Those who do not read history are DOOMED to repeat it.

“History doesn't repeat itself, but it often rhymes.” – Mark Twain

In this blog post, I will be providing a book summary on Maggie Mahar's book Bull!: A History of the Boom and Bust, 1982-2004 (2003). In Bull!, Mahar provides a recount of the dot.com crash by outlining the financial, social and political elements that contributed to the cycle. 

Investment Banking

Investment banking was the lifeline of the firms on Wall Street. The talented analysts on Wall Street who covered stocks had the ability to command the attention of the wider investment community. Companies looking to go public would base their decision based on the ability of the analyst to induce excitement in investors and fetch the highest possible price at IPO.  

These analysts would be ranked each year on Institutional Investors, a business publisher with a strong focus on international finance, where mutual funds and other large institutional investors would make or break a reputation. The higher the analyst was on the rankings, the higher the attention he would receive. The bigger the name, the higher the pay. Merrill Lynch were paying analysts as much as $12 million dollars per year.

It also did not help that investment banking is also an inherently optimistic division of the financial industry. A lot of pressure was placed on analysts from the companies that were covered as well as money managers who placed signficant sums of money on those companies. When analysts downgraded companies, it was detrimental to the investment bank's relationship with those stakeholders as well as the analyst's ranking on the Institutional Investors publication. Downgrading companies put interests at risk.

Since a segment of the investment banks profits came from the fees they charged to the companies they covered, “sell” recommendations proved rare. Investment banks knew that downgrades could put their profits at jeopardy. A fly-wheel of multiple self-interested incentives inherently forces this industry to generate positive coverage.

Mutual Funds

In the 1990s, the mutual fund industry was growing and commanding a higher percentage of the market. By 1998, its asset equated to three times the federal budget. By way of context, it was also the first time in decades that Americans reported that they had more of their savings allocated in the stock market than in their homes.

The mutual fund managers who were performing well were those who chased growth and shunned value. They were believers - even in companies with products that did not work yet - and paid little attention to balance sheet considerations. It was a generation of fund managers crazed by “momentum” whereby they would try to buy stocks that were already airborne, buy high and sell higher. Their goal is to ride the wave and catch a stock whilst its rising. 

These cohort of fund managers were also more focused on the rate of quarterly earnings growth as well as projected growth rather than the intrinsic growth of the company. This induced short-termism and their need for speed. This was why Wall Street loved Cisco; it knew how to appeal to the short-termism of the mutual fund managers. As a result, Cisco's share price skyrocketed; its share price was outpacing the its own intrinsic value.

“In 1990, Cisco was selling at 20 times earnings—with revenues growing at a triple-digit rate. By the time we got to the mid-nineties, if you looked at a graph of the share price, the line was turning vertical—it was going straight up,” observed George Kelly, a Morgan Stanley analyst who helped take Cisco public. “The stock was trading at 80 times the next year’s earnings. Meanwhile, Cisco’s growth had slowed from over 100 percent to 30 percent. By any traditional valuation techniques, the rise was totally irrational.”  

Jim Cramer summed it best:

“Higher earnings estimates spurred fund managers to pay a higher price for Cisco’s shares; in turn, the fact that fund managers owned the shares encouraged analysts to boost their earnings estimates.”

Again, these analysts were naturally inclined to raise estimates on stocks that fund managers favoured. The funder managers’ votes dictated the position an analyst held on the Intitutional Investor’s annual poll, and hence, their salaries.

Mutual Fund Manager

The mutual fund managers of the 1990s were “asset gathering machines.” A firm’s profits depended on the how much money it had under management, not how well it managed those dollars. It was also virtually impossible to go to cash during times of financial euphoria; mutual fund investors demanded that the money they committed was to be put to work. The technology sector leading up to the dot.com bubble was a prime example. 

“In any sector there are times when you don’t want to be buying—the sector has been a favorite for a long time, and now, it’s overpriced,” the technology fund manager explained. “There are no good values. But if new money is coming in, and everyone expects you to be fully invested, you have to buy. If I had a choice, I wouldn’t run a sector fund again unless I could also short the sector, or at least go into cash.”

The mutual fund managers had a faced a trade-off dilemma between risk and reward. On the one hand, if these managers chased higher returns, during these times, he was faced with a greater chance of blowing up the fund. If he took a more cautious approach, as a steward should, he could ruin his career by underperforming his peers and competitors. 

Laurence Siegel, director of investment policy research at the Ford Foundation, explained the pyschological dilemma of mutual fund managers in an interview with Kathryn Welling:

A money manager is judged by his results, and those results break down into four categories, Siegel explained. “You can be right and with the crowd—which is fine. . . . You can be right and alone—and then you are a hero. You can be wrong and with the crowd, which isn’t actually so bad. When everyone else is down it doesn’t hurt [the fund manager’s career] to be down. Or you can be wrong and alone and then you really look like an idiot.” This is the ignominious fate that a career-conscious fund manager strives to avoid at all costs.

This creates a classic case of principal-agent conflict between the mutual fund manager and the client. Depending where a mutual fund manager is in his life, he may choose to make decisions based on his own self-interests are, i.e. a young mutual fund manager will have a natural proclivity to protect his job. His priority is not his clients, it is his career. If a mutual fund managers intentionally preserves a clients' purchasing power and protects their downside risk, they may be perceived as wrong and alone if others are making money. 

The client might say, ‘Look at Janus, they’re making 22 percent. Why can’t you do that?’ 

In the instances where funds are underperforming peers, clients often felt cheated. They could not stand the that others were making bank and they were not. It was common for them to redeem their money to chase higher returns, resulting in the mutual fund managers losing business. A young fund manager could not afford for this to happen. 

The clients to these business had a mentality that can summed by perfectly Buffett’s quote: “It's not greed that runs the world, its envy.” Envy is ingrained so deep in human nature. People always compare what they have to their friends, neighbours, colleagues and ultimately others, in the market, who are making more them. People want a piece of the action. We have all seen and felt this. Since financial markets are a collection of parcipitants, this human tendency of envy is compounded by the large-scale effects of the herd mentality. Most people were comfortable with this fact because “it is warmer inside the herd.” 

If people would have thought with deep rationality, being more of a spectator, as a defensive investor sitting on more cash, would have been wiser than being a speculator. Pascal put it best:

“All men’s miseries come from their inability to sit quiet and alone.”

Individual Investor

Towards the end of the 1990s, momentum investing among fund managers began to dwindle. Individual investors continued the momentum by flocking to index funds and large-cap blue-chip funds. They were the new group driving the market. 

“The market’s own pricing mechanism was breaking down. The public was setting the valuation of these technology companies—without any understanding of the underlying fundamentals.”  

In truth, most individual investors were far more interested in where a company’s share price was headed and less concerned about its intrinsic value. 

“The bubble” that began to form in the mid-nineties was not inspired by dot.coms but rather by the meteoric rise of some of the  most reputable names trading on the NYSE. By August of 1996, the bluechip favorites included Time Warner (trading at 85 times earnings), Microsoft (46 times earnings), Coca-Cola (39 times earnings), Gillette (36 times earnings), Cisco (33 times earnings), Oracle (32 times earnings), Pfizer (31 times earnings), Lilly (31 times earnings), Warner Lambert (30 times earnings), and Boeing (29 times earnings). 

In the 1960s, a similar event happened where fund managers were also crowding out reputable named companies like Polaroid, Xerox and Avon. These high-flying stocks with obscene price/earnings ratios were part of what they called the “Nifty Fifty”. Within a few years, those market darlings of that decade lost 45 percent of their value in the crash of 1973-1974. The bubble of the 1990s had a comparable ressemblance this part in financial history in this respect.  

The popular wisdom of that time was also that if an investor could diversify by purchasing multiple indexes. He was comforted by the notions of:

“Over the long haul, U.S. stocks always outperform other investments.” 

“You can’t time the market.” 

“Buy and hold.”

Boston money manager Jeremy Grantham at Batterymarch Financial Management recognizes that indexing makes sense early in a bull market cycle, not at the end. “Indexing in the long run is sensible,” said Grantham in 1999. “In the short run it can be lethal, particularly now.”

Unfortunately, prices are the differentiating factor between a good and bad investment. References to financial history can show us that is the case. It took 25 years to recover from the Great Crash of 1929 and 8 years to recover from the dot.com crash. 

The history of financial markets in its entirety is a combination of cycles both long-term cycles, short-term cycles and anomolies (as witnessed by the onset of the coronavirus pandemic). Being placed in the present can cause us to forget that these cycles are the norm and that they do go on forever. People often dismiss the history of past cycles as irrelevant in the same way a teenager would dismiss the advice of their parents. Knowing and understanding cycles are the only defence against becoming victims to those cycles. 

The market had been going up for more than 10 years, and psychologically, the longer it goes up, the more people believe it will go up forever. That’s not the way the world works,” he added. “If you look at history you know everything runs in cycles. But that’s the way psychology works.

Berkshire Hathaway chairman Warren Buffett appreciated this even though he built his fortune by buying good companies and holding them long term. 

In truth, patience was only half of Buffett’s secret. An ace market timer, Buffett knew when to hold and when to fold. Granted, he usually held stocks for long periods of time, but he also realized that the stock market was not always the safest place for an investor to stash his savings. Buffett understood that equity markets, like all other markets, are cyclical, and there can be long stretches of time when a prudent investor should get out—and stay out. And in May of 1969, that is exactly what Warren Buffett did. 

It is imperative to read in between the lines and not always take advice as gospel.

News Publishers

In the mid-nineties, the public's enthusiasiam for stocks and insatiable appetite for financial information was met by the media. They released tidal waves of information. The internet also accelerated the democratization of information to a new level. Eletronic news, chatrooms, financial websites and bulletin boards became the norm, all of which were simultaneously competing for the investors' attention.  

Broadcasters and business journalists were relentless on the delivery of news and numbers. In the year 1996 alone, “22 brand-new business magazines hit the newsstands; CNN launched its own financial news network, CNNfn; AOL opened its own mutual fund center, and TheStreet.com debuted online.”

For newspapers, the bull proved to be a cash cow. By 1997, the financial services industry accounted for an estimated 30 percent of national newspaper ad revenues.

Print journalists had learnt to write in “real-time” prose to keep up with the pace of the internet. It became less about veracity and more about speed. Getting the news out first became the priority. It was a competition against the new position the internet established as a legitimate news medium. The print journalists adapted by reducing the amount of fact checking and idea discussion and more on “real-time” decision making. This would come as a compromise to the integrity of the news gathering process and therefore the quality of the news.

The spotlight was always the moment and scoops. Less and less people seemed to worry about the analysis, the financial history and so forth; it just did not sell. People wanted information, not knowledge.

On deadline, many reporters simply repeated analysts’ estimates, ignoring the fact that valuations had less and less to do with the intrinsic value of a company in the real world (what another businessman on Main Street might pay for it) and everything to do with its perceived value on Wall Street (what another investor might be willing to shell out for the stock). 

During the bubble, journalists and reporters had become attuned to sourcing information from Wall Street. They were feeding into the frenzy but was just popular at the time. The greater the audience the greater the advertisement revenue. 

William Powers, a media critic who began his career as a financial reporter at The Washington Post, marveled at the effect the bull market had on the media in a column that he wrote for The National Journal: “For almost a decade, journalists did something quite out of character: We accentuated the positive. Over the years, we had acquired a reputation, largely deserved, for loving bad news. . . . The age-old complaint about the media, in letters to the editor and in polls, was that we were unrelentingly negative. We laughed it off, but we knew it was true. The bull market changed all that. We stopped enjoying the bad news, and got addicted to the good. A trade that had once searched high and low for negative stories about Wall Street and Big Business, devoted most of its energy to positive ones, and the touts were our best sources.”

At the time, it just was not fashionable or popular to talk critically about market timing or market cycles. In many ways, the media just served as a mirror to the investor sentiment of the time. It would therefore serves those then and now to understand the vested interests (and or incentives) of those in the media. Not to mention, those the people behind the cameras, articles and radios, are also humans susceptible to misjudgement. 

Skepticism, fact-checking and independent thinking becomes all too valuable in the the New Age of Information.

“No matter what they tell you on television, information is not knowledge,” Fleckenstein warned. “You know what you have to do to be a good investor? Make a lot of mistakes—and learn from them. The market has a lot of tricks and curves, and you have to encounter each and every one of them to learn.”

401(k)

Prior to 1991, the majority of all pensions promised a fixed benefit equal to a percentage of the employee’s salary during their final years of service. These pensions would ensure that the payments would be made to the retiree for as long as he might live. These plans were also protected by the federal government's insurance pool in case a company underfunded its pension plan and/or went bust. No matter how well or how badly the market did, the pension promised a check for life.

In 1991, more than one-third of all retirement plans were converted to the new “defined contribution” plans which included the 401(k)s and profit-sharing plans. Under this plan, employees would only have to contribute a certain amount to the employee's 401(k) for as long as he was working there. It was a significant detachment of responsibility on the employer's behalf. How much they needed to save for retirement became the responsbility of the employee and how they managed their money was also up to them.  

Corporate America celebrated the fact that they shed the long-term liabilities associated with the traditional pension plans. It was a relief for corporate America because boomers were living longer than their parents and corporate profits were sluggish. 

For the employer, then, the advantages of a 401(k) were clear. The new retirement plans offered low-cost marriage and no-fault divorce. From the outset, 401(k)s were far cheaper than traditional pensions: employers saved both the expense of managing the money and the cost of paying the premiums for federal pension insurance. (401[k]s would not be insured.) And, over time, the employer’s role in funding the plans would shrink: in 1989, employers contributed roughly 70 percent of the money that went into retirement plans; by 2002, employees’ cash contributions outstripped company payments into retirement plans of all kinds—including traditional pensions.Moreover, while employees put cash on the table, employers often matched their money with company shares. In this way, a corporation could mask the expense of funding a pension: accounting rules allowed corporations to contribute stock to a 401(k) without deducting the cost on their income statements. 

The 401(k) allowed employees to control their investments. It was made more dangerous in the 1990s with the individual investor having access to the mass financial information at the touch of their fingertips. It was as though, with no prior experience in the stock market, many individuals expected to win at the game. With little to no consideration of downside risk, people pouried in on equities regardless of fundementals. As long as the bull was charging and people were splashing cash, there was no need for valuations. 

In the early nineties, 12-month flows into funds that invested in stocks barely reached $50 billion; by 2001 inflows exceeded $300 billion. A tidal wave of retirement dollars flooded the mutual fund industry. The 401(k) was invented in 1981, just as the bull market began. By 1998, roughly three of every four new dollars invested in corporate retirement plans were going into 401(k)s. At the end of the decade, two-thirds of all active workers covered by a retirement plan were responsible for directing their own investments. Hands down, they chose stocks. By the end of the millennium, 401(k) investors had stashed 75 percent of their assets in equities. Even older employees preferred stocks: in 2000, 401(k) investors in their 50s had entrusted 49 percent of their savings to equity funds, another 19 percent to company stock.

When everything came crashing down by 2003, it was apparent that the old-fashioned pensions offered employees better protection than a 401(k). The consequences of introducing the 401(k) resulted in those who had the least losing the most. It was a pension plan that was destined to invited speculative behaviour. 

Defective/Creative Accounting

“Stock options are the only kind of executive pay which a company can deduct from its taxes as an expense, but which it is not required [to include] in its books as an expense.”

This was the part of the scene in the 1990s. Stock options to executives were not viewed as a real expenses since the compensation were not “dollars out of a company’s coffers.” Simply put, there was no cash leaving the business. Buffett called the options accounting of the time “the most egregious case of let’s not-face-up-to-reality behavior by executives and accountants.” 

Buffett’s common sense cut across the tangle of financial issues: An expense by any other name is still an expense. “Managers thinking about accounting issues should never forget one of Abraham Lincoln’s favorite riddles,” Buffett advised. “How many legs does a dog have if you call his tail a leg? The answer: four, because calling a tail a leg does not make it a leg. It behooves managers to remember that Abe’s right even if an auditor is willing to certify that the tail is a leg.” 

“If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And, if expenses shouldn’t go into the calculation of earnings, where in the world should they go?” 

It was a defect in the accounting rules at the time that many chose to ignore or reflect upon even though its problems seem blatantly obvious now. 

Along with this defect, overly agressive or “creative accounting” became a pervasive method of financial reporting. Management were making overoptimistic projections and reporting fabricated earnings to meet the targets of their stock option related incentives; it all tied in together neatly in flywheel. The accounting system was simply too malleable. 

“The most reckless corporate officers made the most money. So you had greater and greater incentives to promote the most reckless guys.”

In addition, double-digit growth in earnings was no longer simply celebrated as an achievement but rather a benchmark for company performance. It became an addiction that blurred the veracity of financial reporting. Wall Street rewarded companies with high multiples of earnings. Managemnt with large option packages loved it. The 1980s and the 1990s were characterised by Jerome Levy Forecasting Center the “Two Decades of Overstated Corporate Earnings.” It was common for companies to managing earnings, making sure that the earnings growth expectations were met and that they were consistent.

Many companies, like Cisco, was creating virtual revenues by offering “vendor financing.” Companies were loaning customers money to purchase the product. It gave companies instant recognition of revenue, the deposit amount in cash and the remainder as loaned to the customer. 

Cisco was hardly alone. Telecom-equipment suppliers were particularly generous with their loans: by the end of 2000, they were collectively owed as much as $15 billion by customers, a 25 percent increase in a single year.

Stock Options

People often associate stock options with management and employee alignment with shareholders. At least, in theory. In the 1990s, the power of incentives, weak accounting standards and regulatory bodies turned that theory upside down. So what then, was so special about these options? 

Employee stock options are not all that different from “call” options, which trade in the open market. Employee stock options work in the same way that it gives the investor the right to buy shares at a fixed price at some point in the future. 

The major difference, as Mary Barth, a Harvard accounting professor who supported FASB’s proposal, pointed out in her testimony, is that while the investor who buys a call option pays cash to acquire it, employees acquire options by providing services to their company. The options, then, are part of the employee’s compensation for those services.

When an executive accepts stock options in place of a cash bonus, they know that there is a risk that the options will expire worthless. The upside amount on these options are their opportunity cost. It is the amount they will surrender if they do not meet targets. For most, it was a large component of their salary.  

A Fortune magazine survey of 200 of the nation’s largest corporations revealed that in 1991, newly granted options accounted for roughly half of the $2.4 million that the average CEO earned. 

By 1993, Fortune’s survey of 200 of the nation’s largest corporations showed that average CEO compensation had jumped to $4.1 million, with options representing an ever-larger share of the total. In the even more elite group of Fortune 100 companies, 29 percent of CEO pay now came from options— up from 17 percent in 1987.

Some of the extreme cases of these stock options mania were mindblowing. 

Disney CEO Michael Eisner realized a stunning $197 million gain when he cashed in his options. That same year, Thomas F. Frist Jr., CEO and chairman of HCA (Hospital Corporation of America), hauled home $127 million, with the bulk of his compensation coming in the form of options. At Primerica, CEO Sandy Weill earned $67.6 million. Options accounted for 96 percent of the total. Meanwhile, Mirage Resorts’ casino king, Steve Wynn, cashed in 1 million stock options, raking in a profit of $23.3 million. 

By the end of that decade, the National Center for Employee Ownership reported that 75 percent of all options given to the top five executives in their respective companies. Only a minor amount of the options were allocated to those in middle management and on the front line. 

The Executive Compensation Report’s survey showed that only 2 percent of all companies that issued stock options gave them to all employees. A survey of 350 major corporations by William M. Mercer revealed that less than 6 percent awarded options to even half of their workers.

Many top executives were cashing in their chips as soon as they were permitted to exercise their options. They were allowed to, but why did they? In reality, managers and outsider shareholders have different goals. While the typical shareholder may wish to invest for the long haul, many executives exercise their options to lock in short-term gains. 

As Charlie says, “the worse abuses come where people have the greatest temptations.” If you give people to do the opportunity to do the wrong thing, they will do it. 

Having said that, this is may not always be the case. Each company should be examined on a independent basis to see verify whether the executive management team are the “loving parents” or “restless babysitters” of the company. The anology of “owners” and “renters” can be drawn to make comparisons and reach conclusions about management. Either way, the mentality on both sides is entirely different. 

An insider who is entitled to a stackload of options often succumb to the perverse incentive of doing what is necessary to acscend the company’s share price over the short-term, even if it means releasing news on acquisitions that may very well turn out to be lemons. The stock just needs to be at an attractive price for management to cash out. 

Critics also noted that options encourage senior executives to take unreasonable risks while trying to boost their company’s stock. If the strategy boomerangs and the stock plunges, insiders face no real downside. At worst, their options expire worthless—but then again, they paid nothing for them in the first place. On the other hand, if the gamble works out, and the stock shoots up, their upside is open-ended. No wonder so many insiders preferred options to cash bonuses. As one Silicon Valley banker put it: “Nobody wants cash anymore—it’s too final.”

The cost of these stock options undermined the theoritical value it was supposed to bring to shareholders. In practice, the consequences proved to be dire.

1. The mass onset of option grants diluted out the existing shareholders. To offset this effect, companies would buy back the same amount of shares, some of which would be bought regardless of the price they paid. Responsible management only buys back shares when a company’s stock is a bargain relative to its intrinsic value. In the peak of the bull market, companies were using capital to pay ridiculous amounts for their stock. 
2. The objective of efficient capital allocation became compromised by management’s self-interest. Of the amount that management could have raised with stock options, management could have better employed that capital by paying off debt, acquiring for growth, paying a dividend, financing research, etc. The list goes on. Companies lost precious capital by letting insiders buy shares at a discount that it might have otherwise raised. Management should be solely focused on appropriately capital allocation as a means to building long-term intrinsic value as opposed to cashing in and cashing out options. 
3. The dependency of option values depended on share prices. As a result, management are incentived reduce dividends. Typically, a company’s share price drops immedicately after it declares a dividend. 
4. Insiders who were entitled to these option packages had an information advantage. They were the first to know the company results and what that implied for the company's share price. If things turned south, they could cash out if they really wanted to; leaving shareholders to inherit the perform storm. 

The consequences did not stop there. The wider economy also suffered damage.

“CEOs exercising stock options drain hundreds of millions of dollars each year from the capital needed to make American companies more competitive. In one case last year, a CEO and his wife exercised options for $84 million, capital which their high-tech company could have used to ease serious cash flow problems,” said Levin, referring to the fact that if the company had sold those newly issued shares in the open market to an outsider, they would have fetched a much higher price. Instead, when the CEO exercised his options, he bought the shares at a discount—meanwhile, “cash flow problems [at that company led to] two quarters of losses, extensive layoffs and a slash in stockholder dividends.

Interestingly, a survey by Fortune on executive compensation disproved the theory that CEOs who received options would have an incentive to do a better job. The survey showed that there was very little evidence to suggest that stock options boosted a CEO’s performance. 

The numbers in the report showed that executives who received the most generous stock options that year did no better for shareholders than those who received the smallest packages.

All in all, options grants fundementally signified an unparalleled transfer of wealth from shareholders to corporate management and a deadweight loss to the American economy. To quote Buffett, “true international competitiveness is achieved by reducing costs, not by ignoring them.”

Politics

The options controversy scaled all the way up to the White House. It was a conflict that divided those for and against the Financial Accounting Standards Board (FASB) reform. The reform proposed that corporations should recognize the cost of stock options in a way any investor could understand; corporations were deceiving shareholders by omitting them from a company's financial statements. 

The SEC (Security Exchanges Commission) employs the FASB to be the independent body, or watchdog, that provided a common framework for the financial accounting standards of public and private corporations in America. 

The FASB was funded by private contributions, accounting support fees and publishing revenue whilst the SEC was funded by Congress. It was no wonder, politics got involved. It was clear to see in retrospect that the FASB's push for reform was supported by professionalism and honesty whilst the SEC's opposition to reform was driven by Congress' interest. 

Some of most powerful CEOs in corporate America were in support of the SEC's decision against the options accounting reform. They were pleaing that, ‘Earnings will sink!’, ‘You’ll confuse investors!’, ‘You could kill capitalism!’

Senator Alfonse D’Amato led the attack: FASB’s reforms, he declared, could “destroy capital formation.” After all, if companies had to deduct the cost of options from their earnings, earnings per share would drop, and they might have a more difficult time attracting new capital. 

None of the arguments were really made with reason. It was made on the basis of interest. They were fearful that the truth would reveal cracks in the system, bringing down the markets that so many were heavily invested in. After all, if it did crash, the fingers would be pointed at those who allowed it to happen. Congress did not want to introduce any reforms that could be politically unpopular. 

Politicians were publicly declaring reasons to resist with arguments that were convenient with their political agenda. 

Senator Joe Lieberman declared the FASB's accounting rules as a  was seen as a “grave consequences for America’s entrepreneurs.” 

“The overwhelming number of people who benefit from stock option plans are middle-income Americans, not upper-income Americans.” 

Many of which, like these ones, were statements were simply not true. They were just masking the underlying issues of what these stock options costed and who paid for them. Politicians are neither accountants nor mathematicians; they do not have the training nor inclination to understanding these corporate accounting rules. It is also evident that they represent the financial and social goals of their respective states. None of the preceding points point to the fact that politicans should be interfering with the accounting reforms.  

In 1994, the Senate passed the resolution that declared FASB's reform would have “grave consequences for America’s entrepreneurs” and the economy. It won by a landslide majority of 88–9. By then, shares of companies in the S&P were continuing to report rapid rises in earnings. Companies continued to cook the books by putting a “little lipstick on their projection.” 

In 1995, Congress also passed the Safe Harbor Act designed to shield both corporations and their accountants against shareholder suits if they misled investors about their earnings.

Part of the Private Securities Litigation Reform Act of 1995, the Safe Harbor provision was designed to curtail frivolous lawsuits by offering corporate management “safe harbor” when making predictions about a company’s products, future revenue, and earnings. “The bill is important,” The Wall Street Journal explained to its readers, “because class action lawyers often hold companies’ forecasts against them, asserting they have defrauded investors by lying to them or misleading them with unrealistically optimistic predictions.”

President Clinton vetoed the legislation but received backlash by those in the House and Senate who were in overwhelming support of the bill. Many truly believed that the interests of shareholders and corporate management were simply aligned. Few really knew the underlying difference between insiders and outsiders.  

 “President Clinton has turned his back on everyone who owns a mutual fund, participates in a pension plan or has a job at a public company.” 

Clinton knew that innocent people were going to be shafted. They simply had no protection against the corporations that were ripping them off. 

And they did. Between September 1999 through July of 2000, insiders utilised their first mover advantave by selling en masse. The insiders' sell to buy of ratio of stocks hit a of peak of 23 to 1 just before the Nasdaq peaked. They knew that the fictitious earnings could only take them so far. They essentially ran out of road. 

The Federal Reverse

Insiders had every chance to sell out and so they did. Whilst they did that, Federal Reserve Chairman Alan Greenspan stayed with the ship, making every effort to provide the liquidity necessary to keep the market afloat. 

By the end of the decade, the the Fed chairman had two major concerns: inflation and a stock market apocalypse. Between June 1999 and May 2000, The Fed hiked interest rates six times on concerns that inflation was overheating. In response to the fear that the market may crash, the Fed pumped $100 billion new credit into the economy at the very end of 1999. It was further stimulating the stock market that did not need the additional encouragement. 

This Fed chairman was not about to cut off the liquidity that keeps a bull market party going. 

On Monday, March 2000, the cracks began the show. What the The New York Times called “a small speed bump” became a “tech wreck.” The popular technology funds at the time had soared into the stratosphere finally faced reality. 

 In the 12 months that ended March 1, 2000, the Nasdaq skyrocketed a stunning 108.4 percent— making both the Dow’s 8.7 percent rise and the S&P 500’s 11.5 percent advance over the same span seem puny.

By the end of 2000, Wall Street equated to the loss of the stock market crash to “one-third of the houses in America sliding into the ocean.” The index had fallen 54 percent from peak to trough. In the short amount of time, investors had lost $3.3 trillion in paper wealth. Even though it was terrifying, it was not over yet.

By February 2002, 100 million individual investors had lost $5 trillion since the spring of 2000. Put in context, this was a 30 percent of the wealth they had accumulated in the stock market. The individual investors were the group that got mauled. They were the group that had to least to afford but lost the most. 

The bear had taken no prisoners. 

Closing Thoughts...

People often discredit the past and think that this time is different. But the very thing that creates booms and busts throughout history is always caused by the same; the role human nature, in particular, that of envy and self-interest. It just proved to be a recurring theme. The crooked accounting standards that invited reckless behaviour also added nothing but fuel to the fire.

Buffett also weighed in on this bull market run 2000 by writing:

“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.”

Who was to blame then, if everybody was enjoying this party?