Wall Street Delusions
GRAY, PAUL
Writers & Writing Wallstreet Delusions By Paul Gray Investors who suffered serious losses when the Wall Street stock bubble of the late '90s finally popped in 2000 may not yet, three years...
...A comprehensive answer can be found in Roger Lowenstein's Origins of the Crash: The Great Bubble audits Undoing (Penguin, 270 pp., $24.95...
...The 1990 recession, Lowenstein notes, brought the LBO craze tumbling down in a rash of bankruptcies...
...Denby, of course, proceeds to do everything wrong: "I began shifting some of our liquid assets into mutual funds geared toward technology...
...People did not suddenly become greedier during the '90s, Lowenstein says, but they fell victim to a "sort of mass conspiracy, or mass delusion...
...In fact, the greater a percentage of his company stock a CEO owns the harder he will work to keep the stock valuable...
...that eased constraints on accounting firms so they could earn more for serving their clients as consultants than keeping the books honest...
...When he worries, rather belatedly, that his investments will go seriously wrong, Denby, looking for someone to reassure him, makes an appointment with none other than Arthur Levitt, chairman of the Securities and Exchange Commission...
...With the benefit of hindsight, it appears unbelievable that so many people, including presumed market experts, could have been so wrong about so much, that such huge sums of money could have simply vanished in crazy-seeming speculations...
...As the title suggests, Denby's book deals with delusional behavior, in this case his own...
...That's a sad story, to be sure, but the great bubble and the crash produced millions of worse ones...
...Is it any wonder that so many CEOs act like bureaucrats...
...The CEOs usually did this by taking on huge loads of corporate debt to buy back blocks of their own stock...
...Among the many practical problems this announcement brings is the question of what to do with their seven room Manhattan apartment on West End Avenue...
...The problem, Lowenstein says, almost universally unrecognized or ignored at the time, was that stock options are risk-free to those who are granted them...
...By the end of the '70s," Lowenstein writes, "stocks had fallen far enough to scream 'cheap.' The values inherent in stocks inspired a new and distinctly American phenomen: the hostile takeover...
...This time, Denby's topic is his own foolish behavior in the stock market: "I offer the book not as market history but as a portrait of a single American living within money obsession during the first three years of the millennium....' Denby's cautionary tale begins in 1999, when his wife, the novelist Cathleen Schine, tells him their marriage of 18 years is over...
...Still, Denby's book is worth reading...
...But the diverse fallouts from the market collapse are not the important part of Lowenstein's story...
...Exposure...
...In absolute terms, then, we hadn't lost our money, but we failed to reap profits...
...He introduces his portrayal of the dot-com boom with a look back at the early fortunes of the online auction site eBay, which in 1998 went public with a price of $18 and ended the year at S241: "It strains credulity to report that eBay was trading at 1,800 times its previous year's earnings, but at least eBay had earnings...
...That both men later came to well-publicized grief lends a certain spice to Denby's portraits of them...
...On all of these counts, plus many more besides, the U. S. markets in equities during the last decade and the scandals that later ensued munificently qualify...
...In both of those books, as in his newspaper and magazine work, Lowenstein demonstrated the ability to make arcane economic topics not only accessible to the general reader but entertaining as well...
...Previously, stock prices had been seen as a long-term barometer...
...One reason was an enormously influential 1990 article in the Harvard Business Review by Michael Jensen and Kevin Murphy advocating a change in how CEOs were compensated...
...This idea does not seem as crazed as it will later...
...Why he adopts an investment strategy that nearly everyone warns him is risky beyond measure remains a mystery...
...Lowenstein, a journalist who spent more than a decade at the Wall Street Journal, is the author of Buffet (1997), a look at the legendary investor in Omaha, and When Genius Failed (2000), an account of the collapse of the gilt-edged hedge fund Long-term Capital Management, a failure that threatened for a time to wreak worldwide market upheavals...
...Giving America's business leaders every incentive to pump up their share prices, by any means necessary, was probably not the best way to create a transparent, never mind honest, stock market...
...In a perfect world, these changes might have led, as they were intended, to greater freemarket efficiency and productivity...
...the market price—no matter how transitory—was honored whatever the underlying value...
...Virtually every transgression flowed from this simple corruption...
...But the price paid for all those mistakes probably would have been less spectacular had it not been for two signal events of the '90s: the rise of the Internet, and the burgeoning of the deregulated telecommunications and energy industries...
...that would enable them to pay off the mortgage and taxes, split the remainder and find smaller separate places to live...
...The trouble began, as Lowenstein sees it, during the late 1970s and early 1980s, when Wall Street had very little influence on the lives of most Americans .Stock prices seemed largely stagnant, and corporate CEOs functioned as salaried employees, just like the folks on the factory floor, with no urgent interest in making money for their shareholders...
...Securities were worshiped regardless of the assets they represented...
...On average," they maintained, "corporate America pays its most important leaders like bureaucrats...
...The author sums it up: "Over a period of a few months, from October 1999 into early 2000, we had liquidated life insurance, sold out bonds, dropped value and index funds that were moving slowly, and built up our 'exposure' to aggressive growth, technology, and biotech...
...A brave new world seemed to have dawned, one where all the old rules of finance no longer applied...
...But with a Henry Kravis lurking, the long term might not exist...
...and the subsequent criminal investigations caused him to alter his focus...
...If playing it safe produced such returns, imagine what wonders getting aggressive might yield...
...He doesn't want to move, and he can't afford to purchase his wife's half: "I conceived a simple plan...
...Lowenstein writes: "A poker player will bet aggressively when he is playing with the 'housemoney.' Incontrasi, an executive with his own capital on the line will identify with his company more closely—much more closely—than will a CEO who has simply won the options lottery...
...An extraordinary realization...
...The ordinary investor who buys a share at $20, watches it fall to $ 15 and, needing cash, sells the share is out five bucks...
...We were naked...
...Professional economists may call Lowenstein's explanation of what went wrong reductive or simplistic, but nonspecialist readers are likely to find his logic hard to fault...
...Once Michael Milken pointed out the attractions of high yield junk bonds, leveraged buyouts (LBOs)—debt-financed purchases of whole companies—put further pressure on CEOs to boost share prices so as to make them too expensive to entice avid outsiders...
...Lowenstein's account of these flamboyant developments is especially mordant and amusing...
...Toward the close of 2002 Denby lists his cumulative net losses from his market adventure at $900,000...
...At times I wondered," he writes, "Am I mad...
...A longtime film critic for New York magazine who moved, in 1998, to the same job at the New Yorker, Denby has written about himself before, in Great Books (1996), an account of what he experienced when, in his mid40s, he went back to Columbia University, his alma mater, and enrolled in a two-semester core curriculum course...
...the executive who has an option to buy at $21 simply declares it "under water" and gets another option to buy at a lower price...
...One understands why, distressed at the prospect of divorce, he wants to keep the apartment...
...Are you kidding...
...that became the original squatters on an Internet niche site— were the places for investors to stack their chips, and profits be damned...
...He emerged convinced that the masterpieces of the so-called Western canon remained of vital interest and importance...
...Indeed, their poor performance contributed to their excessive pay, for many took advantage of their slumping shares to grab fresh boodles of low-price stock options...
...After the crash it became obvious that CEOs were not only "vastly overpaid...
...Prices in the short term were notoriously unreliable (this was the lesson of the Great Crash...
...Indeed, the latter part of his book seems rushed and, thanks to publication deadlines, contains no mention of the more lurid Wall Street scandals of 2003—like the forced resignation of New York Stock Exchange Chairman Richard A. Grasso after it became known that a generous board of directors had voted him a compensation package for 2003 somewhere slightly south of $200 million, and the discovery that certainmutual funds allowed favored clients trading opportunities, including illegal ones, not available to ordinary investors...
...Never mind that business history is strewn with the dead husks of companies—from the early makers of automobiles to pioneering personal computer manufacturers—that got a head start on the competition and then fell by the wayside...
...That could not be said about most of the dot-coms marketed during the waning days of the last millennium, but by then the notion of earnings having any relation to stock prices had been trampled into the dust by the public rush to get on the Internet express...
...Add to this mix the government deregulations that sanctioned bankers becoming stockbrokers too, and vice versa...
...In his Acknowledgments, Lowenstein notes that he began Origins of the Crash before the implosion of Enron et al...
...We had some serious resources, and I would throw those assets into the right things and make money quickly...
...This was a significant departure...
...that permitted the same financial house to underwrite stocks and to market them to customers...
...High-tech provided the sheen, glitz and glamour that beguiled hordes of new investors to take the plunge into the markets, the New York Stock Exchange and especially the technology-heavy Nasdaq...
...Ultimately, Lowenstein blames the whole mess on the gospel of "shareholder value" that emerged in the 1970s, when Wall Street languished, as a way of convincing CEOs that their primary obligation was to produce maximum profits for the people who bought their stocks...
...What next...
...The market was booming...
...If American Sucker were a movie, the veteran critic might call attention to a certain lack of suspense in the plot: Financial disaster is foretold and then enacted...
...Corporate raiders such as Carl Icahn and Henry Kravis made CEOs realize that holding on to jobs and perks meant "they had to raise their share price...
...Denby has some market experience...
...How could this have happened...
...he wants to explain what conditions arose, and why, that made the collapse itself virtually inevitable...
...They can probably sell it for at least $ 1.4 million...
...ON THE EVIDENCE of American Sucker (Little, Brown, 335 pp., $24.95), David Denby would almost certainly agree with Lowenstein that "a sort of mass conspiracy, or mass delusion" gripped the stock market before the crash...
...An only child, he inherited $325,000 when his mother died in 1991, and although he invested it conservatively, that nest egg and the savings he and his wife contributed appreciated nicely as the stock market began soaring...
...He asks the question but gives no answer...
...By early 2000, as my wife was about to ship out and I decided to go for broke, I stepped up the pace, placing a good 80 per cent of our liquid assets geared toward the Nasdaq exchange, and I began looking for individual tech stocks to invest in...
...Give CEOs an ownership stake through stock options, the authors argued, and they will become entrepreneurs...
...Episodes of human folly make for irresistible reading, especially when the folly is shared by thousands or millions of people and is tricked out with numerous gaudy examples of bizarre and criminal behavior...
...And as ruinous as the dot-com collapses were to investors, the spectacular failures in the telecommunications sector—including such esteemed companies as WorldCom and Global Crossing—were much more damaging: "The investment in télécoms was at least 20 times greater than in dot-coms...
...But since divorce was not his idea, Denby balks at giving up the apartment: "it was home, and wouldn't let her deprive me of it...
...In the real world, they led to vast opportunities for mischief and occasions of sin...
...The results of this cascade of misdirected capital, strange at the time, looks even more preposterous now in Lowenstein's retelling: "By 1999, Priceline, which resold airline tickets but owned neither gates nor planes, was worth almost as much as the entire, tangible airline industry...
...Sam Waksal, the CEO of the biotech firm ImClone, invites Denby to glittering parties in his SoHo loft...
...That seems like a lot, but to assess what that figure truly says about Denby's investment performance the reader needs to know how much money he started with...
...But such books are coming, and it's easy to see why...
...But the practice of granting CEOs stock options, to make them even more eager to defend their satrapies against LBOs, continued to spread even when the threat ended...
...The mantra of this NewEconomy religion hummed that the dot-coms who made it "first to market"—i.e...
...Near the end, however, he does let slip the following: "When I added up our totals, I realized that we now had about the same amount of money that we had laboriously saved and put into the market over a period of many years...
...In the fall of 1999,1 realized that we would increase our assets that year (on paper, anyway) more from capital gains than from salaries and royalties...
...There is also a problem with the hero's motivation...
...Shareholder value, the author writes, "became a maxim not for enhancing business values, which require years to create, but for enhancing day-by-day quotations, a far more ephemeral thing...
...I would try to make $ 1 million in the market in that year of 2000—yes, $1 million—and then I would buy her out...
...Curiously, despite his candor on matters sexual and emotional, this number Denby does not provide...
...His New Yorker position gives him access to a number of people an ordinary investor could not have met...
...Or as John Maynard Keynes liked to say, in the long run we are dead...
...Half mad...
...Writers & Writing Wallstreet Delusions By Paul Gray Investors who suffered serious losses when the Wall Street stock bubble of the late '90s finally popped in 2000 may not yet, three years later, be in any mood to spend time leafing through books that recount the debacle...
...Ditto for allowing those leaders to surround themselves with complaisant boards of directors, usually made up of executives from other companies, who had a selfish interest in boosting already skyrocketing compensations for everyone of their ilk...
...He lunches and speaks on the phone with Henry Blodget, the Merrill Lynch Internet analyst...
Vol. 87 • January 2004 • No. 1
