Good article in today's WSJ--Burst Bubbles Expose Cooked Books,Bring SEC Probes and Bankruptcies
February 11, 2002
By E. S. BROWNING
Staff Reporter of THE WALL STREET JOURNAL
The bad news for the stock market doesn't seem to end.
First there was Enron's collapse, then Kmart's bankruptcy filing, then news from Global Crossing that the Securities and Exchange Commission is investigating its books. Analysts even have raised questions about the accounting at corporate giants Tyco International and Cisco Systems.
Soon, the optimists say, all these nasty surprises will have to stop, and the budding economic recovery will begin to capture investors' attention.
They could be right, but don't bet all your retirement money on it.
History confirms what a lot of stock analysts and investors have been discovering to their chagrin lately -- that burst bubbles and accounting controversies tend to go hand in hand.
Accounting scandals and bankruptcies, in fact, are one important reason that it can take the stock market years to recover fully from a bubble.
"This is not an isolated event," says Ray Dalio, president of Bridgewater Associates, a money-management firm in Westport, Conn., that oversees $35 billion. "This is something that will spread" as many companies' accounting practices are examined. "Many more stories will come out. The examination will inevitably turn up more cases of aggressive accounting and there will be a penalty for that aggressive accounting."
Consider past experience. Corporate bankruptcies and unraveling frauds were among the hallmarks of the 1930s, following the crash of 1929. One accounting trick of that era was to create elaborate webs of holding companies, each helping hide the others' financial weaknesses, an artifice strangely similar to what Enron did with its partnerships. One of the biggest shocks of the '30s was the collapse of a vast, once-highflying utilities empire called Middle West Utilities, run by an energy magnate and financier named Samuel Insull.
"Our view would be that bubbles create greed on the part of investors but they also create greed on the part of management," says Jeremy Grantham, a co-founder of Boston money-management firm Grantham, Mayo, Van Otterloo. "That was very much the case in 1929 when holding companies put on leverage and bought other holding companies' stock."
As the fallout from the 1929 crash spread, former New York Stock Exchange President Richard Whitney was sucked in and eventually was arrested and jailed for fraud.
A less extensive bubble was inflated in the late 1960s and burst in the early 1970s, when the "Nifty 50" stocks fell apart. Accounting scandals multiplied again. The Securities and Exchange Commission in 1975 censured Peat, Marwick, Mitchell, one of the largest accounting firms of the day, for failing to perform proper audits of five companies that collapsed soon after getting clean opinions.
More trouble followed the crash of 1987, although it was shorter-lived than the problems of the '30s or the '70s. The once-hot junk-bond market unraveled, insider-trading scandals proliferated, the savings-and-loan crisis grabbed the front pages and real-estate investments went bust.
Shelly Meyers of Beverly Hills, Calif., who manages the $24 million Citizens Value Fund as well as other funds, is spending a lot of time these days trying to track down rumors about some of the stocks she holds.
"What we are seeing here in the financial markets is the equivalent of the perfect storm," Ms. Meyers says. "At the same time, we have had three major bankruptcies that were household names -- Enron, Kmart and Global Crossing." On top of that, analysts have repeatedly had to revise earnings estimates downwards, and worries have spread about whether the economy can stage a sustained recovery. Accountants, once among the nation's most trusted professionals, are accused of helping hide wrongdoing and of misleading investors.
The result: Ms. Meyers is hearing as many as four rumors a day about the stocks she holds, and is spending hours on the phone with contacts in brokerage firms and elsewhere trying to check them out.
"My biggest concern at this point is that a rumor-based kind of investing is going to gain momentum," she says. "We, as professionals in particular, have a very important job right now, which is to take a step back, take a couple of deep breaths, and ask whether we are doing our job based on rational analysis or on fears and rumors."
Ms. Meyers, for example, holds WorldCom shares, and spent hours reassuring herself recently that rumors surrounding WorldCom, such as stories that WorldCom Chief Executive Bernie Ebbers was being forced to dump his shares, weren't quite true. (Mr. Ebbers, however, did borrow $339.7 million from WorldCom to cover loans he took out to buy his own shares).
She believes that the swirl of rumors will die down. But "the question is when are people going to have faith in those systems again," she adds.
Some market analysts worry that these problems aren't going to go away soon.
"It is absolutely what almost invariably happens after every bubble," says investment strategist Barton Biggs at Morgan Stanley, referring to the scandals, bankruptcies and accounting disclosures. "You should expect them, but that doesn't mean that people who haven't been through it before aren't going to be surprised. The bigger the binge, the longer and more severe the hangover."
The root of the accounting problem, say Mr. Dalio and others who have studied the phenomenon, is that stock-market bubbles reward aggressive accounting, since it inflates earnings and helps push up companies' stock prices. As bubbles develop and the continued inflation of stock prices becomes paramount, conservative accountants and executives become discredited, and bending the rules becomes standard. |
