Bubble Economy Series: Analysts
With Ben White and Paula Span
Washington Post Staff Writers
Friday, Nov. 15, 2002; 1 p.m. ET

Join Post staff writers Ben White and Paula Span to discuss financial analysts during the Bubble Economy, particularly veteran energy analyst John E. Olson, who was forced to leave over his skepticism about Enron and refusal to tout the energy giant's stock. Read The Market Scholars' Star Turn (Post, Nov. 15).

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.

Below is the transcript.

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.

Ruxton, Md.: You mentioned the deregulation of fixed commissions of analysts, could you explain how that works and what happened? Have the rules changed?

Paula Span: Thanks to everyone for coming by to chew over these issues. This area -- analysts, conflicts, potential reforms -- is changing daily; what we thought might happen last week is different from what seems to be happening this week. But let's dive in.

To respond to the deregulation question: this dates from Congressional action in 1975. Previously, analysts' salaries were paid out of the commissions that brokers charged on each sale or purchase of stock. Every brokerage charged the same percentage (six percent, if I'm remembering correctly). Once the business was deregulated, brokerages competed for customers by cutting commissions. Less money to pay the analysts, therefore; the investment banking side took over and began paying more of the tab. That's how the bankers' influence over analysts began, and that's where the problems began as well.

New York, N.Y.: Paula, what happend to that fellow Melnick, who you wrote about? Is he still with Merrill Lynch? That would be outrageous.

Paula Span: He's currently the research director at Goldman Sachs.

Portland, Ore.: It seems to me the stock exchanges themselves, like the NYSE and NASDAQ, have a big stake in investor confidence in the fairness of their markets.

There has been excellent reporting in this series on the bubble that investment bankers were selling pre-IPO shares to favored clients, and perhaps orchestrating run-ups (laddering) of IPO stock on its early days of trading. All this leaves an individual investor like me feeling like a sucker.

Wouldn't the logical home for analysts be with the exchanges themselves? It wouldn't matter to the exchange if stocks were bought or sold, so long as they were traded (maybe "hold" ratings would disappear :). In hindsight, it looks obvious that investment banks would lean on their own company analysts for favorable ratings. Wouldn't exchange-sponsored analysts be more neutral? Any chance of the exchanges going for this?

washingtonpost.com: The Market Scholars' Star Turn (Post, Nov. 15)

Paula Span: Ah,my colleague and co-author Ben White is joining our discussion.

Having analysts work for the exchanges is an idea that's been discussed, as regulators and Wall Street firms grapple for some sort of "global settlement." It doesn't seem the likely solution, though: the banks don't want to give up their analysts entirely; they need them to advise on IPO's and mergers, etc.

Washington D.C.: John Olsen is one of the very few good guys in the Enron scandal. Does he have a future as a regulator?

Paula Span: He's a quiet, modest sort of fellow, not giving to bossing others around or -- more significantly -- thrashing out compromises. He seems to like being an analyst and he'll probably continue to be one.

Portland, Ore.: Do you think any of the investor lawsuits against Jack Grubman will be successful?

I'm wondering if analysts feel any legal liability for a pattern of bad behavior. Anyone can make a bad call or two, but it seems to me in the case of someone like Grubman, its way beyond that.

Paula Span: That gets more likely as more emails get unearthed on the question of his ratings for AT&T. And we probably haven't begun to see all the lawsuits that will eventually get filed.

Laurel: When Enron collapsed, a popular refrain was "The crimes they committed don't bother me so much as the things they did that _were_ legal."

I know I tend to blame the right-wing for everything, but didn't a socio-political culture of deregulation (in the economic sphere) create an atmosphere that "my job is to make money by any legal means and any ethical impediment that stands in the way must be overcome."

Paula Span: Deregulation probably contributed -- but perhaps more significantly, there was so much more money to be made during the bubble that the stakes for a stock call, a deal that was approved -- anything -- grew vastly higher.

Now that there's much less money to be made -- hardly an IPO to be seen, for instance -- reform looks more attractive.

New York City: Your graphics have lumped some market strategists in with industry specific reseach analysts, even though these big-picture forecasters do very different jobs. Why should they be considered part of the stock analysts bunch?

Paula Span: They have a different function, true, but we included them because of this similarity: they've been criticized for relentlessly hyping the market, making unrealistic prognostications about the endlessly soaring Dow.

Washington, D.C.: Why the sudden rush to crucify the stock analysts? I'm a small investor, and by no means the savviest guy in the market, but it was well-known before the boom that sell-side analysts weren't your best source for objectinve information. It seems that the analysts are being crucified by investors who were quite content to buy stocks without even understanding what they were purchasing.

Paula Span: You may have understood that reality, but it probably wasn't general knowledge. Remember that there were lots of new investors during the last decade, partly because employers switched to 401K's over traditional pension plans, partly because the bull market enticed newcomers. Lots of people saw respected names -- Merrill Lynch, Lehman Brothers -- and thought, "These guys say buy X and they must know what they're talking about."

Vienna, Va.: Paula, it seems that the REAL cause of the "bubble Market" of the 90's was not so much the good economy (thought it indeed performed well). The real reason, as far as I can tell, was that the Baby Boomers realized, as they got into their 40's and 50's, that time was marching on and they needed to start preparing for retirement. This led to a massive amount of stock investing from tens of millions of boomers, thereby driving stock prices to unprecendented levels. Then when all these investors had built at least reasonably good portfolios (and in some cases huge ones), the investing cooled way down, along with stock prices. And today there is simply a lack of investing in the market from a body of investors who just are not as bullish on stocks...they are investing in safer bonds instead. It is a mistake to blame low stock prices today on the Enrons, Arthur Andersons, and other "scandals"...this is not the cause of it. The real problem today is that people no longer WANT stocks. Many investors (myself included) have come to the conclusion that bonds...especially tax-free munis...are the way to go. We are going to see a classic bear market until the basic attitude of investors change.

Paula Span and Ben White: Speaking as the leading edge of the Baby Boom myself, the eldest of us are in our mid 50s and probably not ready to stop saving for retirement yet. So while the market was headed south before these scandals came to light, mistrust of analysts, balance sheets, the markets themselves has got to play a significant role. That's why leading Wall Street bigwigs are suddenly interested in federal efforts to "restore investor confidence."

Arlington, Va.: In your interviews, do you ever discuss the Chartered Financial Analyst (CFA) designation and its parent organization Association for Investment Management & Research (AIMR)whose code of ethics and standards of practice, long in effect, are supposed to deal with these conflicts of interest?

washingtonpost.com: The Market Scholars' Star Turn (Post, Nov. 15)

Paula Span and Ben White: AIMR, whose codes are supposed to prevent such abuses, is working to make them even stronger. And is about to unveil a TV commercial pointing out how much better off we'd be if all analysts were CFA's. But they're not. John Olson is, however.

Washington D.C.: As an investor, I feel that i can't trust any stock research anymore. Any tips for who investors can trust and who they can't? It feels like the entire industry has been tainted by these conflict of interest scandals.

Paula Span and Ben White: Changes are underway that may help reassure people like you. Most of these firms are revamping their ratings systems, and the number of "sell" recommendations is slowly climbing. And there are independent research firms -- Sanford Bernstein -- and brokerages that don't have investment banking arms, like Prudential. More independent firms are listed on the website maintained by Investars.com

But the most significant changes probably will emerge from the negotiations underway between the SEC, the NASD, state regulators and attorneys general, and Wall Street. That's the big enchilada.

Mt. Rainier, Md.: At the bursting of the bubble, who lost? The small investors for sure. The employees at the busted firms like Enron. But Merrill Lynch? Even though they were hot to do business with a morally and now financially bankrupt Enron, you can bet they lost very little money and made huge fees. Which is why self-regulation will not work; if the money is there, then they will go after it. The feds have to end the deregulation because it isn't healthy for the markets or the general economy, and certainly not healthy for most investors.

Paula Span and Ben White: You're right, a $100 million fine for Merrill Lynch is a minor sum for a big investment firm. And firms like Merrill and Credit Suisse First Boston and Citigroup, tarnished by lawsuits and revelations, have probably lost some business along with their lustrous reputations.

But what the feds are proposing is still not going to re-regulate the market so that it functions the way it did pre-1975. That's not a likely scenario any time soon.

Oakton, Va.: I don't think we are going to see a real bull market for quite a while....do you agree? The main problem seems to be that many investors simply don't want stocks anymore. Brokers are still trying to convince investors that stocks are still the best bet in the long run just because they have historically been. But the excessive demand for bonds seems to indicate that unlike past stock downturns, investors THIS time have finally concluded that you just can't beat the safety-return combination of good bonds, especially munis with their double-tax-free status. This has never happened before, but it seems to be happening now....a long-term and maybe permanent shift from stocks to bonds. What do you think?

Paula Span and Ben White: Are you a bond salesman, by any chance?

We're not market strategists, so we can only fall back on that old saw about stocks being more lucrative over the long term. And that most financial advisors think investors should include both stocks and bonds in their portfolios.

New York, NY: Thanks for taking my question on this interesting series.

Every piece seemed to strike a similar theme -- a player in the boom is seen in a different light now that the party's over.

If the market comes back in the next few years, do you think history will alter its view yet again on the go-go 90s?

Paula Span and Ben White: Hey, we're still figuring out how to view the Civil War. And the 1950's (were they really as staid and Eisenhowerish as people think?) And the Excessive '80s (Mike Milken is trying to take a new company public). So while we know that an astonishing amount of wealth was created (on paper, anyway) and then vaporized in the '90s, not enough time has passed to allow any final evaluation. Nor is the aftermath clear. We'll all be mulling this over for a long time.

New York, N.Y.: Follow-up: If what Olsen said about Melnick is true, how was he able to get an important job at Goldman Sachs, and doesn't that mean nothing's changed even after all of this chicanery?

Paula Span and Ben White: Researchers and research executives were roller-skating from firm to firm all the time, particularly as there was so much money to use as lures.

The "chicanery" at Merrill didn't really surface publicly until this year, by which time Melnick was already in his new post. And as we've seen, what Olson accuses him of was hardly limited to one executive or one firm. There are a number of lawsuits filed by analysts claiming to have been wrongfully dismissed because they wouldn't play ball with investment bankers. None has come to trial yet.

Mt. Rainier, Md.: You always expect some people to fall for a new gimmick, the one that's supposed to 'change all the rules'. But I am very surprised at the people who fell for the dot.com routine. Not that computers can't do outstanding things, but how was that supposed to have altered the universe? All these folk with their MBAs are no smarter than that? Right up there with tulipmania and the South Sea bubble.

Paula Span and Ben White: Actually, despite all the handwringing about the rise and fall of tech stocks, the losses were worse in telecommunications -- not entirely a new gimmick.

In some of these cases, investors (and bankers, analysts, traders, too) may have been gullible. In a few cases, the numbers they were working with had been so thoroughly manipulated that even smart people couldn't make sound judgments. And then, a kind of nationwide peer pressure set in: you could feel pretty lonely if you weren't betting on the brave new world.

Silver Spring, Md.: The caller from Oakton has a good point -- the stock market, long-term, is in serious trouble. This is not a matter of being a bond salesman or not, it is observing the obvious. Unlike the past, the means of creating a potentially new bull market are just not there any longer. Bull markets are dependent on investors bidding up stock prices by large purchases. Many of these investors have shifted from stocks to bonds, and are just not interested in stocks anymore....where is the money going to come from to create a future bull market? I just don't see it.

Paula Span and Ben White: We're not sure why investors who've switched to bonds wouldn't switch back again as the economy improves and the international situation stabilizes. There've been crashes and long troughs before, and there've always been recoveries. But hey, if we knew what the future of the markets were, we'd probably find other jobs.

College Park MD: I assume that business majors don't take history or these smart young things would have a better idea of when they're being taken for a ride. It would seem their reading material is pretty narrow altogether since there have been several books out in the last few years on speculation and bubbles.

Paula Span and Ben White: We can bet their professors at Wharton and Tuck and Stern did mention past bubbles and manias. But such lectures probably faded as the market kept rising. And rising. And then rising some more.

Plus, technology was a significant X factor. There was no history to guide people as to what this new thing called the Internet might do, so one analyst's guesses were as good as another's. Party poopers were distinctly unpopular.

It's worth noting that even before the current rounds of horrendous layoffs, some smart young things didn't like the pressures on analysts and were making their exits -- to the buy side, to hedge funds, to second careers entirely. There were people who saw the handwriting and got out.

Washington, D.C.: Where are we with the bubble market and its fallout?

This series failed to wrap up the entire saga with an analysis of where we stand today. After 11 rate cuts in 01 and a half point drop this week, the market still won't trend. Interest rates are at a 41-year low, which should send everything that's sensitive to interest rates, like houses, cars, and stocks, through the roof. Yet the market still won't trend, car sales have stalled, and most business people are bearish on prospects for the next year.

Are we at the end of the millennium boom-bust bubble market, or just the beginning of the latter half?

Paula Span and Ben White: We're only really starting to analyze which factors contributed most, how to address the conflicts and problems we know about -- let alone figure out the fallout years or decades hence. This is an extended endeavor.

Thanks, everyone, for joining us today and our colleagues through the week. It's been illuminating.

washingtonpost.com:

That wraps up today's show. Thanks to everyone who joined the discussion.

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