Bull!

by Maggie Mahar

  No matter. In 2002, Senators Levin and McCain proposed two different amendments to the Sarbane Oxley bill, legislation passed after the Enron debacle requiring stricter corporate disclosure. Their proposal called for options reform. But in each case, corporate lobbyists were able to block the amendments, preventing them from ever coming to an actual vote. In 2003, FASB, the independent board charged with overseeing accounting standards, issued its own proposal for reform and sent it out for public comment. The board hoped to finalize a new options accounting standard early in 2004.

  In the spring of 2002, in the wake of revelations that executives at companies such as Enron, Tyco, and WorldCom had been looting their firms while frosting their books, President Bush made a special trip to Wall Street to express his outrage. But, as The New York Times’ Floyd Norris pointed out, while “his words were harsh…his proposals were generally not…. Bush challenged companies to stop lending money to their executives, but made no proposals to restrict such loans by law or to increase what companies must now disclose about the loans.” He called on chief executives to explain their own pay packages, “‘prominently and in plain English,’” Norris noted, “but he called for no new disclosures, let alone limits on executive compensation.”25

  Cynics could not help but enjoy all of the political posturing: “When George W. Bush went to Wall Street and delivered his speech about corporate reform in front of a banner that read ‘Corporate Responsibility,’ I thought: it doesn’t get any better than this,” Michael Lewis confided to his readers. “It was as if Bill Clinton had flown to Las Vegas to deliver a speech in front of a banner that read ‘Sexual Abstinence.’

  “But I was wrong. It did get better,” he continued. “Tipped off by a friend, I went to the C-Span Web site and watched the tape of Monday’s hearings of the House Financial Services Committee. The committee, previously known mainly as a good place to attract campaign funds from Wall Street, dragged before it for a public whipping the cast of WorldCom Inc. There, as [Salomon telecom analyst] Jack Grubman and [WorldCom CEO] Bernie Ebbers stared stoically into the middle distance, California’s Maxine Waters referred to the corrupt research reports of a Street investment bank she called ‘Salomon Barney Frank!’ [confusing the name of the Wall Street firm with the name of Congressman Barney Frank]. And she was reading from a prepared statement,” Lewis noted.26

  It is not that Lewis felt particular sympathy for Ebbers or Grubman—just that he realized the finger-pointing was Washington’s way of ignoring the larger, structural problems. The CEOs brought before Congress had not caused the market to crash. In fact, by exaggerating their earnings, they helped keep a wildly overpriced market afloat. And they were not the only ones. Everyone was part of the dance, as Ralph Wanger had pointed out. But now, Washington, Wall Street, and Main Street wanted someone to blame.

  This, too, was part of the cleansing ritual that follows any financial frenzy, as John Kenneth Galbraith had noted in A Short History of Financial Euphoria. Galbraith explained that there are two reasons why the public focuses on a few individuals when assessing blame: “In the first place, many people and institutions have been involved, and whereas it is acceptable to attribute error, gullibility and excess to a single individual or even to a particular corporation, it is not deemed fitting to attribute them to a whole community, and certainly not to the whole financial community. Widespread naivete, even stupidity, is manifest; mention of this however, runs drastically counter to the…presumption that intelligence is intimately associated with money. The financial community must be assumed to be intellectually above such extravagance of error.”

  The second reason, Galbraith explained, is that investors are reluctant to admit that the market itself could have been wrong, allowing stocks to trade at ridiculous prices for a significant period of time. Those who believe in an efficient market insist that the market itself must be “a neutral and accurate reflection of external influences: it is not supposed to be subject to an inherent and internal dynamic of error,” Galbraith observed. “This is the classical faith. So there is a need to find some cause for the crash, however far fetched, that is external to the market itself. Or some abuse of the market that has inhibited its normal performance.”27

  In other words, while individuals can be fingered, few wish to recognize the systemic problem in corporate accounting that, in the Levy Center’s words, had infected not just a few apples, but “the whole bushel.”28

  Similarly, while individual money managers might be roundly criticized for taking too many chances, the mutual fund industry as a whole escaped widespread blame. Few questioned why so many fund managers were forced to stay fully invested—even when it became clear that the market was tanking. “We have a special relationship with corporate America,” one industry executive explained privately.29 If his firm’s funds began withdrawing capital from overpriced stocks, the firm would be violating that special tie. He said nothing about a special relationship with the customers who invested in his firm’s products.

  THE ANALYSTS

  As the market fell apart, Wall Street’s analysts became the most logical targets. “Where was the research?” the media asked. In fact, the financial press had been aware, for many years, that Wall Street research was tainted by the Street’s interest in selling stocks, drumming up investment banking business, and remaining in the good graces of large institutional clients who owned those stocks. This was not a problem that popped up at the end of the bull market. Even in the eighties, sell recommendations had become rare.

  As the bull market spun out of control, some journalists threw a spotlight on Wall Street’s hidden agenda. In 1998, for example, in a story headlined “Who Can You Trust? Wall Street’s Spin Game,” Business Week’s Jeffrey Laderman told the story of Thomas K. Brown, a top-ranked regional banking analyst at Donaldson, Lufkin & Jenrette with 15 years’ experience. Recently Brown had been fired. “His sin? He was an outspoken critic of banks that had paid heavily to amass huge empires without much to show for their money,” Laderman reported. “I believed many of the acquisitions are destroying shareholder value,” said Brown.

  DLJ had been trying to break into the top ranks of investment banking, and Brown was not seen as an asset, Laderman explained. DLJ offered Brown a $450,000 exit package in exchange for an agreement that he not talk about the firm for five years. He turned it down.

  And this was but one of a number of stories that ran in widely read newspapers and magazines in the late nineties, exposing the limits of Wall Street research.30 But while the market was going up, these stories barely created a ripple. It was not until after the indices tanked, at the very end of 2000, that a series of scathing articles by New York Times columnist Gretchen Morgenson finally caught the public’s attention.31 Now, suddenly, the media was horrified. CNBC’s anchors began to needle their guests. Closing the barn door, it seemed that the press could not write enough stories about the Wall Street analysts who had led investors astray.

  Allan Sloan would have none of it. Sloan did not hold Wall Street analysts in particularly high regard; he did his own research. But he was struck by the hypocrisy of the media’s attack:

  “WE wrote about these people,” Allan Sloan exclaimed, while accepting the Loeb Prize, the Pulitzer of financial journalism, in June of 2001. “And now we say they’re guilty; it’s their fault. I mean, come on, we’re responsible.

  “Instead, it’s ‘let’s-find-a-villain.’ And now, supposedly, people like Mary Meeker and Henry Blodget are the villains; they’re the people who sowed the madness in America; they’re the ones who cost people billions of dollars.

  “Now, forgive me,” Sloan continued, “I don’t remember reading about Mary Meeker invading a newsroom with a gun and saying, ‘Write about me or die.’ I don’t remember Henry Blodget saying, ‘I’ve got your children hostage and unless you write about my idiotic prediction that Amazon is going to $400 a share, you’ll be getting pieces of the kids back in envelopes.’ Nobody did any of t
hat.”32

  HENRY BLODGET

  Somehow, as the lynch mob gathered, Henry Blodget became the designated scapegoat for the entire analytic community. Of the thousands of analysts who recommended lemons, Blodget was singled out to wear the scarlet A. By 2002, it became virtually impossible to read a story about any analyst without seeing his name mentioned.

  Finally, in April of 2003, the mob handed down its sentence. Blodget would pay $4 million and be barred from the securities industry for life. The judgment capped an investigation launched by the National Association of Securities Dealers. The crime, as The Wall Street Journal described it, was that Blodget “privately harbored doubts” about companies that he recommended.33 In other words, he was convicted of having impure thoughts. In the settlement, Blodget neither admitted nor denied wrongdoing. At 37, he was still a very young man; the ban from the brokerage business left him without a career.

  This is not to say that Blodget did not make some fatal mistakes. The first was to take the position as Merrill Lynch’s Internet “ax”—a job plainly described in the press at the time, with conflict of interest built in. He had explicitly been hired to recommend stocks while bringing in the IPO business that Merrill badly needed.34

  But of the constellation of star analysts who recommended overpriced stocks, why was Henry Blodget punished? Some would say because his e-mails proved that he did not believe his own recommendations. But unless one assumes that the rest of Wall Street’s analytic community was consuming large quantities of mood elevators that they did not share with Henry, the same could be said of almost anyone who was recommending stocks trading at 40 or 50 or 300 times earnings. All but the most deluded knew that a clock was ticking. But, as one analyst explained, “you knew the stock was overvalued—and you also knew it was going to go up.” No one could predict precisely when investors would stop answering the chain letter. And if an analyst was “early” in predicting a stock’s demise, small investors would be no more forgiving than larger clients.

  Why, then, Henry Blodget? Harvey Eisen, who ran money for Sandy Weill at Traveler’s before forming his own firm, Bedford Oak Partners, offered the simplest, and probably the most accurate, answer: “Wall Street needed a tar baby.”35

  Granted, Salomon telecom analyst Jack Grubman was tarred and feathered, too. In a separate settlement, Grubman agreed to pay $15 million, without admitting or denying wrongdoing, and, like Blodget, he was barred from the securities industry for life. But Grubman had already enjoyed a full career—and in his case, the choice seemed less arbitrary. Grubman was not just an analyst; he had helped to run corporations such as Global Crossing and WorldCom, companies engaged in world-class fraud.36 Like Frank Quattrone, the investment banker who became the emperor of Silicon Valley, Grubman wielded an enormous amount of power. And he understood precisely what was going on.

  Far from being an innocent, Grubman possessed a competitive killer instinct that Andy Kessler—who counted himself as one of Grubman’s friends—described in Wall Street Meat. At one point, the firm where both worked decided to turn a corporate retreat into a costume party. Before becoming an analyst, Grubman had enjoyed a brief career as a boxer, and “came dressed in bright red shorts and a yellow cape, wearing boxing shoes and gloves,” Kessler recalled. “About halfway through the party I borrowed padded gloves from someone dressed as a lacrosse player and started boxing with Jack. It started playfully enough, but then I landed a left jab on his face and he decided to teach me a lesson. I covered up like Ali playing rope-a-dope with Foreman, but Jack just beat the crap out of me, with a sick grin on his face.”37 And at the time, Kessler was a colleague, a drinking buddy, and a friend.

  Blodget, by contrast, was a far less aggressive player. He also possessed a nice sense of self-irony. Blodget realized, even at the time, that he was a five-minute celebrity. “He wore his fame so easily,” said a Wall Street veteran who had seen many a guru come and go. Moreover, Blodget’s overly optimistic projections did much less damage than Grubman’s equally rosy estimates, in part because his reign proved so brief. Blodget stumbled into the spotlight with his Amazon.com forecast in November of 1998 and left Merrill Lynch three years later in November of 2001. To be sure, at the height of his career, Blodget began to rival Morgan Stanley’s Mary Meeker as the Street’s top Internet seer. But why was he barred from the industry, while Meeker—who served openly both as Morgan Stanley’s top Internet investment banker and its top Internet analyst—escaped punishment? Meeker’s reign lasted longer, and she was a much more successful rainmaker, bringing in far more IPO business than Blodget ever did.

  Indeed, in 2000, Meeker reportedly helped raise close to $425 million in investment-banking revenue—more than any other Morgan Stanley analyst, and more than twice what she had attracted in 1999. As a stock picker, she did not do quite as well. That year, according to The Wall Street Journal, Meeker ranked 70th out of 111 analysts. Nevertheless, in 2003, when Morgan Stanley reorganized its research department, it named Meeker “co-head” of technology sector research, not just in the U.S., but globally.38

  By the summer of 2003, a number of Wall Street analysts had been charged with securities law violations, but Meeker escaped legal censure.

  Some said Meeker was not hunted down because she was a woman. Others claimed that Morgan Stanley circled its wagons around her while Merrill Lynch hung Blodget out to dry. When the IPO business faded, Merrill realized that it no longer needed an Internet star. The firm offered Blodget a buyout and cut him loose. By contrast, Morgan Stanley kept Meeker warm and safe, inside the herd.

  But some observers believed that the real reason that Mary Meeker escaped both persecution and prosecution is that Eliot Spitzer did not need her. He already had Blodget.

  ELIOT SPITZER

  An ambitious politician, New York State Attorney General Eliot Spitzer had his eyes on the governor’s mansion in Albany. To get there, he needed publicity. In other words, he needed a crusade. In a 2003 interview, Spitzer cast himself as the individual investor’s savior: “I was the only person who tried to protect the small investor,” he declared.39

  Why, then, did he wait until after the small investor had lost his savings? “According to Spitzer, his interest in Wall Street research dates back many years, to conversations with his old friend Jim Cramer,” Michael Lewis noted in his Bloomberg column. “Many years ago, Cramer showed his law school classmate the shocking truth that big Wall Street firms were simply giant machines for peddling securities, irrespective of their value, and not disinterested research institutes devoted to the pursuit of the truth.”

  So when Spitzer became attorney general in November of 1998, he knew how Wall Street worked. At that point, “it would have taken some guts, and might even have done some good, to call attention to the conflicts of interest and intellectual dishonesty in Wall Street research,” Lewis observed. “Now it has no effect on anything important. The time for regulatory courage has long since passed.”40 The money already had been lost, and investors no longer were inclined to confuse hype with hope. The most bullish analysts already had been widely discredited.

  But from a politically opportunistic point of view, 2002 was the perfect time for an attorney general to stand up and take an interest in skullduggery on Wall Street. While the market was rising, no one wanted him to rain on his or her parade. Now, investors and voters were fully prepared to be indignant.

  Moreover, from Spitzer’s point of view, Blodget offered an easy target. The e-mail trail showed that he was skeptical about many of the stocks he recommended and was becoming resentful of the pressure to push them. In truth, the e-mails revealed his honesty: Blodget was not comfortable in his role. But that was not how Spitzer interpreted them, and not how he used them. Somehow, Blodget’s e-mails were leaked to The Wall Street Journal. In a 2003 interview, Spitzer denied that his office was responsible.41 In any case, the e-mails put Eliot Spitzer, champion of the small investor, on the front page.

  While protecting the
little guy, Spitzer also avoided tangling with the big boys. Who had hired Blodget and given him his marching orders? Someone higher up at Merrill had decided that the firm needed an Internet analyst who could bring in banking business. Where were their e-mails—hadn’t they ever put the idea in writing? What about Merrill’s CEO, David Komansky?

  Blodget’s role, after all, was well known around the firm. “At some point during the many conferences Merrill Lynch held for its investors and brokers, the bosses invariably wheeled Blodget in to speak rapidly and with total certainty about the wisdom of sinking money into Internet stocks,” Lewis pointed out. “And the bosses did well by Blodget. By [compensation expert] Graef Crystal’s calculations, Merrill Chief Executive David Komansky was able to pay himself $32.6 million in 1999 (up from $12 million in 1998) and $34.5 million in 2000, in large part because of the huge sums of money Merrill’s Internet group brought in.

  “If you must lynch somebody,” Lewis wrote, “why not Komansky?”

  The answer was all too obvious. “If Spitzer went after Komansky himself—if he didn’t permit Komansky the pleasant fiction that he is shocked by Blodget’s behavior—Spitzer would be far less likely to get a quick and politically useful settlement. What he would get is a war. He might win that war but not without doing a great deal of damage to himself. And damaging himself is the one thing Eliot Spitzer will not do.”42

  If Eliot Spitzer were interested in serious reform on Wall Street, he might have brought a criminal indictment against Merrill Lynch. That would be war. That was precisely what former New York Mayor Rudolph Giuliani had done in the late eighties when, as a young federal prosecutor, he was laying the groundwork for his political career. Giuliani indicted Drexel Burnham Lambert on racketeering charges. The firm went bankrupt.