White knight
Tue Apr 30, 4:56 PM ET
We are shocked--shocked!--that analysts promote stocks and that investors are greedy. So is more disclosure going to change all this? Not very likely.
A ten-month investigation has persuaded Eliot Spitzer, the attorney general of the State of New York, that brokerage house research is tainted. Here is a disclosure as shocking as the truth about professional wrestling. Yet there is a truth about wrestling more interesting than the fact that it's fixed: Knowing that it's fixed, people still watch. It's a show, like the opera.
At ringside or at La Scala, fans suspend disbelief. Investors, too, can put aside reality, as they did in the fantasy phase of the greatest bull stock market. They knew that companies without the hope of net income were not really worth the billions of dollars that Wall Street claimed for them. But they also knew that the market was going up, up, up. And because the market was going up, Henry Blodget, the onetime star internet analyst at Merrill Lynch, seemed a sage.
To prevent a recurrence of the financial excesses leading up to the stock market crash in 1929, Ferdinand Pecora, chief inquisitor of a U.S. Senate investigating committee convened in the early 1930s, prescribed the sunlight of publicity. "[H]ad there been full disclosure of what was being done in furtherance of these schemes," wrote Pecora concerning a certain banker's transgressions, "they could not long have survived the fierce light of publicity and criticism."
In the second half of the 1990s, that "fierce light" was a dim bulb. Many investors claimed that they could hardly read by it. Besides, who had time for the income statement and the cash-flow statement and the balance sheet and the footnotes? Pecora turned out to be wrong about the preventive powers of full disclosure. All the information a conscientious investor could want was his or hers for the asking. It was available to the junk bond buyers of the 1980s, just as it was to the tech stock buyers of the 1990s. The besotted bulls just couldn't bring themselves to look.
Spitzer won a court order on Apr. 8 requiring Merrill to disclose possible conflicts of interest between its investment research department (unprofitable on a stand-alone basis) and its investment banking division (highly profitable). He is known to be investigating other brokerage houses for similar undisclosed conflicts, including Morgan Stanley. Just as Spitzer charges, Wall Street has put itself ahead of its customers. And he could have said so a decade ago. "In less than a generation," writes Martin Mayer, "a market where the participants felt themselves protected by an intricate web of fiduciary obligations had passed through the stage of caveat emptor to the Hobbesian condition [of every man for himself]." That's from Stealing the Market, published in 1992.
Whatever the penalties for duplicity, fraud and cynicism, the guilty brokerage houses should pay them. If they have made a pact with the devil to turn securities analysis into sales propaganda, they should so state. Still, the attorney general is unlikely to change the ways human beings throw their money around.
This is a lucky thing for state governments, New York's not the least of them. In fiscal 2001 the New York State Lottery pocketed $1.9 billion of gross wins from gamblers whose losses could not be blamed on the Merrill Lynch research department. A proximity to wealth--even imagined wealth--can cause heart palpitations, blurred vision and impaired judgment.
With his boyish good looks and eight-figure paycheck for 2001, Blodget is a scapegoat from central casting. However, there are public officials whose judgment concerning the stock market boom proved infinitely costlier than his.
Alan Greenspan (news - web sites)--whose refusal to starve the boom was instrumental in turning a bull market into a stampede--seems to communicate to the public in disappearing ink. Because he speaks in forgettable phrases, what he says is usually forgotten. He himself seems not to recall the details.
In a speech on Mar. 26 on corporate governance, the Fed chairman made the conventional damning point about securities analysts: They are perennially optimistic. "Moreover," said Greenspan, breaking no news, "the bias apparently has been especially large when the brokerage firm issuing the forecast also serves as an underwriter for the company's securities."
Yet only a year before, Greenspan had invoked the same analytical community in support of a bullish profits forecast. Corporate managers are "remarkably sanguine," he intoned. "At least, this is what can be gleaned from the projections of equity analysts, who, one must presume, obtain most of their insights from corporate managers." And because analysts were bullish, the outlook was bright: "Such expectations, should they persist, bode well for continued strength in capital accumulation...."
Note to Spitzer: You don't have to be an analyst to seduce the market--or be seduced by it.
James Grant is the editor of Grant's Interest Rate Observer .Find past columns at www.forbes.com/grant. |
