I am changing my mind about the stock market bubble.
Until recently I was in the camp that said we were all to blame for the market’s remarkable rise and fall. We all bought the Internet story; we were all going to be rich; we all lost sight of reality.
I still say we all have to accept our share of the blame, but I’ve come around to the view that some people deserve a lot more of the blame than others. I’m not referring to the criminals who set out to break the law. I’m referring to the American financial establishment, especially Wall Street.
When the revelations about Wall Street’s conflicts of interest first made headlines, I wasn’t impressed. Anyone who has ever spoken with Wall Street analysts knew these guys were in the tank to their firm’s investment banking clients. But as more news has come out, it has become apparent that analysts weren’t just conflicted. They were utterly corrupted.
Just this past week, New York Attorney General Eliot Spitzer released some private e-mails from Jack Grubman. Formerly of Salomon Smith Barney, Grubman was the king of the telecom analysts. He enthusiastically recommended the stocks of telecom firms, many of which brought their banking business to Salomon Smith Barney. But in one case, a small telecom company called Focal Communications Corp. felt Grubman wasn’t bullish enough.
In his e-mail, Grubman exploded. ”If I so much as hear one more (expletive) peep out of them, we will put the proper rating on this stock, which every single smart buysider feels is going to zero,” he told a colleague. Grubman later called Focal a pig.
If this exchange sounds vaguely familiar, that’s because it should be. In the spring Spitzer released e-mails from Henry Blodget of Merrill Lynch, once the king of the Internet analysts. Blodget too felt pressured to be even more bullish about Merrill’s clients. He too made a threat in an e-mail. ”We are just going to start calling the stocks like we see them, no matter what the consequences are,” Blodget wrote. He referred to some of the stocks he was recommending as ”pieces of junk.”
Think about what this pair was saying: If you guys don’t stop hassling me, I’ll actually tell the world the truth – that we are touting stocks we know to be worthless.
If you don’t find this shocking, you aren’t just jaded. You are ready to join the cast of ”The Sopranos.”
”We had a manipulated stock market,” said D. Quinn Mills. Mills is not a bomb thrower or a disillusioned first-time investor. He is a professor at Harvard Business School. He is also the author of a new book called, ”Buy, Lie and Sell High: How Investors Lost Out on Enron and The Internet Bubble.”
In his book, Mills takes aim at a whole range of financial actors, everyone from investment bankers to accountants to venture capitalists. ”In the modern world, a financial bubble is made by professional players who take advantage of public excitement to realize profit opportunities,” Mills writes.
He shows clearly that everyone along the chain threw traditional standards out the window: The venture firms pushed technology start-ups to get big fast; the investment banks took companies public that had no earnings and miniscule sales; the accountants accepted dubious transactions as revenue. By breaking their own rules, says Mills, the financiers were lining their pockets at the expense of unsuspecting investors. In short, the game was rigged.
When the history of the stock market bubble gets written, others will take their lumps. Alan Greenspan was too exuberant about the new economy. Stock options created a powerful incentive to cheat. The financial press wasn’t sufficiently skeptical. The stock market bubble Hall of Shame will have plenty of members. But the financiers will occupy a special place there. They should have known better. And in many cases, they did.