Enron: How can money really be lost?

Factual Questions
1

I don’t understand investments. Money gets invested. It goes into someone’s pocket somewhere. Call him “Fred”. Let’s say that “Fred” then invested $1MM in stocks of weakening Company X. He’s betting that Company X will bounce back stronger than ever, but instead it soon folds. OK, he’s out $1MM, but someone of Company X gained that $1MM!

Even if Company X spent his $1MM on retooling before folding, then some tool and dye shop made $1MM! Or, maybe they banked the $1MM. Maybe the CEO moved the $1MM into his personal bank accounts…do we care? The money is somewhere!

The point is that the money, as I see it, isn’t lost! Somewhere, somebody got Frank’s money! And, it hasn’t left the economy, even on a global scale, so where dies the money go??? I don’t get it! Maybe I’ve oversimplified the issue and/or I am quite naive on such matters.

OK, so call me naive! But, how can money ever be lost, really?

  • Jinx, the dumb, deaf and blind kid who sure plays mean pinball!
2

Well, if someone stole your wallet, you’ve lost money and the fact that it’s in the hands of the crook is hardly a consolation.

When you buy a stock, the money (less commission) goes to the seller. If the stock drops, you have lost the money you invested. That’s really all that matters to you.

3

BTW, when you buy a stock (other than in the Initial Public Offering), the company gets none of the money. The money goes to the person who sold the stock and the brokers involved.

4

Jinx,

This is an oversimplificiation, but will hopefully help you see the error in your reasoning in regards to “lost money”.

In order to not complicate things, let’s just assume Fred earned and saved his $1 M. He then invests it in Acme Company (and, for simplicity, let’s say he bought the shares directly from the company, such as through an IPO). For his $1 M, which goes to the company, he receives 1 M shares of stock. That is the value he received for his $1 M investment.

Now, Acme didn’t just arbitrarily make up the price of its shares as $1. It had to justify that price in order to get Fred to buy their shares versus some other companies. Acme might justify the value since they see a strong market to sell roadrunner catching widgets to Wile E. Coyote, and they will make big profits, and share those profits over time with Fred, the amount of which is approximately valued at $1 M today.

Scenario 1:

And now the unexpected (and a totally unrealistic) thing happens - Wile E. Coyote dies. Acme already took Fred’s money and bought widget making machines. Now, the entire worldwide market for roadrunner catching widgets is zero, and that million dollar equipment is also worth zero. And Fred’s investment is worth zero. It is not the money that was lost, it was the value of the investment.

Scenario 2:

In a surprise decision, a court finds in favor of a class of coyotes against Warner Bros, for slander of their ineptitude of catching roadrunners. Now, instead of just Wile E., millions of coyotes can now afford Acme’s roadrunner catching widgets. Since only Acme has the equipment to make widgets today, their sales skyrocket beyond expectations. Their profits soar, and the prospects for more money paid as dividends to Fred increase. Other investors, wanting in on the action, offer to pay Fred $10 M for 500,000 of his shares. Again, money wasn’t created, value was.

Now, certainly, money can be lost (destroyed, for example). Creation of money or replacement of money is an issue of money supply by the US Treasury, and is not (directly) related to the creation/loss of value as described above.

Hope that helps.