FOOL ON THE HILL
Scandal Not to Blame

Our behavior from 1999-2002 is very similar to the way people behaved from 1929-1932. When it appeared that stocks wouldn't recover in 1930, society looked for someone to blame. Today, we're blaming scandal for our Wall Street woes, as America did 70 years ago. But are we right?

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By Jeff Fischer (TMF Jeff)
July 22, 2002

"The sagging of stocks has not destroyed a single factory, wiped out a single farm or city lot or real-estate development, decreased the productive powers of a single workman or machine in the United States. All these things are still there, and when they are essentially sound, as this country is, the more magnificently they recover."

That's from the New York Daily News on Oct. 30, 1929, soon after the stock market began its most infamous decline. The peak on the Dow Jones in 1929 was not seen again until 1954.

I've been reading The Dark Valley: A Panorama of the 1930s, by Piers Brendon, and 200 pages into the 800-page book, what I've found most striking are the many similarities between 1929-1932 and 1999-2002.

What we're experiencing today economically doesn't compare to the misery the world saw a mere 70 years ago during the Great Depression. However, what we're experiencing emotionally and how society is reacting to the events surrounding the stock market is incredibly similar to what happened seven decades ago.

In both cases, the country initially had confidence that the stock market would soon return to "normal" -- normal being a poor euphemism for "what we like" (a rising stock market). The New York Daily News quote above could've easily been written in 2000, when everyone said the economy would rebound the second half of that year.

In 1929, financiers said that there had been "a little distress selling for technical reasons, but that the market was fundamentally sound." President Hoover also preached that American business was on solid footing, using phrases not unlike ones we recently heard from Federal Reserve Chairman Greenspan and President Bush.

When stocks didn't soon recover in 1930, confidence that they would began to dwindle, just as we experienced in 2001. Soon afterward, it wasn't just confidence in rising stocks that disappeared, but confidence in the entire system came into question as stocks continued to fall. Then the hunt for a culprit began.

From The Dark Valley: "In the United States the most important commodity to be damaged was confidence. Not only was there disillusionment with Wall Street, but the prestige of business was shattered... Bankers were discredited: Time magazine coined the term 'bankster,' and Depression jokesters quipped, 'Don't tell my mother I'm a banker, she thinks I play the piano in a brothel.'"

That was the early 1930s. Just replace "bankers" with "CEOs," and the sentiment is exactly the same today.

What we're seeing repeated here is human nature -- and not the prettiest side of it. All the reforms we're now calling for (sometimes screaming for) could have been called for anytime in the last decade, and many of them could have been demanded anytime in the last five decades. But people didn't cry out, because as long as we're doing well by a system, we're not going to attack it.

Now that society's dream of ever-higher stocks in a New Economy is shattered, society needs someone to blame. People and media need to direct hostile energy and disappointment at someone. Executives worth millions even after the decline are ideal targets. And some of them -- the corrupt ones -- deserve to be punished. But most do not.

But here's the key thing to remember in all this: Executives -- and corporate America, flawed or not -- are not to blame for the stock market's rise and fall. Not at all.

Here are some of the main reforms being demanded today:

  • Independent auditors
  • Accountability of executives for financial statements
  • Expensing stock options
  • A "wall" between stock analysts and investment banking
  • Stricter punishment for insider trading and fraud

The thing about all of these issues is that none of them caused the rise and fall of the stock market. If legislation related to these issues were in place the past 10 years, the stock market almost certainly would have risen and fallen much the same way, and only a few disasters, notably Enron and WorldCom (Nasdaq: WCOME), might have been averted.

But more likely, those companies would have still collapsed. Fraud is already a crime. Those companies committed fraud. Would a few additional laws have stopped them? Unlikely. On top of that, WorldCom was a dangerously leveraged business, just like Enron, so what truly brought both companies down -- initially -- was risky management decisions. In the boom, people developed hubris and got stupid for money.

Today's front page of The Washington Post says that WorldCom was "felled by an accounting scandal." But it wasn't. The company committed an accounting scandal because it felt it had to. Why did it feel it had to? Because it had made bad business decisions earlier, including carrying too much debt. The company was already felled by its bad decisions. The accounting scandal was a result of those bad decisions. Without faked accounting, the company would have fallen even sooner.

In the growing choir of anger focused on mendacious scandal, we can't forget that scandal is not to blame for the market's fall, or even the fall of the Enrons and WorldComs. The market was falling long before Enron and WorldCom were uncovered, and Enron and WorldCom reverted to scandal in the face of prior bad business decisions. American business must take responsibility for its mistakes if we all hope to learn from them, rather than just blame crooks. Likewise with investors and their mistakes.

There is little doubt that the stock market will be a better place when analysts and investment banking are separated; when company executives are held accountable for financial statements; when auditors are independent; and when stock options are expensed (at best, that practice might decrease outrageous option grants).

But there also must be no doubt that none of these issues led to the rise and fall of the stock market. All of these issues that we're attacking now have been out there a lot longer than 1996-2000. In fact, we've lived with most of these issues for decades.

So right now, what we're seeing more than anything else is human nature repeating itself during a big boom and bust cycle. People enjoy the boom and find scapegoats for the bust. This anger leads to change.

From The Dark Valley, a 1932 telegram to President Hoover: "Vote for Roosevelt and make it unanimous." Jeff Fischer's stock holdings are shared. The Fool has a disclosure policy.