The Lost Decade + 2

Here's a chart of the S&P. It closed Friday at 770. It also closed at 770 on Jan 20, 1997. More than 12 years ago. *sigh*

Stop Trusting Wall Street

The Frog And The Scorpion.

In the late 90s, Wall Street profited handsomely from the tech IPOs they handled. Many of the companies they took public never should have seen the light of day, and, as we now know, the same investment banks that were handling the IPOs were writing the research reports that were intended to inflate prices. Wall Street firms made tremendous profits by taking nascent tech companies public. Who lost? We did, of course, by believing the hype the investment banks generated and buying their product.

Not content just to profit on the fees they were generating from the IPOs, the investment banks made even more money by setting the IPO price below what they gauged the fair market price would be at the open, taking money from the pockets of the original investors and employees in the company by setting an artificially low IPO price. Who lost? The company that was raising funds to finance growth in sales, marketing, development, etc. by going public. The banks were happy to make more profit, at the expense of the firms on whose behalf they supposedly were acting.

Is it the role of government to protect us from Wall Street? Certainly if we can’t read a prospectus and determine the intrinsic value of the company that’s going public, it’s not up to the government to save us from ourselves. All the government should be required to do is to make certain that the company filings are accurate, and the appropriate laws (such as no frontrunning, not sharing insider information, etc.) are being obeyed. In response to the public outrage, the government threw us a bone and started enforcing a Chinese wall between the analysts and the bankers. But in reality, it’s likely that even with this restriction in place Wall Street would still have found a way to profit at the expense of the public.

Fast forward to the present, and we find ourselves in an even worse situation. Banks found that they could package up home loans into new products and get the ratings agencies to give these products AAA ratings. Technically, the banks probably did not violate any laws, although they knew that, as with the IPOs, they were materially misrepresenting the intrinsic value of the product they were selling. And once again, they’re making huge profits by selling the product to the public.

I saw Alan Greenspan being interviewed by David Faber of CNBC. To the question of “what could the Fed have done,” Mr. Greenspan’s reply was essentially that the Fed was powerless to stop the chain of events, even had it known what was happening. And that the Fed will be powerless to stop similar things from happening in the future. In essence, we should expect individuals on Wall Street to act in ways that will maximize their individual financial return. When their interests are aligned with that of the public, it’s good for us. When inversely aligned, caveat emptor. In fact, it's now clear that individuals inside the Wall Street firms are so focused on maximizing their own pay that they're even willing to risk the fates of their own firms in the process.

So why should we ever trust Wall Street again? We can expect the government to throw us some small concessions in an effort to show the public that they are working to ensure that this can never happen again, similar to the Chinese wall they legislated after the dot com bust. But it should be clear to us by now that in a few years, the innovative folks on Wall Street will concoct some new product that it can pawn off to us at wildly inflated prices. It’s in their nature.