by Maggie Mahar
In 2002, Sauerwein was back to social work full-time. Like virtually everyone else, she had taken losses in the crash. “In the last year, I delayed too long in selling some of those positions in my own account because I didn’t want to be stuck with taxes,” she confessed. “Big mistake. And I held on to GE. But I can’t complain, I did okay. At least I moved the money in James’s 401(k). We calculated that if I hadn’t, we would have lost $150,000. And I sold anything in my own account that was on margin long ago. I’ve had so many friends who have had margin calls.”7
Because Sauerwein had gotten so much of her money out before the market unraveled, she managed to hold on to the bulk of her gains. At that point, she had no intention of gambling with her profits. “Sometimes when my husband watches Wall $treet Week with Louis Rukeyser on TV he says, ‘We should get back in,’” Shirley reported in 2002. “But I say no. I’m pretty firm,” she added pleasantly. “Guys like to talk about stocks, but I think a lot of what they say is just false knowledge.”
After a moment’s thought, she chuckled softly, “James’s best position is being married to me.”
THE 401(K)—A “TATTERED PROMISE”
Unfortunately, most 401(k) investors were not married to Shirley Sauerwein. Instead, Vanguard’s study revealed that if you pooled the experiences of all 401(k) investors—young and old, rich and poor—it turned out that more than 70 percent lost at least one-fifth of their savings during the three years ending December 31, 2002, with 45 percent of those surveyed losing more than one-fifth.8
An astounding number of media pundits seemed to think that this was good news. “401(k) plan participants are not suffering too much,” Business Week concluded after perusing Vanguard’s numbers. CBS trotted out an expert who offered some head-in-the-sand advice: “Don’t focus on the dollar amount you’ve lost…investors need to look at their losses relative to the whole market,” he said.9 In 2002, for instance, while the market lost a grisly 22 percent, the average portfolio in the Vanguard’s survey fell by just 13 percent. This was the good news. Forget the fact that 13 percent of $200,000 is $26,000. Just think of it in the abstract—13 percent versus 22 percent. Once again, “relative returns” were being used to mask real losses. But investors would not be able to retire on relative returns.
CBS was not alone in trying to take an upbeat view. Even in a brutal bear market, the media continued to tell investors what they wanted to hear: “Don’t worry—you’re doing just fine.” Some pointed out that if you counted the fresh money that employers and employees were continuing to contribute to 401(k) accounts, things were not as bad as they seemed. In fact, the Vanguard study showed that the average account’s balance actually grew by 1 percent in 2002, with the new money making up for the 13.3 percent loss.
In other words, investors were pouring fresh money into a large sieve. But this is not how the media pitched the story. And no doubt, many investors felt better. “After hearing dreary news about the stock market throughout 2002, investors may have been relieved to see 401(k) year-end balances higher than 2001’s,” noted Gail Marks Jarvis, a columnist at the St. Paul, Minnesota, Pioneer Press. “But,” she pointed out, “investors weren’t truly insulated from the stock market’s treachery. The regular paycheck contributions simply masked the losses.”
The fact that new money camouflaged losses might be one reason why, in contrast to corporate insiders, most investors did not bail out. “Account balances are a common way participants monitor investment results,” said Stephen Utkus, principal of the Vanguard Center for Retirement Research. “They are, in effect, the partially rose-colored glasses through which participants have viewed the recent dismal results of the U.S. equity market.”10
So, in February of 2003, Vanguard’s report showed that, on average, 401(k) investors still had 64 percent of their savings committed to stocks. Granted, portfolios were more balanced than they had been in 1999, when investors had 73 percent of their savings riding on equities. But this did not mean that investors had made a conscious decision to diversify. Over three years, the bear had rebalanced their portfolios for them. Meanwhile, the Vanguard study revealed that investors seemed frozen, neither buying nor selling stocks or stock funds.
Jennifer Postlewaithe was an exception. By the summer of 2003, she was back in the market. Postlewaithe was the investor who had turned a $90,000 nest egg into $500,000 in the six years following her 1994 divorce. Her husband, a history professor, had never been interested in the market. But Postlewaithe had watched a neighbor build a fat portfolio, and she had always been eager to try her hand.
“I was so proud of myself. Here I was, independent for the first time in my life, investing my own money,” Postlewaithe recalled. At the beginning, she researched companies like Dell by reading Value Line, but as she became more confident, she became bolder. By 2000, she was investing online and buying companies that she heard about on CNBC. All of her money was in stocks, and most of it was in technology. At that point, she also began buying “on margin”—borrowing money from her online broker so that she could purchase more shares.
When the Nasdaq meltdown began in the spring of 2000, Postlewaithe was visiting relatives in England. She read about the Nasdaq’s plunge, but she assumed it was a temporary correction. Meanwhile, her portfolio served as the collateral for her margin debt, and as its value fell, so did the amount that she was allowed to borrow. Within a very short time, she was over her limit. While she was still traveling, her broker began selling her positions in order to pay off the excess debt. This was perfectly legal, and Postlewaithe was quick to admit that it was her own fault that she hadn’t kept track of her margin balance while she was traveling. Nevertheless, the results were disastrous.
Within a very short time, Postlewaithe had lost roughly 60 percent of her savings. “The one good thing is that I had sold some of my Dell shares six months earlier to purchase a small house in New Zealand,” she recalled. “I sent the money to my brother, who lives there, and after he purchased the house for me, I asked him to take the money that was left over and put it into New Zealand stocks and bonds. The bonds were paying 8.5 percent, and the stocks have gone up by about 35 percent since I bought them,” she reported in 2003. “It’s the old story—I was lucky to have eggs in more than one basket.”
As for her U.S. accounts, “Like many others, I don’t like to look at my statements,” Postlewaithe admitted. “Fortunately, some of my money was in an IRA—and with a retirement account, they don’t let you buy on margin. So my losses in the IRA weren’t as steep.” But in 2003, she was still carrying margin debt in her taxable account. “Because I have so little left I’ve decided to ride it out and not pay off my margin debt,” she explained in July. “I’m praying that the market will continue to go up. As you know, the profit is greater when you’re on margin because you’re leveraged.”
And, although she preferred not to open her statements, she did continue to trade. “I must admit, I still love it,” she said. “So many companies are wriggling along in a fairly flat line that I have found I can buy on the dips and sell on the rises—sometimes in the same day. I find that on days when earnings are reported, if the company beats the analysts’ estimates, and I buy at, say, 9:35 A.M., I can make $1 or so a share.”
“I do it because I need to build my accounts up and also because I really enjoy it,” she added. “Is it gambling? I suppose it is a somewhat educated guess. I do a little more research than I was doing at the market’s high, but I confess I just take a look at a chart of the company’s share price, do a quick reading of what they produce, and that’s it.”11
Jim Tucci, by contrast, washed his hands of the market. In March of 2002, he sold a portfolio of equities that had once been worth $600,000, clearing just $121,000. “At one point if you included the stocks and an investment property that I owned, I had been a millionaire—with a high school education,” said Tucci. “When I was raising a family, I worked two jobs for 13 years—finally I became national sa
les manager of my company.”
Now, all he had to show for his efforts was $121,000. But Tucci did not dwell on the past. Instead, in 2003, he decided to put his financial house in order. He sold the investment property—a condo on Boston’s Beacon Hill—and used the proceeds to pay off the mortgage on his home. His nest egg had shrunk, but at least he was debt free. Then the New Economy struck again. In April of 2003, at age 61, he was laid off. Jim Tucci was now part of the “jobless recovery” that all but inevitably follows a long period of overinvestment.
In the first half of 2003, a rally offered hope that the market might give back what the bear had taken way. But Jim Tucci would not get back into the market. “I’m sure as heck not going to buy anything,” he said. “And even if I were, who would I listen to for advice? No one seems to even give off a whiff of honesty about any of this stuff.”12
Even buy-and-hold investors who had stuck with the program were realizing that it could take a long time to dig out of the hole. In June of 2003, Bloomberg’s usually optimistic mutual fund columnist, Chet Currier, acknowledged that, by his reckoning, since October of 2002, investors had regained only about $2.21 trillion of the $7.41 trillion erased from their net worth between March 2000 and October 2002. (Somehow, no one ever talked about the savings lost before March of 2000.)13
While investors waited to recoup lost paper gains, they squandered the opportunity to make money by putting their cash to work elsewhere. For example, if an investor sold stock worth $100,000 in June of 2000 and shifted into a diversified portfolio of municipal bonds, Treasuries, foreign bonds, gold, and real estate investment trusts, he stood a decent chance of averaging at least 7 percent a year over those three years. At that rate, his $100,000 would have grown to nearly $125,000. By contrast, the Vanguard study suggested that the typical investor who sat on a $100,000 portfolio of stock from 2000 to 2002 had wound up with $80,000—or less.14
In fact, by 2002, roughly 40 percent of all investors age 40 to 59 showed balances of less than $50,000 in their 401(k), an Employee Benefit Research Institute survey revealed. Less than one-fourth reported having more than $100,000 in their retirement accounts. The grand illusion of the nineties—that hordes of small investors were on their way to becoming millionaires—was much like the “reality TV” born of the same decade. It was make-believe.
By 2003, observers had begun questioning the basic premise behind 401(k)s: the notion that employees could be their own pension managers. The Wall Street Journal noted that the Zeitgeist was shifting: while a 401(k) might work well “for the 15% to 20% of the population that has the know how and desire” to take control of their retirement savings, many investors wanted more help. “Time to Turn Over the Reins?” the Journal asked. Spotting an opportunity, in the spring of 2003, Fidelity introduced a new service that let workers turn over management of their account to professionals—in return, of course, for an extra fee.
By now, it was becoming clear that, for many investors, 401(k) accounts would never match the nest eggs they would have had under a traditional pension system. In 2002, Edward N. Wolff, a New York University economist, did the math: to produce the equivalent of a $20,000 annual company pension at the age of 65, a 401(k) investor would need to have accumulated $200,000 in savings by age 50. At the time, the 401(k) accounts of households in the 47-to-64 age group averaged only $69,000. The most desirable solution to the problem, Wolff suggested, “may be to re-establish the [old-fashioned] pension system.”15
But in 2003, it did not appear likely that employers were going to agree to switch back to what was, for them, a more costly alternative. Moving in precisely the opposite direction, they were cutting back funding of their 401(k)s. Companies like Goodrich, Textron, Goodyear, Ford Motors, and Charles Schwab had already announced that they were temporarily reducing or suspending their matching contributions.
All in all, the Journal reported, “the 401(k) is looking increasingly like a tattered promise.”16
ON WALL STREET
In Lower Manhattan, the big losers were the brokers, bankers, traders, money managers, and analysts who lost their jobs as the financial world downsized. Some were laid off, others left under a cloud. By the spring of 2003, Frank Quattrone, the Credit Suisse First Boston banker who had taught Mary Meeker how to spot an IPO, was being investigated for possible criminal obstruction of justice. In March he resigned from CSFB.
In contrast to the average individual investor, many of Wall Street’s pros still had the nest egg they had accumulated during the boom. Their bonuses were not paper gains; they could not be restated. Some used the money to bet on the market and lost much of it. But many pros agreed with Paul Scharfer, the venture capitalist who, in 1997, had confided: “I have a favorite saying, ‘Make money on Wall Street, bury it on Main Street. Take it out of harm’s way.’”17 If you lived behind the scenes on Wall Street, it was harder to suspend disbelief.
A few prescient money managers, such as Fidelity Magellan’s former manager Jeff Vinik, and the Acorn Funds’ skeptical founder, Ralph Wanger, made a graceful exit. As noted, Vinik dissolved his hedge fund while he was still on a roll, in the fall of 2000. Wanger sold his fund company in February of the same year—a month before the Nasdaq’s meltdown began—and put all of the money in bonds. Asked if he had timed the market, Wanger replied:
“Well, I guess we did. Eventually,” he added, “the grown-ups win.”18
THE GURUS AND THE GREEK CHORUS
Gail Dudack also landed on her feet, setting up her own shop as managing director of research at SunGard Institutional Brokerage. Meanwhile, as fate would have it, in March of 2002, Lou Rukeyser was summarily sacked from his own show in much the same way that he had disposed of Dudack.
Rukeyser was blindsided when the Baltimore Sun broke the news that Maryland Public Television and AOL Time Warner’s Fortune magazine were poised to create a new Wall $treet Week—without Rukeyser: “I was unaware of any of this until yesterday,” he later told Dow Jones newswires. “Most people who have heard that MPT [Maryland Public Television] is going to try do Wall $treet Week with Louis Rukeyser without Louis Rukeyser think it must be somebody’s idea of a bad April Fool’s joke,” he added.
It turned out that Rukeyser and Maryland Public Television had, in fact, been negotiating over Rukeyser’s role on the program. “The reality is this,” Rukeyser ultimately acknowledged, reading from a prepared statement, “MPT is my partner, and I decided we had to make changes and we were going to work together on what those changes should be when they decided unilaterally not to proceed with me as the host of the show I created, wrote and maintained for 32 years.
“They then tried to get me to remain with the program in a senior-commentator capacity, but I decided I didn’t want to have anything further to do with them. Since then, my phone has been off the hook with alternative offers, and I will certainly consider all of them.”
Rukeyser did just that and quickly found a new home—at CNBC.19 Many saw it as a perfect match.
In the meantime, Alan Bond, “that old Dartmouth basketball player” Rukeyser had chosen to replace Dudack on Wall $treet Week’s elves’ panel, wound up in jail. In 2003, Bond was sentenced to 12½ years for cheating clients and taking kickbacks from brokers.20 As for Ed Kerschner, the market strategist who had slid into Dudack’s chair at UBS Warburg, he remained ebullient: in June of 2003, he predicted that corporate earnings would grow 6.3 percent by the end of the year.21 A month later, UBS Warburg announced that Kerschner, 50, would be retiring at the end of the year “to pursue other interests.”
Though never Kerschner’s equal as a cheerleader, in the summer of 2003 Abby Cohen remained optimistic, forecasting 10,800 on the Dow and 1150 on the S&P 500. Yet she sounded cautious: her prediction for corporate earnings came in below the Wall Street consensus.22
In June of 2003, newsletter writers such as Richard Russell, Jim Grant, David Tice, Kathryn Welling, and Marc Faber still expected a long bear winter. Steve Leuthold, by contrast,
was bullish over the short term. “We’re invested balls-to-the-wall, right now,” Leuthold reported cheerfully. But he made it clear that he viewed the upturn as a trading opportunity. He did not think that it was the beginning of a long-term bull market.23
THE CEOS
Inevitably, many investors wanted someone to blame. Most were willing to acknowledge that in the end, the decision to buy had been theirs: “I read everything—I thought I knew what I was doing,” a 34-year-old well-educated New Yorker who booked guests for a television network later confided. “But I didn’t,” she confessed, coloring slightly, still surprised at how everything could have gone so wrong.24
Still, they were angry—at the CEOs who absconded with their savings, at the analysts who slapped a “buy” recommendation on virtually every stock in sight, at the talking heads who had assured them if the Fed just cut rates one more time, all problems would be solved.
Congressmen, in particular, enjoyed berating CEOs, especially when the cameras were rolling. Some, like Senator Carl Levin, a longtime advocate of subtracting the cost of options from profits, pushed for genuine reform. Many senators and congressmen now stood with him, including Senator Shelby, now chairman of the Senate Banking Committee, and Senator John McCain, an influential Republican who had run for his party’s presidential nomination. The Council of Institutional Investors—the leading organization representing large investors like pension funds—had opposed reform in 1994 but now supported it.