Bubble Economy Series: Regulators
With Paul Farhi
Washington Post Staff Writer
Wednesday, Nov. 13, 2002; 2 p.m. ET

Join Post staff writer Paul Farhi to discuss his piece in the second part of the Post's Bubble Economy series on the key regulators, including Frank G. Zarb and other Nasdaq officials, about their role in enabled thousands of highly risky companies to list their shares on the market. Read On CNBC, Nasdaq 'Casino' Had Few Safeguards (Post, Nov. 11).

Send your questions and comments now or during the discussion.

The Bubble Economy, once known as the New Economy, had everyone cheering and the activity of the financial markets became a national obsession.

Starting around the mid-90's, investors were jumping to get in on the Internet action, unemployment virtually disappeared, companies projected 20, 30, 40 percent annual growth rates and stock prices were flying high.

But in 2000, the bubble burst, the good times halted and shortly thereafter, the economy sank into a recession. Meanwhile, the talk on Wall Street shifted to corporate scandals and speculation about when the Dow would rise above 10,000 again.

The Post's six-part series takes a retrospective look at the key players in the Bubble Economy and gives an analytical view of the bubble phenomenon. Read the Post Business Special Report: BUBBLE: The Roots of the '90s Boom and Bust.

Editor's Note: Washingtonpost.com moderators retain editorial control over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.

Paul Farhi: Thanks for joining me for a chat about Nasdaq and, by extension, the Post's series on the late-1990s "bubble." Bring your questions, opinions, and rants. Now let's get started....

washingtonpost.com: On CNBC, Nasdaq 'Casino' Had Few Safeguards (Post, Nov. 11)

Paul Farhi: By the way, here's a link to my story on Monday about Nasdaq. There will be a test later on it.

New York: These kinds of series by The Post are always great. But, this one begs the question -- where was all this reporting while the bubble was happening?

Paul Farhi: Fair question. We DID do a lot of reporting on the bubble--or what looked like a bubble--back when. But, like most newspaper coverage, it tended to be day-by-day, lacking what editors around here like to call "altitude." The bubble series this week is an attempt to reconsider an accumulated series of events, with the benefit of hindsight of course. Personally, I think newspapers should do more of this--re-examining recent history and trying to figure out what, if anything, we can learn from it.

Washington, D.C.: I think analysts should be more clear in the way that they rate companies. Buy, Sell, Hold is simply amiguous. Is there any notion to change this to be more specific?

Paul Farhi: I think it's worse than ambiguous. It's an almost blatant attempt to deceive, or at least go easy. Analysts are in many ways captives of the companies they cover. Make a few tough calls, and the company will freeze you out. This may explain why during the bubble years almost all recommendations from analysts were positive.

Washington, D.C.: The Federal Reserve keeps cutting rates, do you think that's the answer or a stopgab solution to the recession?

Paul Farhi: I don't know for sure, of course. But I'll say this: the Fed has cut rates so much that there aren't many bullets left in that chamber. And rates are already low. I hope it helps, certainly. But what worries me is what will they do if it doesn't.

Washington, D.C.: What do you see the challenges being as we enter the post-industrial society in economic turmoil? Do you think that the crash of the economy has killed off any chance that Internet business will survive?

Great piece by the way!!! I'm glad someone is finally taking a look at the economic phenomenon of the 90's.

Paul Farhi: Internet businesses will survive, of course, and thrive. I mean, the Internet, as a commercial phenomenon, is only six or seven years old, tops. Was anyone asking whether the auto, steel or chemical industries would survive when they were six years old?

Re: an earlier answer: That's true that analysts are captives of the companies they rate and now that everyone is aware of this, why isn't anything changing?

Paul Farhi: Well, I think some things will change. Elliot Spitzer, the New York attorney general, has done an amazing job exposing the duplicity and hypocrisy of analysts. Merrill Lynch paid $100 million to get him off their backs. You'd think some lasting reform will come out of all that.

Towson, Md.: How is that so many companies have restated millions of dollars in earnings and haven't been penalized for their errors? How can you mistake millions of losses as millions in profits?

Paul Farhi: Not been penalized? Anyone heard from Worldcom, Enron, Global Crossing or Adelphia lately? They're all in bankruptcy. As for how they could "mistake" millions of losses for profits, well, that's why we have federal peneteniaries...

Laurel: When the NASDAQ shot up to 5,000 then dropped to 1,250 where did the money go?

The simple answer would be the people who sold at 5,000 made money and the one who bought there lost it. But are there any useful generalizations about what types of people fall into each group? Did the IPO insiders make out like bandits at the expense of people who jumped onto a sinking ship?

Paul Farhi: You are, of course, getting at one of the magical concepts of American capitalism--paper wealth. Some people rode the bubble up, got rich on paper, but never cashed out (these people are know, technically, as "paupers" today). I don't really know what the numbers of ACTUAL winners/losers are. But I do recall seeing a story in the Wall Street Journal some months ago about the telecom industry. Basically, insiders and their investment bankers were the first out the door before the roof collapsed. And ain't that always the case?

Baltimore, Md.: With all this talk of corporate reform, it's so hard to differentiate what has been proposed and what has actually been done. That said, I don't think enough is being done.

Paul Farhi: Okay, let's put in a plug for Corporate America here. There are something like 17,500 publically traded companies in the U.S., all told. A handful--maybe a dozen?--were out and out fraudulent. A few hundred more were trolling the gray areas, but didn't clearly step over the line. I don't know that we have to throw out babies and bath water.

Atlanta: Perhaps this question would have been more appropriate of Howard Kurtz earlier chat, but here goes;
Was the Post, and by extension the other media, guilty of 'exploiting' the bubble for their own benefit? That is to say, that they - the media - stood to profit from the bubble (more ad lineag, time, etc) and in so doing didn't blow the whistle or give stories more play that, in essence, said the emperor has no clothes.
While I am not saying that there was some great 'media conspiracy' to keep the bubble going, neither was there, in hindsight, a reality check.

Paul Farhi: Yes, the Post and the rest of the media benefitted from the bubble. But I think we're at risk of making this black or white. There WERE plenty of stories questioning the eye-popping stocks (Amazon, in particular). There was skepticism. I know at the Post we are generally more invested in pessimism/bad news than in celebrating success. That said, it's very, very hard to see the future. We didn't, but I'm not sure you can convict us of that crime.

Laurel: During the late 90s boom, person of a pro-business political orientation regularly exclaimed the whole wealth creation thing as a triumph of capitalism, laissez-faire, deregulation, and all those other things that protect the little guy from the rich.

Now that we know deregulation also allows corruption, why didn't the Democrats capitalize better on the obvious frauds perpetrated on ordinary citizens by the corporate and financial sectors?

Paul Farhi: I am passing your comments on to the DNC. They could have used your advice, Laurel, last Tuesday. Forget political ideology for a moment: If you were running a Democratic campaign, wouldn't you have put this issue among your top three?

Arlington, Va. : Do you think that there are any overvalued stocks from the bubble days still lingering in the marketplace? Or has the market corrected itself?

Paul Farhi: The market has corrected itself with a vengeance. If there are some over-valued stocks still left, they're over-valued by a fraction of what they USED to be over-valued by.

Bowie, Md.: I sent a similar comment & question to Kurtz's noon chat:

Except among a very few, very knowledgeable people, stock market investing boils down to: diversify and hold long term. That's how the investor makes AND KEEPS money.

Most of the stockbrokers know this and countenance such an approach because they are professionals and are ethical, even though they could increase their own income by frequent churning. But the financial press can't keep selling magazines with articles "Keep Holding those Stocks Five More Years."

Turning to the NASDAQ. Did you get the impression that they were deliberately setting up a "high energy" stock market to encourage speculation, frequent trading, and gambling; as opposed to the sane financial institution a market should be?

Paul Farhi: Yes, I agree. Money mags are like women's fashion mags or golf publications. They're all about new advice, every month. No one ever says "remember how we told you to putt last month? Do that again." Instead, they have 10 new ways to grip your club, or do your hair and makeup. Same with financial advice...As for Nasdaq, I don't know about whether they were deliberately setting it up as a high-energy market, but that is certainly what it is. Stocks on Nasdaq (most of them at least) are inherently riskier than those on the NYSE or Amex.

Towson, Md.: Do you believe that the stock exchanges should take more responsibility in regulating companies listed on their exchanges?

Paul Farhi: I do. I appreciate Nasdaq's purpose and mission--to funnel equity capital to small companies that can't make it on the NYSE. But the bubble demonstrated that everyone--investors, at least--would be better served if the market had higher listing standards and policed its companies better.

Indianapolis, Ind.: What's the reason behind a number of government bail outs of financial institutions over the years -- savings and loans, hedge funds, foriegn currencies and banks? Why do it?

Paul Farhi: Mainly, to prevent wider damage to the economy, or at minimum to the sector involved. It's actually a pretty common phenomenon. During my adult lifetime, I can remember government bailouts of car and steel companies, banks, s&ls, hedge funds, etc. I don't know enough to say this with assurance, but it seems that these have been pretty good investments, all things considered.

About the NASDAQ: It seemed one of the critisms in the NASDAQ article was that by allowing a lower minimum capitalization than the NYSE, the NASDAQ was guilty of allowing marginal companies into its exchange rather then relegating them to the Pink Sheets. I think this position seems to take away some of the responsiblity from the individual investor. Our system is a disclosure rather than merit system. The SEC is concerned that information be presented to the investing public and is not passing on the advisability of investing in a certain company. I don't see where, if an investor is given the correct information and the company is not engaging in fraud, how the NASDAQ by giving these companies access to capital markets is at fault simply by giving these companies more publicity by allowing them on thier exchange.

Paul Farhi: As I see it, there are two flaws in your comment. One, the disclosure system was inherently flawed; note the number of earnings misstatements and accounting "errors" during the bubble years by Nasdaq-listed companies. Two, yes, it's buyer beware, but the markets have to set the bar somewhere. Some companies, maybe a lot of internet IPOs, were too chancy, too weak, too speculative to be thrown onto the public market. You were, after all, dealing with an entirely new industry, making concepts like "risk disclosure" and "asset valuation" kind of ludicrous.

Atlanta, again: Agreed - if all could have foreseen the future, most would have gotten out before the bubble burst and none of the media would be convicted for not foretelling the future!
So what measures is the media in general and the post in particular taking to gain "altitude" towards economic events and how are they going about covering economies and companies with healthy skepticism, if at all?

Paul Farhi: We haven't all sat down to answer that question, but I think the once-burned rule applies. A reporter simply can't get away with the same breathless coverage we saw in '96-'99 anymore. But give us a few years; everyone forgets.

Policing companies?: Are you advocating a merit based system as opposed to our current one of disclosure or are you saying that they NASDAQ should have been more vigilant in uncovering some of the accounting abuses now being found? Seems though that role is best suited to the SEC.

Paul Farhi: I'm trying hard not to advocate anything, to tell you the truth. But looking back, trying to learn something about the bubble, maybe it would have been wiser not to have allowed the pell mell rush onto the market. I'm all for entrepreneurialism, but the IPO market was waaay overheated in '98 and '99. Someone should have said "let's slow down a bit and take a good hard look at this."

Washington, D.C.: What do are regulators doing now to ensure that this won't happen again?

Paul Farhi: I'll go non-partisan, or maybe bi-partisan, on this one. From my liberal side: if they can ever get the Pitt-Webster mess untangled, an accounting oversight board seems like a good start, as is intensified SEC oversight of the market's self-regulatory bodies (particularly the NASD). But my free-market side says that one gigantic, enormous, soul-grinding correction does tend to clear up the markets' excesses (is there an IPO market anymore?). But you can count on this: there will be another bubble in another generation or so. It happened regularly throughout the 19th and 20th centuries. I doubt the 21st will be any different.

Paul Farhi: And on that cheerful note, I thank you and bid you happy reading. Investing, too. Regards...Paul.

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