June 16, 2002

Goldilocks and the swindlers

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In the story, the porridge was just right — not too hot and not too cold. For a period during the late 1990s, many commentators liked to refer to the US economy as the “Goldilocks” economy.

In their eyes, the economy was just right: not too hot to rekindle inflation and not too cold to worry about growth. The “new paradigm” merchants (many of whom are still in jobs in this town) suggested that the world had changed and, as a result of new technology and new communication, productivity of the US and Ireland had increased irrevocably, creating a world where profits could increase effortlessly every year. With such an outlook for profits, the ludicrous valuations the financial markets put on companies were legitimised.

This hogwash (and those who saw it as hogwash in 1998/99 were ridiculed by the herd) was used to assuage many investors’ worries that they were buying at the top in 1998. Unfortunately, as anyone who bought almost any share — and particularly telecom stock — will know, it was indeed the top. Goldilocks was a fairytale that, for most investors, has turned out to be a nightmare.

Amazingly, many market scribes (not surprisingly paid by brokers and investment banks) are still talking as if Goldilocks were a true story. This is dangerous talk for investors. Assuming that brokers are not swindlers, some of the fighting talk of recoveries, second half upswings and a return to the good old days may just be due to the fact that the market has not fallen dramatically overnight. Rather it has fallen precipitously, weighted down by the enormous debt burden of the telecoms investors and the inflated expectations of bull market investors.

Whereas in 1987 the FTSE, for example fell 38 per cent in four months, in this downturn it has taken over two years to fall just over 30 per cent. The relatively gentle but prolonged fall has left many of the commentators underestimating the extent of the problems. Added to this, the fact that there has not been a full crash means that stocks are still expensive relative to their historical averages and therefore susceptible to bad news.

So here we are, two years after the dotcom peaks, still falling on the back of worse than expected news.

Up to the end of last year, most of the bad news was economic and geopolitical in nature. Since then, the fears of investors have switched to trust. A series of scandals, and in some cases theft, have eroded investors’ trust. Last week George Soros said the main problem for the financial markets now is that investors do not know whom to trust with their money.

All the excessive practices that became commonplace during the boom are now seen as damming in the bust. As JK Galbraith expertly put it “recessions see what the auditors miss”.

First, investors feel that they cannot trust their accountants. This week in Houston, Arthur Andersen is on trial, charged in connection with the destruction of thousands of documents related to Enron last autumn when the firm knew the Securities and Exchange Commission was conducting an informal inquiry into the company.

Prosecutors contend that Andersen invoked a little-used documents policy to signal that files should be destroyed. Defence lawyers argue that the policy was cited merely to complete files that were certain to be reviewed in the wake of the Enron debacle.

Either way, the impression given to investors is that one of the finest names in the business was not acting honestly and that the accounts given by companies had been doctored to manipulate profits.

Second, this feeling of being taken for a ride is reinforced by dodgy practices of high profile chief executives in the US and to a lesser extent in Ireland and the rest of Europe. Even when some stocks have fallen by up to 80 per cent, some chief executives are still walking away with seven figure bonuses. Many investors are left wondering why they didn’t just give their money directly to the chief executive’s pension fund or bank account without bothering with the charade of buying the stock. When taken together with questionable accounting, any slight suspicion over the management will damn a share as the experience of Elan shows.

Third, stockbrokers have been exposed as swindlers. Merrill Lynch, the biggest broker in the world, was lucky to get away with a $100 million fine over the behaviour of its analysts. These guys were bringing companies to market for huge fees, telling investors that the new companies were the best thing since sliced bread, while privately calling the firms a “crock of shit”.

Therefore, at every stage of the investment process, the investor has been misled. This is not to say that every investor has been treated badly — far from it — but the suspicion is that we have only uncovered the tip of the iceberg as far as bad practice is involved.

Why are we surprised? It was ever thus. The history of investing is a history of people trying to rob each other. And every speculative mania has ended with people going to jail. In probably the best account of all this carry-on down the ages, Charles Kindleberger in Manias, Booms and Panics devoted an entire chapter to swindlers. Yet there are also two sides.

It is hard to avoid the conclusion that this outpouring of victimisation on the part of punters is sour grapes. Had things gone well, we would never hear any grumbling from shareholders, and so we have to be careful not to overlook the common greed that infects us all. Every mania — from the South Sea Bubble in the 17th century to the dotcom malarkey of 2000 — has led to the same conclusion. As Charles Trevellyan, of Fields of Athenry fame, put it when referring to the after-effects of the railway mania in England in the 1840s: “It is as ever mere gambling; and the shareholders having lost, are now kicking over the table and knocking down the croupier.”

Probably more invidious than the “greed, scam, tears” cycle has been the academic pretension which has accompanied the roller-coaster. The theory of “shareholder value” has come to dominate corporate discussions and has been used to legitimise all sorts of ridiculous business practices.

In the 1990s, American business schools concluded that as long as the share price rose, the executive was doing a good job. In addition, by linking executive pay packets to the share price via share options, firms could guarantee that the executive would act in the investors’ interests. Nothing could be further from the truth.

The doctrine of shareholder value, and in particular linking pay to stock performance, has caused executives to cut corners, fiddle the numbers, sell off viable business, generate short-term cash at all costs and to some degree replace long-term planning with short-term fixes.

It is this, rather than swindle, which will be the corporate legacy of the bull years. Let’s just hope that the result is only one bear markets rather than the three bears of Goldilock’s fame.


  1. Jack Feeney

    Elans latest fall cannot be directly linked to ‘management’
    but it does prove the old axiom “If it looks like dodgy
    management and if it smells like dodgy management….it
    probably is dodgy management”…… A case of one too many
    off balance sheet transactions OR is it just devine
    retribution?

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