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Gambling on Stocks

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Nationalization wipes out equity.

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Over the weekend, U.K. Prime Minister Gordon Brown decided to nationalize troubled lender Northern Rock after rejecting bids by the bank's own board and Richard Branson's Virgin Group Ltd. The rival offers reportedly didn't do enough to protect taxpayers – who had become the bank's largest creditors.

The bank's shares are essentially worthless already, and any remaining value is sure to be wiped out during the nationalization process.

The rapid unwinding of the credit bubble and its effect on companies like Countrywide (CFC) and Northern Rock show just how speculative an equity investment really is. As recent as July 20th, 2007 Countrywide's stock stood at almost $35 per share. Less than six months later shares bottomed out under $5 as the company faced bankruptcy and eventually agreed to be acquired by Bank of America (BAC). Hardly enough time to organize a proxy fight.

Now more than ever, investing is little different than pure gambling. When billions of dollars in equity can be wiped out overnight – see Credit Suisse's (CS) 'pricing error' – shares in a company represent nothing more than the market's whim on a given day.

We're taught that shares of stock represent ownership of public corporations. Invest in a company and reap a portion of the profits in good times, while retaining the right to toss out lousy management during bad ones. Glossed over is the nontrivial fact that if the company goes belly-up, shareholders stand at the back of the line to pick up the pieces.
No positions in stocks mentioned.

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