Again: What is Corporate Finance About?

As I've said before, I teach a course called "Corporate Finance."  And following up on what I said before, I still can't figure out what this course is about.

Recap: I used to think this was about people who who want to raise money for projects--the guy at the widget works who wants to expand his factory and goes to the market to hire some capital--debt or equity--to let him do it.

Restating: not any more.  I think the inflection point was around 1980 (give or take) when deals stopped chasing money and money started chasing deals. And not just high rollers who wanted to get rich: no, formerly staid and sober managers--like your pension fund which keeps promising you it can get eight percent--found themselves chasing after projects in deals.  And the odd part was that all of a sudden, there was money enough sloshing around to make it happen.

In a simpler time, I used to think it was just a matter of too many profits and not enough good ideas.  Or at least, bankable ideas.  I can see now that this was naive.  There are at least two phenomena which conspired vastly to increase the volume of deals.

One, the deterioration of reserve requirements.  Suppose there are 10 banks; a lends to b, b to c, etc.  Start with $1.  If a bank can lend only 80 percent of its holdings, the total lending in the system is $4.5.  If 90, $6.5 and if 95, $8.  If the bank is totally unregulated I suppose you get all the way to $10.

The other is the decline/disappearance of "insurable interest."  If I want to buy protection against the destruction of the house at Fourth and Magnolia, I have to show that I own it, or the insurer won't write the policy.  If I want to buy protection against the risk that LittleCo will default on its bond obligation, I may be the creditor who owns that obligation, but vastly more likely I'm just a bettor taking a flutter.  Once you've uncoupled the bet from insurable interest, you've opened the doors to a virtual infiinity of deals.

This framework suggests two more boring practical questions

One, how far should I go in teaching them about apparatus?  I have to clarify "what's a stock, what's a bond?"--these kids are plenty bright but their financial experience is not great and we start at the beginning. Also "what's a bank?" (as if I knew).  Do I also have to teach them what's a put, what's a call (yes?)?  And what's a credit default swap--and do I have to show them how far it's "really" insurance, how much a kind of a bond?

Speaking of banks,I assume I have to make sure everyone understands the difference between a commercial bank, an investment bank, a proprietary trader, a hedge fund, a private equity fund.  Is it my job to tell them how Iceland went broke?  And how China's banking institutions just aren't strong enough to sustain it as a global swashbuckler?

Corollary of all this: I suppose I need to explain how the vast majority of financial transactions have nothing whatever--zero, nada, bubkas, zilch--to do with the raising and allocation of capital.  They're just "finance."

By the way if we get  in this deep, shouldn't I also be telling them something about Offshore?--the City of London, Jersey/Guernsey/Man, Caymans?  So, do I need to explain that all the really big deals don't "take place" in New York, or even Delaware (saying nothing of Palookaville).  And does that mean I have to teach the nature of sovereignty too?

I think I'll go take a nap.