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Inventing Value: financial value in practice

This is the second of four posts composed of extracts from the introductory chapter of my recent book Inventing Value (Cambridge UP, 2022).

“The second, more empirically oriented, part of this book is about these processes in which finance sector actors influence asset valuations. It discusses how asset circles are constructed and how their members are persuaded to apply particular lay theories of value to the assets they are interested in. Having introduced these concepts in the first four substantive chapters, the next three use material from publicly available sources to apply the argument to three different classes of financial assets. All three are cases where value remains in doubt, either because the assets are relatively new or because their valuation has been in crisis. First, I discuss venture capital, which constructs high valuations for companies with highly uncertain futures in order to launch them onto the stock exchange; second, the cryptocurrency Bitcoin, where the entire valuation system still remains in doubt, and may yet collapse; and third, mortgage-backed securities and related derivatives: the precarious assets, invented and then constructed as safe by leading investment banks, that brought about the 2008 crisis.

My cases are all drawn from the riskier end of the spectrum of financial assets. In a sense the advocates of each of these groups of assets are seeking to borrow the discourses and theories of value that underpin the valuation of financial assets at the safer end of the spectrum – assets like shares in well-established companies with steady divided flows, state issued money and government bonds – and apply them to quite different types of asset. The very uncertainty of these cases makes the work that is done to persuade potential investors more apparent.

I begin in chapter six with the case of venture capital, which in some ways is the simplest case because venture capitalists are not trying to introduce a whole new class of assets, but rather to invent value for new examples of a familiar asset class. Venture capitalists buy stakes in private companies and seek to develop them into larger companies that can be sold on, often by floating them onto the public stock exchange, ideally as unicorns – private companies valued at over a billion dollars – so that they can sell their stake at a large profit. In doing so they aim to create a new financial asset – public shares in the company they have invested in – but in a context where shares in companies more generally are a familiar asset within a well-established institutional and discursive context.

While venture capitalists seek to develop the revenues of the businesses they buy, arguably their largest contribution is to build an asset circle for the company’s stock and to spin a set of narratives about its value. The chapter traces this process through its typical stages, beginning with the business plans that form the basis for an initial investment by the venture capitalists – works of fiction that create a narrative about the business’s revenue prospects. Ultimately, however, venture capitalists have little interest in the revenues of the companies they back, except as a means to a very different end: the possibility of selling its shares at a profit. They thus gradually construct an asset circle, beginning with other venture capitalists who are persuaded to join in subsequent funding rounds, and then on to other major institutional investors when it is time to launch the stock on the public exchanges. At each stage narratives are constructed that connect the business being promoted to existing theories of corporate value and existing schemes of categories. At each stage every possible effort is also made to associate the business with existing institutions possessing the symbolic capital required to consecrate its value in the eyes of potential investors. Finally, in some of the most successful cases for venture capitalists, the initial public offering of shares provides a test of both the size of the asset circle that has been established and the success in establishing narratives that justify a value for it – and if successful, positions the venture capitalists for their payday. Venture capitalism is thus a complex of practices and organisations that builds businesses but also constructs their valuations, drawing on but also developing the wider culture of valuation that prevails in the finance sector.

By contrast with the case of venture capitalists, the advocates of Bitcoin have invented a whole new class of assets from scratch, and done so outside the framework of established financial institutions. Bitcoin is an electronic currency, based on a blockchain: a cryptographically secured distributed database of previous transactions. Chapter seven investigates how this new type of asset has come to be regarded as having value. What kinds of discourses have been deployed? What valuation conventions have been invoked or developed? Which audiences have these discourses been addressed to? What forums have been used to address these audiences? How have they been persuaded to join the asset circle for Bitcoin? These discourses have functioned largely outside the mainstream financial system and yet they have succeeded in constructing a purely virtual asset as valuable. This provides an illuminating comparison with the more mainstream cases. It shows the processes of narrative construction very clearly, in a context where existing financial power was largely absent, demonstrating both the potential and the limitations of such situations.

Bitcoin began life, not as a financial asset, but as a form of money. Its early advocates were not trying to create an asset circle but a monetary circle for Bitcoin: a group of social actors willing to accept Bitcoin in payment. Their early narratives were thus strongly oriented to the strengths of Bitcoin as a means of payment, but these narratives have encountered significant resistance. Although they remain in circulation, and continue to provide a motivation for some Bitcoin buyers, there is a sense today in which they are merely the ideology of Bitcoin, while most owners of Bitcoin now hold it as an investment, a financial asset. More recent narratives of Bitcoin’s value have become increasingly oriented to its potential as an investment, and gradually the original monetary circle has been supplemented and arguably largely supplanted by an asset circle: actors who regard it as a potentially valuable investment.

Because Bitcoin does not generate a revenue stream, other than the possibility of selling it on in the future, it is in some respects a particularly pure form of financial asset: one whose value depends entirely on the belief that it could be sold on in the future at a profitable price. Its valuation conventions are therefore also separated entirely from beliefs about such revenue streams and instead depend very much on beliefs about future price changes – an example of what Keynes referred to as the “beauty contest” model of financial markets (Keynes, 1973, pp. 154–5). In this model, potential buyers and sellers of an asset value it on the basis of what they think other buyers will be willing to pay for it in the future. In such contexts, asset prices are notoriously volatile. At the same time, however, there remain “hodlers” of Bitcoin who continue to hold it for more ideological reasons, providing a relatively stable minimum membership of its asset circle and thus insulating it from total collapses in value.

The contrast between Bitcoin and the topic of the third case study could hardly be greater. Chapter eight deals with the rise and fall of structured securities built from subprime mortgages in the early twenty-first century. These were relatively new products, which “sliced and diced” low quality mortgage debt to create new securities that were often given AAA risk ratings and purchased in large numbers by major financial institutions. While the early backers of Bitcoins were complete outsiders, the inventors of these new securities were some of the most powerful actors in the global financial system: the US investment banks. While the dominant discourses have tended to dismiss Bitcoin as a dangerous unstable invention of cranks, until 2008 they presented mortgage-backed securities as one of the great innovations of modern finance. Yet they turned out to be equally unstable and in 2008 their value collapsed, threatening to bring the world financial system down with them.

While the narratives of Bitcoin’s value were built on its innovative nature as a new kind of asset, the most important narratives of the value of these new kinds of securities positioned them as just another variation of an already familiar form of financial assets: fixed-income securities like government and corporate bonds. Considerable care and indeed power were devoted to having them rated by the same credit agencies that rated those bonds and therefore to having them positioned in the market as equivalent to those bonds. A security backed by subprime mortgage repayments could therefore receive the same AAA rating as the safest bonds, which made them investible by the most conservative mutual funds and investment managers. Rather than constructing a new asset circle for these new kinds of assets, the investment banks constructed a narrative that inserted them into a class of assets that was already backed by an asset circle with a huge amount of investment funds at its disposal.

The success of this insertion in turn depended on the enormous multi-faceted structural power of the investment banks. Their political power had enabled them to push back regulation of financial innovation since the 1980s, making it possible for them to sell risky new products with little or no regulatory intervention, and indeed they continued to employ that power to protect these assets from regulation until the crisis unfolded. Their discursive power – their symbolic capital, in Bourdieu’s terms – meant that potential investors were willing to trust their narratives of safety and equivalence for these new products. And their economic power enabled them to manipulate the ratings system to secure the high ratings from the credit agencies that were required to make these securities acceptable to major institutional investors. Their power to construct value for these securities made them enormous profits, but also had a devastating impact on the global economic system when the narrative could no longer be sustained.

On the one hand, these case studies begin to illustrate the sheer diversity of the financial assets that can be constructed as valuable and of the actors inventing their value. On the other, they reveal the similarities between the structures of value in all of these different cases. In every case the process depends on the construction of narratives of value that encourage potential buyers to see the financial instrument concerned as an investible asset, shape how they categorise the instrument, and thus influence the valuation conventions or lay theories of value they are willing to apply to them. None of this is natural or inevitable, and the assets the process constructs are utterly dependent on the complex of institutions and discourses that sustain these narratives. When the narratives are cast into doubt, so are the assets upon which our entire contemporary financial system is based.”

Sources

Keynes, J. M. (1973). The General Theory of Employment, Interest and Money. Macmillan.

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