Many of today's investors first became interested in the stock market during the late 1990s, when it seemed as if every stock was going up and up forever. That's when I first began to tune into the opportunities for growing wealth that the market represents. Actually, I didn't enter the market until mid-2001, partway through the crash that followed the dot-com bubble. My first two investments, Cisco
After those beginning losses, I started over again with the mantra "profits and underlying business matter" resounding in my ears.
How the giddiness of the market -- the remnants of which had affected me when I bought those two stocks -- came about is the subject of Roger Lowenstein's Origins of the Crash. This book can be read over the course of a weekend afternoon, but it emphasizes lessons about the psychology of businesses and the market as a whole which can be appreciated over a longer time frame.
Share price at any cost
Lowenstein begins the story well before the bubble even began inflating, introducing his first main thread. The book opens with a discussion of a lack of corporate governance which was becoming noticeable in the 1970s. There was a growing concern that many companies were not doing well. One response was the hostile takeover, soon followed by leveraged buyouts; the idea was to remove the dead wood. Managers, fearful of losing both positions and companies, responded by trying to make their companies too expensive to buy. This began a focus on the stock price.
That focus was sharpened by an attempt to solve a related problem, namely keeping management aligned more with the interests of the owners and less with their own. One solution was the granting of stock options. Lowenstein presents the argument that this does not solve the problem it is supposed to, but rather creates a wholly different, and worse, situation. His premise is that when someone is given something with upside potential and no downside risk, that person is willing to do a lot to increase the upside. This led many managers to focus on growing the stock price and beating the quarterly numbers to keep Wall Street happy.
Who shall guard the guardians?
The second main thread weaving its way through the book is a lack of oversight by those who are supposed to be the "gatekeepers." Lowenstein includes analysts, auditors, politicians, boards of directors, and financial journalists. Among the problems he describes are:
- how auditing firms became conflicted after the removal of rules that prevented them from doing underwriting business with their audit clients;
- how analysts hyped companies that their firms did business with even if they felt that those companies did not deserve such praise;
- how directors turned a blind eye to many things management was doing;
- and how the government, with many ties to big business, failed in its regulatory role because times were good.
The resulting mischief
Lowenstein writes that a result of these two things, focus on the stock price and failure of the gatekeepers,
A sort of mass conspiracy, or mass delusion, ensued. Securities were worshipped regardless of the assets they represented; the market price -- no matter how transitory -- was honored whatever the underlying value. This obsession with appearances, with the market snapshot as opposed to the enterprise in the flesh, caused horrendous mischief.
Horrendous mischief, indeed. Lowenstein follows the two threads throughout the book, using several examples along the way. Included are the well-known scandals of Enron and WorldCom, a discussion of General Electric
While The Intelligent Investor gives you some nuts and bolts about successful investing, Origins of the Crash is a description of what happens when business ethics and common sense both break down at the same time.
For readers who were invested during the bubble and the crash that followed, the book might bring up painful memories. For investors like me, who began during or after the bubble burst, it provides a decent look at many, though probably not all, of the causes of the crash. For both groups, it provides lessons in how human we really are and pointers on what to avoid in our investments as we go forward.
Intel is an Inside Value recommendation.
Fool contributor Jim Mueller has repurchased Intel. He also has an interest in General Electric through his wife. Of the rest, not a share. The Motley Fool is investors reading and writing for investors.