The boom and the bubble

Origins of the Crash: The Great Bubble and Its Undoing by Roger Lowenstein; Penguin Press, New York, 2004; pages 270, $24.95.

Bull!: A History of the Boom, 1982-1999 by Maggie Mahar; HarperBusiness, New York, 2003; pages 486, $27.95.

EIGHTEEN months ago, American capitalism seemed to be in crisis. Stocks had plunged and some of the nation's most celebrated business leaders had been exposed as phonies if not crooks. Now the economy is growing, and the Dow's been back above 10,000. Federal Reserve Chairman Alan Greenspan gave himself a big pat on the back at the American Economic Association meetings, in effect declaring that he was right all along. So is it safe to buy stocks again? After you read Roger Lowenstein's Origins of the Crash and Maggie Mahar's Bull!, you will have serious doubts. Both tell the story, from different angles, of how ordinary investors got suckered into supporting the lifestyles of the rich and shameless. And you have to wonder whether anything has really changed.

Lowenstein's title may convey the impression that his book is mainly about stock prices. It is not. It is about the epidemic of corruption that spread through corporate America in the 1990s, though that epidemic was in part both an effect and a cause of the bull market. A better title might have been "Executives Gone Wild". As Lowenstein, also the author of Buffett: The Making of an American Capitalist and When Genius Failed, explains, not that long ago the orthodoxy at business schools - one that corporate management found highly persuasive - was that the trouble with American executives was that they did not make enough money. Or, to be more precise, the problem was that they did not stand to gain enough if their companies did well. The most famous of the business-school theorists, Harvard's Michael Jensen, wrote in 1990: "Corporate America pays its most important leaders like bureaucrats. Is it any wonder, then, that so many CEOs [chief executive officers] act like bureaucrats?"

The answer suggested by these theorists, and eagerly adopted by much of corporate America, was to hand executives huge grants of stock options to give them a stake in corporate success. It did not. For one thing, once the principle of giving CEOs gigantic pay cheques in return for performance had been established, acquiescent boards found ways to keep those gigantic paychecks coming even when executive performance was mediocre or worse. Lowenstein describes how Michael Eisner, the CEO of Disney, managed to get paid $800 million over a 13-year period, while delivering a return to investors less than they would have gotten from Treasury bonds. Worse yet, rewarding executives for even brief increases in a company's stock price encouraged, even mandated, creative accounting that kept reported profits high and growing. In 2001, a chastened Jensen wrote an article titled "How Stock Options Reward Managers for Destroying Value".

And those who cooked the books were not just richly rewarded; they were celebrated. In 1998, CFO Magazine gave an Excellence award to Scott Sullivan, the chief financial executive of WorldCom. In 1999 it gave one to Andrew Fastow of Enron. And in 2000, it gave one to Mark Swartz of Tyco. All three have since been indicted.

Those who tried to blow the whistle were silenced. Lowenstein tells the sad story of James Bingham, an assistant treasurer at Xerox who was ordered to "destroy" an e-mail message warning of accounting misstatements. When that instruction became public, the company characterised it as an "unfortunate selection of words". Then the company fired him. Two years later, all his misgivings were confirmed.

What happened to the regulators? Bipartisan pressure prevented public watchdogs from doing their job. When the Financial Accounting Standards Board tried to get companies to account for the cost of issuing stock options, Kathleen Brown, the Democratic California treasurer, led a public rally at which she shouted: "Give stocks a chance!"

ALAN GREENSPAN - who Mahar says won his job as Federal Reserve Chairman "first and foremost because he was a Republican" - emerges as a particular villain, not just because he so quickly switched from condemning irrational exuberance to cheering it on. Faced with growing concerns about accounting for derivatives, he "repeatedly sided with private bankers to inhibit controls and even to suppress disclosure". After the collapse of the hedge fund Long-Term Capital Management, which nearly caused a global financial crisis, Greenspan called for less regulation.

If you have been following the story of corporate scandal, Origins of the Crash will not add that much to your understanding. But if you do not know quite what happened at Enron and WorldCom, and why they were not just isolated bad apples, Lowenstein's book is an excellent introduction. Yet I have two complaints. One is that the book is a bit drier than one might have expected. It is, after all, a lurid story; that luridness does not really come through. The other is that Lowenstein does not spend much time explaining why the public was so easily fooled. For that, turn to Bull! - which also has a lot of the writing pizzazz somewhat lacking in Origins of the Crash.

Mahar's focus is not on corporate corruption, but on the enablers who cheered on false business heroes and made the corruption possible. Although she tries to frame the book as an investment guide, it reads more naturally as an indictment of stock analysts and the financial media. What I learned - something I did not fully appreciate before - was the extent to which the stock market bubble of the 1990s was supported by intimidation as well as exuberance. Mahar, formerly a writer for Barron's and Bloomberg, opens with a scene from the life of Henry Blodget - who became famous for valuing Amazon at $400 and has since become a symbol of dot-com delusions - at the height of his fame. This is not a tale of arrogance, it is a tale of fear: Blodget, who had been slightly negative about a stock, receives an abusive phone call from a fund manager who owned the stock and resolves never to be negative again. A bit later we get the plight of Prudential's Ralph Acampora, who had to be given a bodyguard after he warned of a bear market.

Not all the intimidation was that explicit. To some extent, analysts and money managers simply felt that they had to run with the herd. Mahar quotes Laurence Siegel of the Ford Foundation: "You can be wrong and with the crowd, which is not actually so bad... Or you can be wrong and alone and then you really look like an idiot."

What is striking in Mahar's account is the extent to which the forces that cowed analysts and money managers into going along with the trend also biased press coverage. Partly this was because the public did not want to hear bad news. David Faber, CNBC's investigative reporter, gives a remarkably blunt explanation of why he did not do much, you know, investigating: "When you break a big story, for example, about fraud at a Waste Management or a Cendant... the response was not necessarily as encouraging as you might have expected."

But it was not just audience lack of interest that led to the de facto cover-up. Newsweek's Allan Sloan sized up AOL correctly, realising that it was not profitable and had little hope of becoming so, but says "his bosses objected to his constant carping about AOL's numbers: Whenever I published one of these stories, everyone would carry on".

Louis Rukeyser fired Warburg's Gail Dudack from Wall Street Week in late 1999 - just a few months before the market turned sharply down - because of her bearishness. And let us give special mention to The Wall Street Journal, which not only promoted "Dow 36,000" (which Mahar describes as "mildly lunatic"), but in 1998 told its readers to "rest easy": "U.S. corporate accounting has been getting steadily more conservative in recent years, not less so."

In other words, we should not blame the public too much for getting caught up in irrational exuberance. Foolish ideas were made to seem sensible by the unanimous optimism of analysts and the financial media. That unanimity was the product of a climate of fear in which everyone knew that asking hard questions put your career at risk. It was not just a market bubble: the system failed.

Which brings us back to the question I asked earlier: is it safe to buy stocks again? Very few of the corporate villains have faced charges, fewer still have been convicted: some are still running what is left of their companies, others ruined their stockholders and employees but did very well for themselves, thank you. It is hard to escape the feeling that the forces that suckered so many Americans during the boom years are ready to do it again.

New York Times Service