Illustrated By Mortgages

A mortgage upon a building or a parcel of land may be at the time a very desirable investment,but an upheaval of nature's forces may occur on the spot where the pledged land is located and destroy all the value in less time than it takes to write this paragraph. Did this not happen in Pompeii? Can it not happen again? The ashes of Vesuvius in a few hours swept into total destruction all the capital permanently laid out in homes and in other structures of the doomed city. Only a few years ago an earthquake attacked Messina and, while the city was not completely destroyed, the catastrophe did irretrievable harm to capital permanently invested in property. And that capital, in the light of subsequent events, could not be properly classified as being invested, since it was at all times subjected to extraordinary risks risks such as are grouped under the term "speculation."

Men make values, but they merely assist in making conditions. As long as values are thus made, uncertainty, naturally, will surround them. If the human race preferred stones as money, gold would immediately decrease in value, its only uses being in the industrial arts. Gold is valuable because it is accepted as a common and standard medium of exchange. Anyone will take it in return for some commodity or article he wishes to sell. It is the distinction mankind makes between the degrees of security which defines the division between investment and speculation.

It is popularly supposed that a bond or a mortgage is an investment because some physical property is pledged to secure it. However, this is not always the case. The property securing a bond may be as valuable as it is represented to be for the purposes for which it is pledged, but, should it be employed for other uses, it might not realize anything like the sum represented by the bond. So also with a mortgage.

There are bridges on some of our principal railroad systems that were built with the money raised from the sale of bonds. As long as the railroads use these bridges and pay rental for their use, these bridge bonds are desirable investments, but should the railroads abandon them, whence would the interest for the bonds come? The property, as old iron and steel, would never realize the capital invested in it. So with a mortgage on a water-power plant: if the water supply should be exhausted there would be no need for the power plant and its machinery, and the essential security which had made the mortgage a good investment would pass with the passing of the water.

The Element Of Risk

Investment of money is, therefore, wholly a problem of human judgment, so far as safeguarding it against extreme risks is concerned. It is taken for granted from the very beginning that speculation involves taking large chances for extraordinary gains. Speculation consists in forecasting changes of value, and buying or selling in order to take advantage of them. It may be wholly legitimate, or pure gambling, or something partaking of the qualities of both. Mr. Pratt, in The Work of Wall Street, says: "Speculation is an investment of money in which large risk is taken in expectation of great gain." I have already tried to show that there is an element of risk in most investments. In Mr. Pratt's definition the emphasis is laid on the largeness of the risk, which alone distinguishes a speculation from an investment.

Nature Of Investment And Speculation. Test Questions

1. Why is a knowledge of investment and speculation of great value to the business man?

2. What is the distinction between investment and speculation?

3. What conditions cause the amount of risk to vary in different securities?

4. Show what factors will cause government bonds to fluctuate in value.

5. How may a mortgage become a speculation?

6. Why is physical property by itself not an adequate pledge behind a bond? Illustrate.

7. According to Mr. Pratt, what is the determining factor that distinguishes an investment from a speculation?