June 14, 2002
View from Lodi, CA: When it
comes to market options, it’s caveat emptor
By
Joe Guzzardi
Once in a great while, a prominent
public figure will speak out so candidly listeners are
caught off guard.
Such was the case last week when
Henry M. Paulson, the chairman and chief executive of
Goldman Sachs,
lashed out at the management and regulation of
public companies.
Said Mr. Paulson, “I cannot think
of a time when business over all has been held in less
repute.”
Listen to the speech in RealAudio.
Paulson continued, “In my lifetime,
American business has never been under such scrutiny.”
As the nation applauded, no one
reminded Paulson that American business has been caught
bottom feeding before—and not that long ago.
Whenever
financial disasters cause innocent investors to lose
their shirts, sanctimonious platitudes and pieties
similar to Paulson’s echo throughout corporate
boardrooms. A few months later, things die down and
business returns to normal.
Enron,
Tyco and
Merrill Lynch—to which Paulson indirectly referred—
are the three most recent examples of corporate
malfeasance.
But two huge blood-lettings
occurred while Paulson was a Managing Partner in the
Chicago Goldman Sachs office in the late 1970s and early
1980s.
Twenty-five years ago, the
Washington Public Power Supply System (WPPSS),
ill conceived and mismanaged, incurred staggering cost
overruns that caused the financial collapse of four of
its five proposed nuclear plants. The
WPPSS failure created the largest default in the
history of the U.S. municipal bond market.
To refresh your memory, investors
lost the tidy sum of $2.25 billion dollars in WPPSS
bonds. For all the widows and orphans who thought that
municipal bonds were the safest place to invest, WPPSS
was a rude awakening.
The uproar over WPPSS had barely
died down when the savings and loan scandals bilked
innocent investors out of their savings and retirement
funds.
So many savings and loans went
bankrupt in the 1980s that the
Federal Savings and Loan Insurance Corporation had
to be bailed out by the federal government. This cost
American taxpayers the present day equivalent of $225
billion.
In 1990, Gary Hector of Fortune
Magazine wrote a scathing piece, “Where Did All the
Billions Go?” The answer: into the hands of corrupt
savings and loan officials, politicians for sale and
sundry crooks.
Despite the tremendous cost of the
bailout, nary a peep was heard from John Q. Public. The
savings and loan fiasco was, in the minds of most, “too
difficult to understand.”
Maybe lasting change will come this
time around. But don’t count on it.
The New York Times is on the
reform bandwagon. In a June 7 editorial,
“Blunt Talk by an Investment Banker” the Times
praised Paulson for his warning to corporate American to
“clean up your act or we’re all in serious trouble.”
Paraphrasing Paulson, the Times
wrote, “Clean up your act or we are all in serious
trouble.”
To be sure, some encouraging signs
are out there. The Securities and Exchange Commission,
responding to Merrill Lynch’s shilling of low-grade
stocks to unsuspecting investors, has approved new
guidelines that must be put into effect within six
months
Among the most overdue changes are
that security firms may not tie research analyst’s
compensation to investment banking transactions. Also,
analysts must use the lure of a favorable stock rating
in exchange for underwriting business.
And Merrill Lynch must disclose
whether it has received banking fees from the companies
on which it issues a research opinion.
But the S.E.C. isn’t restricting
Merrill Lynch analyst’s participation in pitching stocks
to institutional buyers—the meat and potatoes of its
stock business.
Many are hopeful that the $100
million fine imposed by New York Attorney General Eliot
Spitzer will encourage a lasting separation of powers
between research and banking.
As imposing a sum as $100 million
is, it
represents only one-third of the total spent by
Merrill Lynch on postage last year. In other words, the
fine is water off a duck’s back.
I’m pessimistic because I’ve been a
Wall Street insider. For nearly twenty years, I worked
as a Wall Street banker. Most of those years were spent
at Merrill Lynch.
The calls for reform miss the heart
and soul of the Wall Street game. Wall Street only truly
works when investors buy.
Despite what you’ve seen in the
recent Charles Schwab television commercials, don’t
expect to hear “sell” encouragement from your broker too
frequently.
According to Thompson
Financial/First Call, between March 1st and
May 1st, the percentage of stock analyst
ratings that were “sell” or stronger were a mere 2.5%.
People still quiz me about my
market opinions. I have one standard response: “Caveat
emptor.”
Joe Guzzardi [email
him], an instructor in English
at the Lodi Adult School, has been writing a weekly
column since 1988. It currently appears in the
Lodi News-Sentinel.
