Column

WEB OF DISHONESTY

Fallout from the greedy practices of the dot-com surge still poisons the market

Peter C. Newman August 12 2002
Column

WEB OF DISHONESTY

Fallout from the greedy practices of the dot-com surge still poisons the market

Peter C. Newman August 12 2002

WEB OF DISHONESTY

Column

Fallout from the greedy practices of the dot-com surge still poisons the market

PETER C. NEWMAN

I ONCE DEBATED the irrational nature and unpredictable behaviour of the stock market with Andy Sarlos, one of the wisest gurus ever to grace Bay Street. “Investing in the market is a gamble as crazy as throwing your money away at a casino,” was my opening gambit.

“Dat is not true,“ Sarlos replied in his thick Hungarian accent. “Casinos have rules.”

Then he corrected himself: “One stock market rule dat must be obeyed is dat when a taxi driver dell you what shares to buy, you stop de cab, give de guy 20 bucks, run back to your office und sell everydink.”

Sarlos, who died in 1997, was predicting the dot-com bubble, and his advice was impeccable, though most investors joined the buying stampede and, instead of selling their high-tech shares at their peak, waited until their certificates were useless except as doilies for summer picnics.

Last week’s yo-yo stock quotes demonstrated that the fallout from the dot-com phenomenon still poisons the market. The many CEOs and CFOs who lied about their companies’ performance and prompted their auditors to sign false statements were willing participants in the madness of the high-tech boom. The going formula was that your corporate earnings had to shoot up at least 40 per cent per quarter, or you weren’t a player. I remember when the earnings of one of the most solid of the New Economy companies, Dell Computer Corp., increased only 38 per cent during one 1998 quarter; its stock went into a free fall.

“Once you became convinced that the value of your shares had stopped growing fast enough,” Nobel Prize-winning economist Franco Modigliani pointed out at the time, “nobody wanted to hold the stock, because it was so obviously overvalued. Everybody tried to get out, and it collapsed beyond its fundamentals.” (This exercise in financial leger-

demain didn’t require any earnings, or even economic activity. In 1996, Bre-X stock, for example, was driven up to almost $300 a share, strictly on the basis of phony claims and the Bay Street analysts who believed them.)

The unethical habits formed in those go-go years that have become standard practice ever since have been fuelled by the obsession of most executives to drive up the value of their stock options, instead of advancing the net worth of their companies. This shoddy business ethic resulted in a phenomenon known as “managed earnings,” which meant that boosting quarterly income (even at the cost of doctoring your books) became accepted practice. That would give share values a quick boost, thus adding millions to the value of executives’ stock options. (They’re worthless unless share prices keep rising, because they grant their holders the right to buy shares at a fixed price.)

Why the billionaires caught in the current web of deceit and dishonesty felt the need to increase their already wildly extravagant fortunes by stripping the treasuries of their own companies can be better diagnosed by their shrinks than by either the SEC or OSC. But it is a symptom of the profound dysfunction in the capitalist system that, for good or evil, sustains us all.

Stock market instability is hardly a recent phenomenon. According to a report by the Boston Consulting Group, investors associated with 60 leading private banking firms worldwide lost $2.9 trillion in 2001,

Unethical habits have been fuelled by the obsession to drive up the value of stock options, instead of advancing the net worth of a company.

which is as much as is hidden in the safes of Switzerland’s entire private banking industry.

Nor, of course, is it strictly an American tragedy. Shareholders in BCE Inc., Canada’s largest communications company, dropped $4.7 billion in 2001, and have lost much more since. Shares in Nortel, our very own poster high-tech company, slipped from a high of $124.50 in July 2000, to their currently shameful status as not much more than a penny stock.

Meanwhile, the reason for mounting concern about the future is switching from stock market losses to economic meltdowns. Argentina remains an economic killing field. Brazil’s currency fell precipitously last week to its lowest level since it was first floated in 1994, while the country’s national debt has reached alarming levels, with the IMF still undecided on an emergency bailout. The economic malaise is spreading to Uruguay (which last week extended its partial freeze on bank withdrawals), Columbia, Peru and Ecuador.

The Mexican peso is wavering, and Canada’s dollar could be on the verge of a significant devaluation. At the other side of the globe, Japan’s banks are carrying the equivalent of US$1.3 trillion in bad debt; their capital base has dwindled to barely two per cent of their assets—a quarter of the regulatory ratio required. With Japan’s banking system immobilized, and its government paralyzed, its economy is nearing a crisis. (I knew something was seriously wrong when a Japanese treasury bond issue yielding zero-per-cent interest was oversubscribed 200 times.)

It will take some seasons for sweet reason to return to the trading floor. But in the end the stock market is a pendulum that swings both ways. “In the short term I remain cautious,” I was told by Rod Sim, Yorkton Securities’ new chairman and CEO, “because we’re going to need a cathartic event to signal the end of this two-year bear market. But I’m also optimistic in the long term, or I wouldn’t be in this business. I do believe in the ultimate integrity of market participants and the accommodating practices of the central bank.”

And that’s about as good as it gets. lil

Peter C. Newman’s column appears monthly. pnewman@macleans.ca