VideoAmerican stockmarkets fell at the start of this week, even as the economic outlook grew brighter. The Dow Jones Industrial Average and the technology-heavy Nasdaq touched their lowest levels for months. Investors have had their confidence bashed by a series of revelations of corporate malpractice and number fiddling before the stockmarket bubble burst. The continuing sagas of Enron and its auditor, Andersen, have kept their spirits low. Almost any half-suggestion of impropriety can make them twitch. This week they twitched at the resignation of Dennis Kozlowski, chief executive of Tyco International, a once high-flying agglomeration of ill-fitting businesses, days before he was charged with evading more than $1m in taxes on paintings that he bought last year in New York.
Investors have not only lost patience with corporate America's greed and its inability to do what it says it is doing; they have also lost confidence in Wall Street's ability to act as an honest broker between them, the providers of capital, and the corporate users of it. "There is an air of cynicism surrounding every institution that underpins our capital markets," says Stanley O'Neal, co-head of Merrill Lynch, an investment bank that recently paid $100m to settle a lawsuit over the integrity of its analysts when the Internet hype was at its peak. "This cynicism has gone beyond reasonable questioning, and could easily turn destructive." What should be done to divert this potentially destructive force?
Although there are important differences, there are also echoes today of the 1930s when, in the aftermath of a stockmarket bubble and the 1929 crash, Wall Street became public enemy number one. Business then went into a severe decline as investors and companies lost faith in the trading and issuance of securities. The Pecora hearings in Congress (named after Ferdinand Pecora, a lawyer who orchestrated the proceedings) provided an outlet for the public's Depression-era fury and humiliated leading Wall Street figures such as Jack Morgan, the boss of J.P. Morgan. (Famously, during a break in testimony a circus midget climbed on to the financier's lap and posed for photographs.)
Congress passed several laws that imposed unprecedented regulation on the business of finance, all vigorously opposed by Wall Street at the time. The quality of this legislation was mixed, though the laws that defined the structure of the industry were worse than those that regulated the conduct of the industry's participants. The Glass-Steagall act, which banned firms from doing both commercial and investment banking, was eventually scrapped in 1999. But the creation of a "cop on the corner" of Wall Street in the shape of the Securities and Exchange Commission (SEC) proved to be a masterstroke, greatly increasing public faith in America's capital markets.
Today, Wall Street once again faces both a prolonged slump in business and the prospect of punishment and further regulation. Trading in shares by institutional investors, especially hedge funds, continues to accelerate. But many individuals who flocked to the stockmarket during the second half of the 1990s are now giving up en masse. Day traders (so called because they buy and sell stakes within the same trading day, thus producing a rich flow of commissions for brokerage firms) are now yesterday's traders. And many people who traded only occasionally, or who put their money into mutual funds, are also bailing out of the market.
According to the June issue of Bank Credit Analyst, a newsletter, retail investors have now "lost most of their profits accrued during the bubble years". The BCA proxy for the average price paid for shares suggests that the cumulative profits of those investing steadily since 1995 are down to less than 10%, compared with a high of 40%. Companies, too, are using Wall Street's services less. Both mergers-and-acquisition (M&A) activity and initial public offerings of shares (IPOs) are miles below their highs of 2000. The likelihood is that the depression on Wall Street will continue for some time, and that the recent rounds of job-cutting will not be the last. At the very least, firms will have to get used to much lower revenues and slower growth.
Everybody agrees that action is necessary to ensure that America's capital markets remain the best in the world. But the battle to lead that punishment and reform process promises to be unusually messy. That, in turn, makes the future path of reform highly unpredictable. As well as such assorted congressmen as Paul Sarbanes, Edward Markey, Jon Corzine and Richard Baker, state politicians such as Eliot Spitzer, New York's attorney-general, are jockeying for a share of the limelight.
Mr Spitzer brought the recent case against Merrill Lynch, which focused on internal e-mails in which Merrill analysts — notably their former Internet guru, Henry Blodget — abused Internet firms as "crap" and "shit" while simultaneously issuing research reports that urged investors to buy their stock. Now Mr Spitzer hopes to repeat his victory — Merrill paid $100m to settle the case, though it did not admit any wrongdoing and was never charged with any specific offence — by obtaining e-mails from Morgan Stanley (home to Mary Meeker, an analyst once known as "the queen of the dotcoms") and Citigroup, whose telecoms analyst, Jack Grubman, is facing growing public scrutiny.
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