New Economy Not Resting in Peaceby Christopher Mayer
It may still be too early to pen the postmortem on the New Economy. The final chapters on that episode are still being written. Nonetheless, Leon Levy's discursive memoir, The Mind of Wall Street, is a first cut, perhaps inadvertently so, at disentangling some of the threads that helped create the great bull market of recent vintage.
Levy is a very wealthy man, ranked among the Forbes 400, with a net worth of over $750 million. He is the co-founder of mutual fund giant Oppenheimer and also founded the celebrated hedge fund Odyssey Partners, which returned 28 percent annually during its fourteen-year life. Because of his success, his views on markets, while certainly not in the laissez-faire tradition, deserve some attention. A few of his observations are explored below.
Levy's view of history is rooted in Mark Twain's maxim that "history may not repeat, but it often rhymes." In Levy's mind he has seen all of this before. With the bubble finally deflating, as inevitably all bubbles do, investors, Levy writes, "snap out of their trance and ruefully look back on the myths, delusions, and outright lies they had cherished as truths when they were blinded by a rising market."
The New Economy mythology was just such a collection of cherished falsehoods. The long boom was more an illusion than a time of real growth and expansion. By August 2001, losses by Nasdaq companies wiped out all of the profits from the prior five years.
The New Economy was a prolific producer of supposed world-changing wonders, and one by-product was the claim of increased productivity. Ironically, even the author of the famed phrase "irrational exuberance" was snookered into believing that the old laws of economics had somehow been repealed. Greenspan never hesitated to use this prop (increasing productivity) to justify ever-dizzying stock market prices. In retrospect, as Levy points out, the productivity gains were a myth.
Levy points to the work of James Grant, among others, that show the only productivity growth in 1990s came from the computer industry and that most of the economy's productivity gains lagged the gains registered in 1980s. Moreover, as Levy cites, McKinley and Company has also done work in this area that demonstrates that much of the productivity gains came from a surge in consumer spending.
The current economic malaise has not shaken Greenspan's faith in the potency of productivity. In his remarks to Congress on February 11th he still cited "favorable underlying trends in productivity" as a positive force in the economy. Robert Samuelson addressed this issue in a Washington Post editorial titled "Economic Darwinism". He noted that labor productivity in 2002 was 4.8%, the best showing since the 1950. However, that productivity surge was not due to the sorts of things that normally drive productivity in a growing economy. Instead, as Samuelson notes, much of the increase was due to layoffs, bankruptcies and cutbacks.
The problem with the 1990s boom and one that Levy glosses over (his focus is on the investor psychology) was its fuel: rampant credit and monetary expansion, which led to massive malinvestment. The Internet and the computer revolution were supposed to break the old laws of economics. Instead, the landscape is dotted with lifeless dot-coms and the still smoldering wreckage of telecom bankruptcies, among other limping and wounded industries. As Samuelson notes, "The efficient production of what's unneeded…is still wasteful. Productivity statistics, temporarily puffed up, were somewhat misleading."
Then, there are all those phony accounting reports. Levy writes, "companies artificially pumped up earnings by treating ordinary expenses as extraordinary events (Enron, Cisco), by booking earnings and revenues long before they were realized (Computer Associates, Calpine), by including capital gains from investments in earnings (Microsoft, General Electric)…" and on and on it goes.
The time of reckoning was inevitable. "Companies can maintain the illusion of operating earnings for only so long, " Levy writes. "In a corporate replay of The Picture of Dorian Gray, earnings …remained eternally ebullient while hidden from public view was the true portrait that had become disfigured by warts, goiter and pox." A prime example would be Computer Associates, which, in October 2001, reported record second quarter earnings of $359 million in its press release, while at the same time it reported a $291 million loss in its filings to the SEC using generally accepted accounting principles.
Another example: Enron, whose very name has come to symbolize corporate deceit and sleaze, was still on target to meet its pro forma earnings predictions as late as November 2001, even as a firestorm of controversy raged around it. As Floyd Norris of The New York Times commented, Enron "managed to go broke without ever reporting a bad quarter."
Such examples underscore the absurdity of the accounting abuses of the late 1990s. They also show how economic reality was blurred by massive credit expansion, and how naïve investors (perhaps operating under the poor assumption that Greenspan and the Fed could sustain the bubble) so willingly suspended their belief in the older ideas of economic progress through hard work and real savings. The loose monetary order of the time provided a rich soil for wide-scale malinvestments that would not have been possible in a hard money regime.
It would all have been much more amusing if it didn't ache so much. After all, trillions have been lost ($4 trillion in the Nasdaq alone). As Levy writes, the bubble's "legacy is like a wretched hangover. Long after the valuations of new-economy stocks collapsed, major companies continued to take significant writedowns of their assets...without the prop of an irrational stock market, investors finally tuned in to the fantasy accounting that had become pervasive in American business, and they slaughtered stocks whose earnings came under suspicion."
It is still quite stunning to go over some of the anecdotal happenings of that frenzied time. Priceline.com, a company that sold airline tickets at discount prices, had a market capitalization greater than the entire airline industry. By 2001, it had a value of 1/100th its old valuation. Theglobe.com was another Internet darling, whose IPO went from $9 to $97 in one day. In little less than one year later, its stock would go for pennies.
The collapse inevitably draws comparisons with the '29 Crash and the ensuing Great Depression. A septuagenarian and child of the Depression, Levy began his Wall Street career when the wounds of that calamity were still raw and viscerally felt. It was a vastly different world in many respects. Perceptions of risk, for one thing, were very different from what they are today.
At the tail-end of 20th century America, a pension fund manager was fired for investing in Treasury funds rather than stocks (it was the manager of the California State pension fund), apparently he was being too conservative. In mid-century America, it was against the law for a pension fund to invest all but a small part of its portfolio in stocks.
As Levy writes, "to a fund manager from the 1950s catapulted into the late 1990s, the notion that someone could be fired for investing in bonds would make no sense, somewhat akin to hearing that ice cream was good for you. Back then, with the memories of the Great Depression still fresh, those entrusted with other people's money eschewed stocks as too risky." While a seemingly small thing, Levy writes that the episode served as a "tap on the shoulder," a telling reminder about the extraordinary state of affairs of the late 1990s boom.
These events support the idea that another contributing problem of the 1990s boom was ideological, and it is one that still persists in the aftermath. It was a cultural error that made a hero out of a Fed Chairman and that put so much faith in the Fed to begin with, at the expense of sound economics. For this reason, the best way to avoid a like situation in the future and to reform the financial structure of the country is to destroy the ideas that continue to support such institutions and that also continue to support government intervention in markets. In this way, the head of the axe is really brought to the root of the tree.
So what is Levy's view of the future? For those interested in prognostications, Levy offers the view that we are in "but the third act of a five-act Shakespearean drama that portends a bad ending." Admitting he has no crystal ball, Levy sees a protracted recession and lists many reasons why. Debt burdens, low savings rates and government deficits do not form a sound foundation for new growth (government debt appears to be the new growth industry of post-bubble America).
In a recent interview, Levy disclosed that he has 50% of assets in treasuries and advises investors to use stock market rallies to sell equities—a contrarian view to say the least.
However, Levy has built his fortune by going against the crowd, by buying assets out of favor and then selling in them when the tide turned. It takes an incredible amount of discipline and intellectual independence to consistently make such commitments. That is why there is a built-in lid on the number of people that can invest like Leon Levy. Contrarianism is a self-limiting proposition. As investment writer Steven Mintz once observed, it is akin to the old riddle that asks how far a dog can run into the woods. The answer is halfway. After that, he's running out.
March 24, 2003
Christopher Mayer is a commercial lender for Provident Bank in the suburbs of Washington, D.C. Feedback invited to: CWMAYER@provbank.com
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