March 14, 2008

The Stupidest Thing I've Read in Years

AFTER DOING SOME SEARCHING in my archives, I know I've been prone to using the above phrase in the past. For instance, I used it back in 2005 when a Colorado woman sued her teenaged neighbors for leaving cookies on her doorstep. I used it later in that year when Forbes ran a stupid story about how to deal with criticism from bloggers. I also used it in October, when George Monbiot wrote something I thought was particularly dumb.

Still, I don't use the phrase lightly, and I'm about to use it again.

You see, I wasted precious minutes of my life reading Rachel Beck's hagiography of Eliot Spitzer's crusading reforms against Wall Street, and couldn't believe some of the things written in it. Not about Spitzer, mind you -- I don't really care about that -- but about business and about Wall Street. I mean, can someone explain to me how the Associated Press's national business columnist can write something like the following, yet somehow not be mortified at doing so? (emphasis added)

Whatever he might have done in his personal life, though, doesn't tarnish that he made the investment environment more open and friendly for individual shareholders. Before Spitzer got involved when he was New York's attorney general, no one knew of the conflicts that existed in stock research or that mutual funds were giving trading perks to wealthy investors and hedge funds.

"No one knew of the conflicts that existed in stock research?" Are you kidding me?

Now, I'll admit that novice investors -- perhaps even investors with some knowledge of the markets -- might have taken the advice they received at face value back in the day. But certainly not everyone did, and I would submit that even back in the good old Nineties, there was a pretty strong correlation between "experience in investing" and "distrusting stock market analysts." And by the good old Nineties, I mean the 1890s, because anyone who knows Wall Street's history knows trust is a precious and scarce commodity there.

But even in the 1990s, most investors had to know (or should have known) something was up, even if they didn't operate on the sound principle of trusting no one. All one had to do was analyze the companies being touted. If the financials were shaky and the fundamentals weren't sound and the business plan wasn't sound, then the stock was crap and you didn't buy it, never mind what some analyst said about it. And if one did operate on the trust no one principle, one just assumed the analyst was lying (or worse) and paid no attention to what he said. Looking at analysts' recommendations in the aggregate also paid dividends, because even if the stock was a dog hardly anyone actually said to sell it. Thus, the "buy means hold and hold means sell" principle.

In the days before disclosure -- which rightfully became popular after the tech crash -- I was taught to view stock recommendations with deep suspicion. I remember when I made my first investment, which I decided upon after reading about it in a financial newspaper. I had to justify it; I couldn't rely on the simple fact it was listed as a good pick. It didn't matter what the writer said, even if he was as morally pure as an angel, because you had to operate on the assumption he had already bought the stock, and so had his friends. That was a lesson I remembered very clearly. (This is one reason why, on the rare occasion I talk about my investments, I tell you what I own).

Yet Ms Beck goes on. She writes:

After the dot-com bubble had burst and companies long heralded as corporate America's finest were collapsing under the weight of scandal, Spitzer went into attack mode. His first targets were the big investment firms that had made so much money during the stock market's surge in the late 1990s. Little did we know that much of it was at our expense.

We would soon learn that their game was fixed: Research analysts were recommending stocks so that their investment-banking colleagues could win more lucrative business from those same companies. Spitzer subpoenaed e-mails from Wall Street firms and used those messages to build a solid case of how they misled investors.

The findings were shocking, especially for anyone who bought a high- flying Internet stock during the market boom.

One e-mail showed star Merrill Lynch & Co. analyst Henry Blodget describing InfoSpace Inc., one of the firm's highest-rated stocks, as "a piece of junk." Another exchange had Salomon Smith Barney telecommunications analyst Jack Grubman telling a friend that his recommendation of AT&T stock helped secure spots in an exclusive Manhattan nursery school for his twin daughters.

Ten Wall Street firms eventually agreed to a $1.4 billion settlement, and new rules were put in place that separated banking and research. Independent research was also made more available to investors, and the firms were required to disclose potential conflicts of interest.

I would contrast Ms Beck's words with those of Mr Fred Schwed Jr, who wrote (in "Where Are the Customers' Yachts?") the following about the validity of financial predictions:

On the theoretic side our chief preoccupation will be an inquiry which is quite simple, but which is more awful in its implications than any Senate investigation. It has to do with what has become the major part of the business of Wall Street -- the foretelling of price moves. Concerning these predictions, we are about to ask:

1. Are they pretty good?
2. Are they slightly good?
3. Are they any damn good at all?
4. How do they compare with tomorrow's weather prediction you read in the paper?
5. How do they compare with the tipster horse-race services?

Mr Schwed -- who wrote those words in 1940, for Pete's sake -- was a bit more charitable in his assessment of these predictions, essentially chalking them up to foolishness and human failure than downright avarice. But his opinion of them is pretty clear:

It is hard to find a Wall Street man, from the oldest partner to the youngest "runner," who is willing to be just a croupier. This causes a great deal of anguish in the long run, and the reasons for it are both human and economic.

For one thing, customers have an unfortunate habit of asking about the financial future. Now if you do someone the signal honor of asking him a difficult question, you may be assured that you will get a detailed answer. Rarely will it be the most difficult of all answers -- "I don't know."

The average male likes to sit at breakfast and tell his wife and children what Adolf Hitler will do month after next. This is a harmless vanity. But from this it is an easy step for him to go downtown and start telling people what United States Steel will do month after next. That is liable to lose someone's life savings for him.

Of course, if you want avarice, there are plenty of books detailing that. In 1923, Edwin Lefevre wrote "Reminiscences of a Stock Operator." In the 1980s, Michael Lewis wrote grand books about Wall Street's excesses. Still, considering that skullduggery involving stocks has existed since the Mississippi Company debacle in 1719-20 -- hell, since the Amsterdam Stock Exchange was founded in 1602 -- it's kind of tough to be "shocked" at anything Wall Street does. I mean, Daniel Drew would be shocked people actually got in trouble for the stuff Spitzer crusaded against, which he would have considered child's play. (This was because Mr Drew was ruthless).

Dismayed at Wall Street's actions, on the other hand -- well, God help us if the $415 trillion in derivatives contracts come unglued. You-know-who has the story. Again.

Posted by Benjamin Kepple at March 14, 2008 11:01 PM | TrackBack
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