Oh, woe is the stock market! As I write this
on July 21, 2002, the Dow stands at 8019, the lowest level since
1997. Nasdaq and the S&P 500 are at similar, pitiful levels.
Thereís more. Richard Grasso, chairman of
the New York Stock Exchange said today, "Mondays following
Friday declines have always been difficult and I suspect
tomorrow will be no different."
Whatís going on?
The first thing to remember is that the
precipitous market drop is deeply significant to the country,
and not just to investors. The Dow and other U.S. stock markets
represent the present and expected future values of all the
publicly traded companies that operate in the country. There is
no better analyst, person or institution, of where the economy
is headed in the future than the market acting as a collective
This does not discount the role of moods,
emotional and irrational investors. But the market itself does
not work this way. Over the very short-term, the market is not
unlike a horse race or football game, where capricious and small
events can change outcomes in dramatic ways. But over the
long-term, even measured in a couple of months, the market is
like a scale. It tells the truth.
The bad news that we see on the stock front
is also apparent in the bond market as well. Mike Darda of Polyconomics
demonstrated this point last week: "The spread between
zero-risk Treasuries and BBB industrial bonds, a forward-looking
measure of both credit risk and the cost of capital, has widened
by 107 bps (basis points) in the last two months. At 748 bps
over Treasuries, risk spreads are at their widest levels for the
Let me break this down in laymen terms,
starting with the basics and moving up from there. Thousands of
different bonds exist, but all of them can be characterized as
different types of I.O.U.s. Like any loan, there is a risk that
the debtor wonít pay the creditor back. The bigger the risk,
the higher the interest rate for the debtor. The difference
between a Treasury bondís interest rate, which has almost zero
risk, and the BBB industrial bonds interest rate, which measures
the level of economic uncertainty, has risen significantly. This
is an excellent indication that the market expects tough times
ahead, which makes loaning capital (primarily money) more
expensive, which in turn means less risk-taking and economic
So things look bad. But what got us into this
The short answer is that it depends who you
talk to. However, most people would blame the steep declines to
either the loss of trust in the corrupted corporate class, or
the response that Washington has taken to the entire corporate
class because of a few bad apples.
Even this choice ignores other variables that
may be hurting the markets. The deflationary spiral that brought
upon the mild recession is ending, but the readjustment process
may prove difficult. Also, the threat of future terrorist
attacks hurts the markets as well. Having said all this, the
collapse in corporate confidence has to be the primary culprit
for the marketís current woes.
These corporate scandals are common after
boom years, as companies are freer to overplay their hand.
Moreover, the deflationary
period just ending made the dollar stronger, so debts would
become harder to pay back. This is a bad combination.
Still, whoís to blame: corporations or Washington?
Clearly, the Enron debacle was the biggest
corporate crime ever recorded, but they are in a long
list of perpetrators who carried out massive deceit.
There have been numerous cases of lying, wishful thinking gone
amok, and top executives providing cushy parachutes for
themselves while leaving the rest of the staff in the lurch and
high and dry. Indeed, the corporate elite hasnít had
sufficient checks and balances against them for a long time.
Executive pay hasnít been tied to results for a long time,
which is a scenario inconceivable for anyone else.
Moreover, an article
in the World Socialist Web Site points out that "During
this period the wages of the average worker rose by 28 percent,
just barely ahead of the inflation rate of 22.5 percent, making
the net gain only 5.5 percent. But the compensation of corporate
CEOs, combining salaries, bonuses and stock options, rose 481
percent, for a net gain after inflation of 459 percentóa rate
of increase 82 times as great as that for workers." Many of
you may be wondering why Iím quoting a Marxist website. Well,
Iím no fan of the dead ideology and its legacy in the 20th
century, and I have faith that freer markets, when working
properly, can perform wonders for every part of the world. But
Marx was onto something when he observed that if the capitalist
class, if left to their own devices, would eat their own seed
corn and destroy the system that made them wealthy in the first
place. Greed and venality has always been a part of human
nature, and we have to protect ourselves from it.
Leaving these issues for another day, there
is the counter-argument that corporations, while never perfect,
have a vested interest to play it straight with its
shareholders, so as to maintain their long-term strength. This
does not require much foresight. Why would an investor risk her
hard-earned money tomorrow if she was gypped yesterday? Enron
and WorldCom are the exceptions that proved the rule.
According to this view, the bills going
through Congress right now are so heavy-handed that they will
chill legitimate business practices by CEOs just as much as they
would prevent the crimes of illegitimate ones. Indeed, the bill
that passed the Senate contains civil laws that would apply to
CEOs, and civil courts require far less proof of conviction.
Jude Wanniski, again from Polyconomics, put it this way:
"It is one thing for the feds to be snooping around looking
for criminal fraud at Acme Widget, another for the trial lawyers
to go on fishing expeditions." Larry Kudlow and Senator
Robert Bennett have said similar things in the past few days.
I will be able to surmise which side was in
the right on this issue by August, when it will be clear whether
corporation mismanagement has hit endemic proportions. If not,
then Washingtonís behavior is clearly to blame for the current
mess. Either way, I can drop my studied ambivalence.
I am still an optimist.
The opportunities that will propel the market for the next 30
years are still staggering. Itís just that things may
get darker before dawn.
by David McCullough
by Ann Coulter
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