your mind and decide that GM’s (or Washington’s) management sucks, you’ll be able to find someone to give you cash for your bonds. Maybe at a discount, maybe at a profit.

But, and let me reiterate here, you wouldn’t have been a primary buyer unless there was at least the potential for a secondary buyer. You can call the secondary market a bunch of predators or speculators or greedy Jews, but remember Point One — all investment is speculative. And the presence of those evil “parasites” makes your “noble” investment both desirable and possible.

(Why some folks think that the primary market is all nice people and the secondary market is all pond scum is beyond me. Remember that with the exception of the occasional IPO or new stock issue, the entire stock market is a secondary market.)

And another thing…

During bankruptcy, bondholders get paid first for very good reason — they traded power for security. When you buy a bond, you get no say in how a company is run. Instead, your investment is secured by real assets. So your risk is less, but so is your reward — bondholders typically make less than stockholders when a company does well. Stockholders not only get a say in how a company is run, but they also can make some really wild profits. Of course, not being secured assets, stockholders typically fare worst when times are tough. That’s their higher risk.

So. If bondholders discover that their assets aren’t actually secured, or that the bond market has been corrupted, they will disappear. There are no fixed entities called “Bond Buyers” who buy and sell bonds because that’s what they do. No, if the bond market sucks, or appears to be rigged, those people will disappear. And they will take corporate (and public) finance down with them.

If no one buys corporate debt, then say goodbye to economic growth. And if no one buys public debt, then say hello to hyperinflation. And then you really will be looking at millions of lost jobs.

And yet another thing…

If GM goes belly up (which it’s going to do anyway, duh – they’ll file C11 on Monday), millions of jobs will not be lost. Let me repeat: GM could disappear tomorrow, and not much would change. GM barely employs 50,000 people anymore. And the people they do employ destroy wealth, they don’t create it — that’s the definition of a money-losing operation.

Bankruptcy allows GM’s assets to go to people who will, it is hoped, use them to create wealth — that’s the definition of a money-making operation. And if GM’s new owners can’t make a go of it, then the company will go away and, at the very least, stop losing money. Workers will find new jobs, because the economy will improve once we stop propping up wealth-destroying outfits like GM.

If Old GM goes away, in other words, we’ll all be richer. But we’ll all be poorer — like, Zimbabwe poorer — if we destroy or corrupt the bond market.

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