Origins of the CrashI've finished the very readable book by Roger Lowenstein, titled "Origins of the Crash". There are many books that talked about crashes, but this book focuses more on the dot.com bubble, collapse of Enron, accounting scandal at Andersen and the telecommunications bubble, with the author linking the excesses of past markets to the downfall of future bubble.
There are a few key take aways that I got from this book. Bubbles are caused by a series of factors:
1. Lack of corporate governance.There are stories of dot.com companies where the CEO and chairman of the board of directors are the same person. Boards full of the CEO's 'independent' friends, some of whom are blatantly related in familial ties, some are the CEO's lawyers, accountants and so on. Audit committee do a perfunctory job of looking through results, and had absolute trust in the CEO.
Special purpose vehicles (SPV) are set up to transfer assets to these, so as to lighten the balance sheet to make it more attractive, less debt-ridden and thus able to borrow more.
2. Massive conflicts of interestCEO is paid to direct the company. Board of directors are supposed to monitor the performance of the CEO. Audit committee in the board are supposed to monitor the results of the company, while external accounting firms are supposed to make sure the results released satisfied accounting standards.
All these broke down in the dot.com era when the CEO is the chairman of the board of directors. Audit committee and the renumeration committee are but cronies of the CEO, who are not only not independent but also had a massive stake in the company and/or subsidiaries. Some of them sitting in the board are also directors in the subsidiaries owned by the company. Accounting firms also act as consultants for the firm besides their accounting jobs, with some even switching over to become the CFO of the firm they used to work for.
3. Greed and emphasis on share priceNot only of the CEO with their massive pay scale and millions of options given to them, lifetime pensions and usage of company jet, serviced apartment, car with chauffeur etc, but investors are also at fault. Investors are so sure of being able to buy high and sell higher that all aspects of the business are thrown out. Only prices matter, even if the companies do not have earnings. In fact, earnings and fixed assets are seen as negative aspects anchoring the price because without them, the hopes and promises of the company becomes intangible - a value hanging in the air - and all who buy into it can hang onto their false hopes long enough to sell it to the next smitten investor.
(There's a very good side story of Jack Welch - famed CEO of GE, who got many perks after his retirement from GE. His lifetime perks included the use of a $15 million Manhattan apartment with complimentary wine, food, laundry services, newspapers and toiletries. He also have access to a corporate jet, floor level tickets to New York Knicks, courtside seats at the U.S Open, a box at Metropolitan Opera, a car and a driver. This is besides a $350,000 monthly pension, and a combined past earnings of more than $400 million while working at GE.)Only when the share prices start to fall that the investors' dream become their nightmare.
4. Nobody guarding the guardsGatekeepers are supposed to keep the gates, but who makes sure that the gatekeepers do their job? Apparently none.
Auditing firms became conflicted after the removal of rules that prevented them from doing underwriting business with their audit clients. Analysts in investment banks hyped companies that their firms did business with even if they felt that those companies did not deserve such praise. Directors turned a blind eye to many things management was doing. The government, with many ties to big business, failed in its regulatory role because times were good. There are also many stories of the whole lineup of politicians in the US being involved in the whole debacle.
Even the SEC chief was a lawyer who once fought against excessive clamping down on accountants.
Are we seeing more crashes in the future? I'll bet we will. But did you notice that many of the things that happened is happening now again? As the saying goes, there is no new thing in the market, history repeats itself again - in different forms.
(This site is a very good review of the book:
http://www.eraider.com/images/articles/BookReview4.pdf)