WALL ST. SCAPEGOATS
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June 20, 2002 --
SINCE its peak in March of 2000, the stock market has lost about a third of its value, or almost $6 trillion, according to Wilshire Associates. Everyone would like to think that these immense losses - painful to individual investors and possibly threatening to the economy - are someone else's fault. And now, suitable culprits seem to have emerged: Wall Street and corporate America, whose greed and dishonesty allegedly rigged the market.
Hardly a day passes without some new scandal, whether of dubious accounting practices, illegal (or unethical) trading by insiders or dishonest stock advice. Americans were, it seems, duped. Companies overstated profits. Brokerage houses issued misleading reports. The wealthy played small investors for suckers. Finding the guilty doesn't make Americans richer. But it confirms popular outrage.
Alas, this is mostly myth-making. Every financial mania ends with a search for a scapegoat. But finding a scapegoat and discovering the truth are often two different things. Here, the theory sounds good. It just lacks for evidence.
For starters, accounting abuses are exaggerated. About 10 percent of companies in the Standard & Poor's 500 index have had questions raised about their accounting, estimates analyst Steve Galbraith of Morgan Stanley. Even if profits were wildly overstated, they can't explain the stock market's run-up.
From 1996 to 2000, the reported profits of the S&P companies increased 29 percent. Over roughly the same period, the stock market jumped almost three times that (78 percent for the S&P 500). And many high-flying tech companies had no profits to be exaggerated.
Well then, Americans were deceived by Wall Street analysts. Eliot Spitzer, New York's attorney general, has shown that Merrill Lynch's Internet analysts kept recommending companies, despite private doubts. True. But many other Wall Street analysts and commentators warned that stock prices - especially for tech stocks - were outrageously overpriced.
But while the market rose, most investors weren't listening. To be skeptical - as was this columnist - was to be dismissed as an outdated crank.
OK, it must at least be true that sophisticated investors profited at the expense of ill-informed patsies. Of course that happened. The worst abuses involved executives cashing out - unloading their lavish stock options - before their companies crashed.
But here, too, the record is mixed. Many big investors lost big. George Soros, one of the world's wealthiest men, saw his hedge fund lose more than $5 billion on tech stocks. Similarly, some well-connected Wall Street firms lent billions to now-bankrupt telecommunications companies.
What's occurring now is selective revisionism. The press and politicians are busy exploiting people's resentments. Almost everyone wants to denounce greedy executives, accountants and investment bankers.
Consider Spitzer's transformation from successful Wall Street investor to successful Wall Street critic. In the mid '90s, he invested $1 million in a hedge fund run by James Cramer, whose TV and written commentaries talked up the market. In his new book, Cramer claims to have made a "ton of money" for Spitzer. (A spokeswoman for Spitzer declined to say how much.) Now Spitzer happily berates Wall Street for its excesses.
It's certainly true that many executives, accountants and stock analysts are correctly accused. It is also true that Wall Street firms gleefully exploited the bull market. People clamored for tech stocks, and Wall Street firms obliged by cranking out IPOs ("initial public offerings" of shares).
In 1999, there were 456 IPOs. About 77 percent of these companies had no profits, says economist Jay Ritter of the University of Florida. Typically, says Ritter, IPO companies had profits (75 percent did in 1994) and were much older. Investment banks relaxed their screening because the rich fees, normally 7 percent of a stock offering, were so tempting.
But it's not true that all this bad behavior caused the market bubble. Nor is it true that greed was confined to the top. On Aug. 12, 1982, the Dow Jones Average was 776.82. By the mid 1990s, when it passed 5,000, a rising market began to look like a sure thing. Everyone could get rich quick.
Americans poured $1.1 trillion into stock mutual funds from 1996 to 2000. Greed went democratic. A speculative culture produced speculative behavior across the social spectrum. The market rose on a tidal wave of money and a mindless enthusiasm for Internet technology, glorified by much of the media.
The present backlash may produce some constructive improvements in accounting practices, financial reporting and corporate governance. But no reform could have prevented the stock mania, which stemmed from human nature. Moreover, the condemnations can be overdone.
When stock prices get too high, they will ultimately fall. But the drop may be deepened and prolonged if people believe (falsely) that all executives and brokers are crooks and the market can never be trusted. A sickly market might cripple consumer confidence and spending - and the economy. There's the true threat.
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