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The Daily Reckoning Presents: The following is a portion of the recent testimony by financial commentator Christopher Byron before the House Committee on Financial Services, which is currently investigating the actions of Wall Street analysts. We produce it here for its insight into the bubble that was.


“For nearly four years…the analyst community on Wall Street, and the media organizations that covered it, engaged in what amounted to a massive, shameless and totally irresponsible free-for-all riot in pursuit of money.”

The huge amplification of voices now provided by the digital age is creating new and increasingly difficult challenges for the self-regulators and the Securities and Exchange Commission. One can make a strong and convincing case that the entire tech-sector bubble, which swelled the Nasdaq stock market to three times its size in barely 24 months, then popped in March of 2000 like a champagne bubble in a glass, was caused by Wall Street’s amplified megaphones of cable television and, most especially, the Internet – megaphones through which the analysts shouted “come and get it” to uninformed investors all over the earth.

That fact has huge and obvious public policy ramifications for Congress, because the collapse of the Nasdaq market has brought an end to the longest-running bull market in the nation’s history, and now threatens to tip the economy into a recession that no expert has yet shown a convincing way to avoid.

Trillions of dollars in national treasure have been drained from the economy by the implosion of what Federal Reserve Chairman Greenspan has termed the “wealth effect” created by that bubble, and the Bush administration and the Federal Reserve are now engaged in an uncertain effort to replace it with a combination of tax rebates and lowered short-term interest rates. Yet if stock prices had not been pumped up to the indefensible heights they eventually reached in the first place, they would not now have fallen as far as they have and we would not now be groping for a way to pump them back up again.

This bubble was financed largely by individual investors. And it is the Wall Street analysts and the media voices that helped turn the analysts into pseudo-celebrities who must now bear responsibility for the consequences. In some cases, we have even seen the spectacle of professional investors simultaneously purporting to be analysts, investors and journalists all at once.

For nearly four years – from the Yahoo IPO in April of 1996 to the deluge of IPOs that spread across Wall Street in the first three months of 2000 – the analyst community on Wall Street, and the media organizations that covered it, engaged in what amounted to a massive, shameless and totally irresponsible free-for-all riot in pursuit of money.

In stories and columns I wrote during this period, I attempted to call the public’s attention to the colossal pocket-picking to which it was being subjected. Most particularly, I wrote repeatedly about the outrageous situation in which IPOs would be offered to investment bank clients at a cheap “pre-market” price, even as the bank’s analysts engaged in nonstop commentary designed to pump up demand for the stock among individual investors in the aftermarket. Then, when the stock would come public, the insiders would instantly dump their shares into the waiting and outstretched arms of individual aftermarket investors at four and five times their pre-market price. Within hours thereafter, the stock price would collapse. You can call it what you want, but I view schemes like that as nothing more than swindles and fraud.

You may review the trading histories of literally dozens of tech-sector IPOs during this period and find this precise pattern repeating itself over and over again. To that end, I would thus respectfully call the Committee’s attention to the following IPOs, which are simply illustrative of the process I have described:

— VA Linux Systems Inc. (Insider price, $30; first sale to individuals, $320.)

— theGlobe. com Inc. (Insider price, $9; first sale to individuals, $97.)

— WebMethods Inc. (Insider price, $35; first sale to individuals, $336.)

There are many, many more like them. These stocks, and countless more, were pumped to wildly unsupportable prices by impossibly grand claims from analysts regarding their potential as businesses. The fact that these claims echoed through the megaphones of TV and the Internet, to reach individual investors [in] every corner of the globe, simply underscores just how much capital can be raised on Wall Street now that the whole world has access to the same information simultaneously. And this is only the first instance in which this unexpected alliance of analysts and the electronic media has come to bear on the market. Unless efforts are undertaken now to prevent a recurrence, we may look for even more disruptive performances in the future.

To that end, I would respectfully suggest consideration of the following:

That so-called Section 17B of the Securities and Exchange Act of 1933, which, in layman’s terms, requires anyone who is paid by an issuer to circulate, publish, or otherwise disseminate stock recommendations, be augmented to require – as a matter of law – that anyone publishing or disseminating such information disclose, on the same document in which the dissemination takes place, any financial interest, either direct or indirect, that he or she may hold in the stock in question. It is not enough for self-regulatory bodies such as the Securities Industry Association and individual investment firms to do this on a “voluntary” basis. In this particular area, volunteerism has shown itself to be inadequate, and the law should be brought to bear. If Section 17B of the 1933 Act does not violate anyone’s First Amendment rights, then I doubt that the augmentation I have suggested would do so either.

Secondly, I believe that Section 10B of the 1934 Act, which deals with fraud on the market, should be aggressively enforced by the SEC. In the now famous Foster Winans case, a Wall Street Journal reporter ran afoul of the Act by using information obtained in the course of his work for that newspaper to trade in stocks before publication of his stories – in violation of an agreement he signed with his newspaper not to do so.

His essential violation thus amounted to promising not to do something, then doing it anyway. That basic principal can, and I think should, be applied to an implied covenant that can be presumed to exist between all disseminators of financial information that is offered to the public under color of impartiality. Any conflict of interest can be waived by disclosure, to be sure, but the regulatory authorities, and ultimately the Congress, can set clear, convincing and unambiguous standards as to what sort of disclosure constitutes adequate disclosure.

The goal should not be the “minimum” disclosure necessary to give comfort to the disseminator of the information, but the minimum necessary to give comfort to the consumer of the information that he or she is being fully informed as to any hidden agendas lurking in a recommendation. I thank you kindly for your time and patience.

Christopher Byron,
August 28, 2001

for The Daily Reckoning

Christopher Byron is a magazine, newspaper and Internet columnist and a radio commentator. His columns appear weekly in the New York Observer newspaper and on MSNBC Interactive on the Internet. He also hosts a daily webcast radio program entitled “High Noon on Wall Street.” A version of these excerpts first appeared on the website.

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Mr. Greenspan won’t be the only one to see his reputation return “to trend” in the downturn. Yesterday, the Italian press caught up with Milton Friedman, who remarked: “The key problem after the recession ends in 2002 will be how to control inflation.”

We don’t know how Mr. Friedman could know that the recession will end in 2002. But we know why he thinks inflation will be a problem. His analysis of the Fed’s monetary policies has made him famous and won him a Nobel Prize. Friedman believes you can control economic growth with monetary policy. In this, we believe, he is about to be proven wrong.

The price of gold isn’t moving. And the spread between TIPS (inflation adjusted 10-year notes) and regular T-notes has narrowed to a new low of only 1.53%.

Deflation is what the market fears – not inflation. And deflation is what the market is going to get…deflatingstocks, houses, the dollar, computers, cars, just abouteverything.

Here’s Eric’s report on yesterday’s deflating market:


Mr. Fry in Manhattan…

– Just two trading days after Cisco wowed tech-stock investors with the pronouncement that its sales would be no worse than it had forecast two weeks earlier, the long faces returned to Wall Street.

– Stocks fell hard Tuesday, with the Dow dropping 160 points to 10,222 and the Nasdaq sliding 47 to 1,865. Cisco, for its part, fell more than 5% to 17.

– A downbeat consumer confidence report, released one-half hour after the start of trading, accelerated the sell-off that was already underway. The Consumer Confidence Index fell to 114.3 in August from a revised 116.3 in July. For some inexplicable reason, consumers feel less confident when jobs disappear.

– Friday’s rally now looks to have been the kind of one-day wonder that typifies bear markets.

– Watching the stock market fall is enough to make you lose your appetite. And, in fact, we Americans have been: we are dining out less and less frequently, and that is toxic for restaurant company profits.

– The Smith & Wollensky Restaurant Group Inc. – owner of Manhattan’s famous steakhouse of the same name – reported a 12.3% drop in sales in its latest quarter. The company blamed the slowing economy for its troubles and said its three New York restaurants, Cite, Park Avenue Cafe and Manhattan Ocean Club, were hit particularly hard.

– Likewise, Morton’s Restaurant Group, a chain of 61 steakhouses nationwide, saw its same-store sales drop 9.6% in the second quarter.

– “As the shaky economy gives more consumers the jitters,” writes the Wall Street Journal, “the $258 billion restaurant and bar industry is grappling with the biggest slowdown in a decade.”

– The weakening economy is also pushing consumers not to indulge themselves in at least one other way: we’re playing less golf! Yes, sadly, it’s come to this. “Hard times have hit the links,” reports the Wall Street Journal. “National Golf Properties, which owns 146 courses in 23 states, reported [recently] that same-course revenue fell 5.1% in the first half largely due to the weakening economy.”

– The Journal continues: “Big companies are hosting fewer charity benefits and tournaments for employees and clients. Membership sales also are down. ‘Uncertainty over jobs has been impacting people’s willingness to pay initiation fees,’ says National Golf spokesman Edward Sause.”

– Does the U.S. golf slowdown remind anyone else of a bubble economy from a different place and time? Let me give you a hint: Nikkei 1989.

– Yes, that’s right, the average market value of a Japanese golf club membership hit its peak on March 10, 1990 – just three months after the Japanese stock market touched it’s now-infamous record high. (For financial bubble trivia buffs, the Nikkei reached its peak level of 38,915.87 on December 29, 1989. The hapless index closed Tuesday at 11,189.40)

– Meanwhile, the Nihon Keizai Shimbun Index, which tracks the average price of golf club memberships at 530 major Japanese country clubs, has collapsed more than 90% from its all-time high. Even one decade after the bubble burst, this index continues to make new lows. Fore!

– But just because some U.S. consumers are reining in their spending here and there doesn’t mean that the entire country has suddenly become as thrifty as “Poor Richard.”

– Rather, typifying America’s thrift ethic – or lack of it – the Daily Express relates, “In a recent poll of 1,205 people 21 to 35 years of age, 54% of the women surveyed said they were more likely to own 30 pairs of shoes than to have saved $30,000 in a retirement fund…70% said it’s important to look successful…48% of the women surveyed said that their money was to spend, not save.” Imelda Marcos wannabes – 1; U.S. Savings Rate – 0.

– On Monday, the Daily Reckoning noted the withering demand for new office furniture in the wake of the dot-com implosion. Tuesday, Herman Miller Inc., known for its stylish office furniture, brought the grim situation into high relief by announcing that its sales are slowing and its earnings will be lower than previously forecast.

– In lowering its sales outlook, the furniture company cited a forecast from the Business and Institutional Furniture Manufacturers Association suggesting that the industry’s decline this year will be one of the deepest in history.


Back to Ouzilly…

*** Today’s the big day. GDP figures are to be revised.

*** The BBC says it sees “Fresh Signs of a U.S. Slowdown.” Insider stock purchases are at an 8-year low. Tannette Johnson-Elie says she sees “Pay Day Loan” sharks doing a bustling business in Milwaukee. And Warren Buffett says he is preparing for an 8-year period of hard times.

*** Will the new GDP number be negative, showing a deflating economy?

*** We will see, dear reader.

*** Meanwhile, Pierre has gone all-out to make sure the attendees at our writers’ conference eat well. We’ve had platters overflowing with various dead animals – chicken, duck, lamb, beef.

*** Imagine Pierre’s expression when he learned that several guests were vegetarians. At first his face registered shock, then denial…and then betrayed an unmistakable look of disgust.

*** “Why would these people not want to eat meat? Why would they come to France?” he asked.

*** To Pierre, vegetarianism is as repulsive as cannibalism.

The Daily Reckoning