Wall Street's Trick - Marginal Pricing

The role of the bank is to provide capital to borrowers who intend to create wealth with the loan from lenders who have surplus capital to invest. The task of the bank is to judge if the borrower will make enough wealth to repay the loan and their charges of acting as the intermediary. If the bank is successful in doing this it has acted as a catalyst in the wealth generation process but it is not the direct producer of the wealth. Unfortunately with sub prime lending the banks have failed in their role. The banks themselves exists as part of the stock market and financial industry which is a larger process of matching borrowers with lenders. In order to have users (i.e the investor/lender) of their services the financial system must promise (its sales pitch) that enough wealth will be generated via their good judgement in the direction of this capital to reward the investor - minus their charges. Dividends and stock prices are the indicators of the wealth created. Dividend payouts and more importantly stock price increases are the way the financial industry shows that its service has delivered.

Stock price increases are more important because they happen more frequently than dividend payout and cost less as they only reward the marginal sellers (i.e most people are happy with the psychic income of the price going up rather than taking it as they wait for even bigger gains). This pricing at the margin is the key marketing technique that the financial industry uses to sell its services and takes advantage of the lack of understanding of the difference between marginal and absolute prices and the financial industry advertises marginal stock prices as absolute prices. In other words, if there are 1,000,000 shares of a company and last 100 shares of a company sell for $100 then people believe that all 1,000,000 shares are worth $100. It is this misunderstanding the leads people to believe that we are now wealthier than we were before and also that the financial industry has actually creating this wealth. All the financial industry needs to do is keep driving up the marginal stock price by getting more buyers than sellers and it looks like they are generating real wealth. The problem of course is when the sellers become much greater in number than the buyers and quickly discover that there is a much lower marginal price and the repricing of all the shares makes it look like wealth has instantly evaporated. The financial mantra is not to sell and wait until the recovery as in the long run shares go up. However, the new demographics of the western world do not bode well for this as older people do not have the time wait for the recovery and being very risk adverse will remain sellers.