The Dark Heart of The Tech Bubble
Investment banks are under public scrutiny at last for their role in the technology stock bubble. Merrill Lynch has settled one suit and doubtless more will follow as class action lawyers work on the bona fides of research put out by the tipsters of the leading houses. But important issues are not being addressed. Beyond the culpability of specific firms and analysts is the bigger question of the structure of the financial services industry and its relationship to the media.
It has taken an extraordinary episode to awaken public and officialdom to the conflicts of interest which are endemic in the relationship between investment banker and stockbroker. Yet anyone who has worked for the research department of an investment banker/ broker knows that the "Chinese walls" which are supposed to separate the two functions are bamboo curtains. Investment bankers thrive on fees which mostly flow from the propagation of "good news" regardless of the interests of the investors who are also their clients.
Regulatory bodies have long turned a blind eye to all but the most blatant abuses of separation of functions often relying on the good faith of the compliance officers of the investment banks themselves. The industry also has a record of crushing those researchers who draw attention to unethical but highly profitable behavior of the sort which leads to huge bonuses for participants. Hopefully the tech fallout will lead to a cleanup. But one has to ask why greed has been so long allowed to triumph over ethics at revered institutions of Western capitalism.
Hopefully too the bust will lead to new laws that create real walls between financial functions, at least between investment banking, brokerage, mutual fund management and insurance, and between auditing and consultancy.
Financial services combines create conflicts of interest within organizations. Clients of brokers get supposedly professional advice which is actually nothing but a sales pitch for the investment banking part of the business, and captive mutual funds get stuffed with shares left over from failed public offerings. Profits come before duty of trust. Moral hazard increases with vertical integration and systemic risk increases with size.
Financial combines are also, by definition, less transparent than single business entities, and thus prudential supervision of them is that much more difficult. At the same time they become "too big to fail," threatening a repeat of the megabank bailouts seen in Japan.
Likewise the fewer large auditing firms there are, and the more reliant they are on consultancy fees, the less likely they are to quarrel with the accounting policies of big companies.
The media need scrutiny too. It may now be baying for analysts' blood, but it was celebrity journalism as much as Wall Street that created the idols of the tech bubble and made heroes out of humdrum research analysts. The brighter ones noted that the more outrageously bullish their analyses, the more attention they got for themselves and their firms' corporate clients. Meanwhile stodgier publications threw away their journalists' gut skepticism away in favor of reportage the publishers expected would and for a while did generate advertising from the "new economy" stars.
Oiling the wheels were the financial wire services. It is an awkward truth that some of these global providers of news get most of their revenue from a smallish group of banks, investment banks, brokers and foreign exchange dealers. Naturally they want to be close to their clients, to reflect their views. Thus comment on the politics of, say, Indonesia comes not from a seasoned local expert but from a brokerage analyst, perhaps a 28-year-old who has been there for three months.
This financial sector bias enters the news chain at an early stage. It is now being magnified by the vertical integration that has taken place in the media and communications industry. When the number of players diminishes, there is increased tendency for myths to become received wisdom, for the psychology of the crowd to replace reasoned discussion.
While welcoming actions against those who exploited investor credulity it would be wise to look at the institutional roots of the tech bubble, whose fallout will last a generation.
(C) 2001 International Herald Tribune. via ProQuest Information and Learning Company; All Rights Reserved
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