"What have you got, Dodger?"
"A couple of pocket-books," replied that young gentleman.
"Lined?"
Charles Dickens' "Oliver Twist" features the character of Fagin who trains boys, runaways, to pick pockets and bring home cash and watches and jewelry. Wall Street analysts, though rather better remunerated, wearers of slick suits, not tattered clothes, and normally considered within the law, are modern equivalents of Fagin's boys: They are there to bring the money in.
Their bosses will be happy if lucrative mandates to sell shares and bonds come in from the companies they analyze oh so insightfully and objectively. Then happiness will abound! The bosses and the analysts will go home with their bank accounts well-lined, which is what they want, and the bank will make profits, which is what it wants, and the shareholders will make money, which is what they want, and all will be well. But what happens when, after all the cheer-leading, comes huge defeat? Now the question is being asked: Whose pockets have suffered?
The brokers are being questioned. New York state Attorney General Eliot Spitzer investigated Merrill Lynch, the U.S. investment bank, which paid a fine of $100 million in May. What precisely can have been wrong? Investors have said that Merrill and others were cheerleading rather than analyzing. Their research into companies served to "ramp up" the stock market, as Americans put it, rather than give an objective view of the prospects for the fine companies they analyzed, such as Enron or Global Crossing, which have since gone under entirely, while many stocks have simply sunk, losing two-thirds of their value, in the case of the NASDAQ index, but nine-tenths of their value in many cases.
Why were the analysts, many of whom had buy recommendations on these stocks, so far out? Could it have anything to do with the lining of bank accounts?
The evidence against the brokers is strong because emails have been uncovered in which one analyst or another called the company he was trumpeting "junk." And then there is the system of rewards for analysts. At bonus time they have in the past written self-assessments in which they boast to their bosses of their role in obtaining lucrative investment banking business for the firm.
What is this business? If Merrill Lynch wins an assignment to sell shares or bonds for a US corporation, the bank will charge the corporation a fee. It also has an opportunity to distribute bonds to clients -- who, in turn, will want to enhance their relationship with the bank, in order to be first in line for popular new stocks or bonds -- and it will then be able to trade those stocks or bonds heavily and gain revenues from so doing. Investment banks want capital markets business and analysts are valued when they help to get that business. An honest analyst who tells unpleasant truths about assets that his colleagues want to sell is more likely to be seen as a nuisance, even if some clients value his assessments.
So there we have it, Fagin and his boys on Wall Street are not exactly honest. They are salesmen. But should investors be surprised? The answer, surely, is that only very naïve investors can be surprised. Or perhaps cunning ones who see in the entirely wrong research they once received an opportunity to obtain reparations for their bad investment decisions.
Analysts in banks ought to be objective but are not. They write about companies from which their colleagues want to obtain business and are under enormous spoken or unspoken pressure to play ball. Yet even this does not explain why Wall Street's research has been so uniformly wrong on U.S. stocks in the past three years.
Numerous analysts have no reason to be kind to companies. The bank or investment house for which they work has no chance of obtaining a mandate to issue the company's stock or bonds. Yet buy recommendations have abounded on Wall Street in recent years. A sell recommendation was almost impossible to find three years ago and even now, after injunctions in many banks that analysts issue more "sells," still the "sell" recommendations account for only about 5 percent of the total.
Look, too, at the research of institutions that are not banks at all, such as that of Standard & Poor's, or indeed of numerous writers on stocks in newspapers and magazines. It, too, is mostly wrong. The reason is simple. Predicting what stock prices will do is difficult and despite the marketers of one "ideal" stock-picking system or another, or the loud claims made for some banks or analysts, almost all the time the analysis is wrong.
Why is this? Go back to a typical investment bank. A view on the likely performance of a company is really a composite piece of work: the fusion of the ideas of a series of highly-paid experts. The bank's economist has a view of the U.S. economy; the strategist a view of the market and of sectors; the analyst a view on the company. Each of these people is likely to be highly-educated, intelligent and perhaps experienced.
But how many economists forecast the sudden downturn in the U.S. economy in 2000? How many strategists would have forecast in 1998 that the Nasdaq index would double in two years? And how many in late 1999 forecast that it would fall by two-thirds in the next two? The experts are mostly wrong. The economy and the market is more unpredictable than they can imagine. There are too many variables, too many events, too many factors for any computer or any person or group of people to weigh it all successfully.
So economies and markets are highly uncertain and literally unpredictable: Is that the only answer we come to? Is that the net result of our misgivings about Wall Street's cheerleaders?
No, there is something more and it may matter.
The cheerleading was something more general. It was also practiced by companies themselves. The exaggerated claims made for corporate prospects, the dubious accounting that has kept stock options off balance sheet, and debts tucked away, the now exposed manipulation of numbers that made weak companies seem strong has damaged investors' faith in corporate America.
Now a different view is being taken of U.S. assets and the U.S. economy. Foreign investors are wary. The spell has been broken. They are not going to pour money any more into U.S. assets. That is why the dollar has begun to fall after years of strength.
The boom of the late 1990s favored the United States and, most particularly, those who benefit from financial assets: holders of shares and stock options and the financial industry itself. That time has gone.
The investment banks are going to shrink. The business is not going to be there to support the staggeringly high salaries and bonuses they pay.
More important, U.S. stocks and the U.S. economy are going to struggle. Money is no longer going to jump magically into American pockets having been conjured up by a band of cheerleaders and a stock market index that was dancing to their merry tune. Consumer spending is going to slacken. House prices are going to fall. The first years of the new millennium are going to be gray and sober ones.
Fagin, would have understood the brokers' feeling well. "All I have to live upon, in my old age," he says of his "trinkets." But the sadness is that it will not be the over-rewarded brokers who suffer most from the end of the cheerleading days. Ordinary people will in the United States and around the world as economies and stocks suffer.
A final (more hopeful?) word. This economist, too, might be wrong. But if he is, the reader can be sure of one thing: No one paid him to be.
Global View is a weekly column in which our economics correspondent reflects on issues of importance for the global economy. Comments to [email protected].
