Bull!

by Maggie Mahar

  Six months after the selling began, the Nasdaq cracked—the most visible sign yet that a bear market had begun. That same month, the S&P 500 crested. After that, the long slide began.

  Later, CEOs who sold shortly before the peak would claim that they just got lucky. “Who knew?” one asked The Wall Street Journal.3 But it seemed that many knew. This was not what corporate PR departments dismissed as “part of a regular pattern of selling.” This was a sudden bulge in insiders’ sales: by February of 2000—just weeks before the Nasdaq would peak—insiders were selling 23 times as much stock as they bought, compared with the typical ratio of 10 to 1. In July, they were not fooled by a summer rally; that month the ratio remained at 22 to 1.4

  How did they know? Some high-ranking executives knew that their own companies’ earnings were fictitious. They also realized that they were running out of road: one can only restate earnings so many times. Others were in a position to know that many of the companies that they did business with were not nearly as profitable as they appeared: orders were down, and inventories were building, along with corporate debt.

  Of course, insiders had every right to sell, and certainly it made sense for a multimillionaire to diversify. Some were, in fact, following prearranged selling plans—though in many cases those “plans” were set up in ’99, when insiders began to realize that the bull was on his last legs. An orderly exit would attract less attention.

  In the end, a 2003 Chicago Tribune study of sales by top executives at the 30 corporations listed on the Dow suggested that either these insiders were uncommonly lucky or they were using what they knew about their companies to time their sales.

  Looking at sales by chief executive officers and chief financial officers from 1995 through the end of 2002, the Tribune’s analysis showed that in 25 percent of all cases, the share price of the company in question tumbled by at least 20 percent—and sometimes as much as 50 percent—in the six months following the sale. Insiders were equally fortunate in picking their spots when buying their own companies’ stock: more than half of all purchases preceded gains of more than 20 percent, with several well above 50 percent.

  None of the executives in the analysis had been accused of illegal insider trading, but the Tribune noted that its findings “raise questions about the advantages that executives enjoy in trading their shares because they have access to detailed, private information about their companies.”5

  Insider selling became so pervasive—and so lucrative—that by 2001, The Wall Street Journal was able to name 50 top executives to “the $100 million club.” Those who qualified had sold more than $100 million worth of shares in their own companies sometime between October of 1999 (when insider selling began to double) through the end of 2000 (when the last train was leaving the station). In many cases, they sold at a point when their companies’ shares were worth more than they ever had been before—and ever would be again.

  Scient chairman Eric Greenberg, for instance, managed to reap more from selling his shares in the Internet consulting company during these 15 months than the entire company would be worth in 2001. But some insiders held on, notably Edward “Toby” Lenk, CEO of online retailer eToys, who watched a paper fortune of $600 million vaporize as the company slid into bankruptcy. Nevertheless, Lenk never bailed out. “There were lots of people at eToys and other Internet companies who wanted to build something meaningful, not just make a quick buck,” he said.6

  GLOBAL CROSSING

  Some insider sales stood out by virtue of their sheer size. From 1999 through November of 2001, top executives at a soon-to-be-bankrupt fiber optic darling, Global Crossing, disposed of shares worth $1.3 billion—an amount that exceeded even the insider sales at Enron, the Texas energy trader that fabricated much of its business before going belly-up in 2001.

  Global Crossing founder Gary Winnick had learned finance at the knee of Mike Milken, the junk bond king of the eighties. Formerly a bond salesman at Drexel Burnham Lambert, Winnick had served as one of Milken’s lieutenants. It is perhaps no accident that Enron CEO Kenneth Lay also turned out to be a Milken admirer. (Milken had provided the financing when two old-line pipelines, InterNorth and Houston Natural Gas, merged to spawn Enron in 1985.)7

  The story of Global Crossing’s rise and fall turned out to be a classic tale of too much money chasing too few ideas, leading to the inevitable ending: overinvestment creating too much supply. Winnick’s somewhat grandiose scheme involved building an undersea phone network linking 27 countries and 200 cities. Trouble was, the expected demand for 100,000 miles of fiber optic never materialized. When the company finally went under early in 2002, it carried $12 billion in debt. By 2003, a congressional committee was investigating charges that Global Crossing and another fallen telecom, Qwest, had inflated earnings by fabricating transactions between the two companies.8

  In his heyday, Winnick spent lavishly, whether buying a $65 million, 15-bedroom home in Bel-Air, or hiring and firing five pricey CEOs in as many years. When Robert Annunziata came on board, for instance, his contract reportedly included first-class airline tickets for his mother, a pledge to buy him a new Mercedes—specifically a 1999 SL500—and a signing bonus of $10 million, plus options on another 2 million shares. Salomon telecom analyst Jack Grubman, who played an active role in advising both Winnick and WorldCom’s Bernie Ebbers, had recommended Annunziata for the job, illustrating, once again, that the bull market of the nineties depended on a web of relationships.9

  When it was all over, Winnick wound up a winner. Thanks to a combination of hype and accounting legerdemain, Global Crossing’s shares rose fivefold. With the stock still in orbit, Winnick managed to unload shares worth nearly $734 million, making a neat profit of $715 million on an initial investment of $20 million.

  Winnick was not alone. Cofounder Barry Porter reaped $95.9 million; directors Lodwrick Cook and Joseph Clayton cashed in $31.9 million and $16.7 million worth of shares, respectively, while former CEO John Scanlon sold stock worth $23.1 million.10

  By contrast, the company’s 8,000 employees were not able to sell the Global Crossing shares in their 401(k) plans in the month before the bankruptcy was announced. Their assets were frozen, Global Crossing explained, because the company was in the process of changing 401(k) administrators, shifting the plan’s assets from Putnam and Merrill Lynch to Fidelity. Critics questioned the timing of the shift at a point when the company’s finances were obviously precarious. When the so-called lockdown began, Global Crossing’s shares had already plunged from a high of $67 to $12. When it ended, the telecom start-up was trading at $9.11

  Arguably, the drop from $67 to $12 should have been enough to tip off employees that the stock was a lemon, but loyalty to company stock proved the undoing of many. They bet both their job security and their retirement savings on one company—and lost everything.

  Executives were not the only insiders who managed to cash out before Global Crossing became a penny stock. Former President George H. W. Bush became an insider even before the company went public, simply by agreeing to give a speech.

  In 1998, Lod Cook, an old oil-patch buddy, asked Bush to come to Tokyo to address potential customers of Gary Winnick’s fledgling telecom operation. At the time, Cook, the former chairman of Atlantic Richfield, was serving as cochair of Global Crossing. The former president agreed, and in a gesture of friendship, he offered a 20 percent discount on his usual $100,000 speaking fee.

  The speech went smoothly, and the next morning, over breakfast with Cook and Winnick at the Hotel Okura, Bush began asking questions about their venture, prompting Winnick to suggest that he take his fee in the form of stock rather than cash. Bush agreed.

  Global Crossing went public later that year, and before long, the alchemy of financial euphoria had turned Bush’s $80,000 honorarium into a $14 million windfall. Fifteen months later, in November of 1999, just as corporate insiders began to bail out en masse, a trust in Bush’s name registered to sell a portion of his holdings for an estima
ted $4.5 million. According to The Wall Street Journal, rumor had it that proceeds would go toward maintaining the Bush family retreat in Kennebunkport, Maine.

  The enormous sell-off by Global Crossing insiders turned out to be just one example of industry-wide sales by telecom executives. In the end, their gains dwarfed the profits made on Internet shares, The Wall Street Journal reported in 2002, referring to the profit taking as “one of the largest transfers of wealth from investors—big and small—in history. Hundreds of telecom executives, almost uniformly bullish, sold at least some portion of their stock and made hundreds of millions of dollars, while…outside shareholders took a bath.” But few executives were publicly apologetic about timing their sales so well, the Journal noted, quoting Randall Kruep, former senior vice president at Redback Networks, a six-year-old company that went public in May 1999. “I would have gotten out faster if I could have,” said Kruep, lamenting the fact that he was able to sell only $100 million worth of stock during 1999 and 2000. Rules that limited how soon insiders can sell stood in his way. In March of 2000, when Kruep was in the process of liquidating his shares, Redback stock changed hands at $191.03. By August of 2002, Redback traded at $1.07—and Kruep had a new job as chief executive of Procket Networks.12

  Virtually all of these sales were perfectly legal. To prove insider trading in court, a mind reader would need to show exactly what an insider knew, when he knew it, and how he interpreted it before selling his stock.

  THE FED TO THE RESCUE

  While insiders fled, it should be said that Fed Chairman Alan Greenspan stayed with the ship, making every effort to provide the liquidity needed to keep Abby Cohen’s tanker afloat.

  The Fed chairman seemed to be of two minds on what action was needed. On the one hand, he was worried about inflation. Concerned that the economy was overheating, the Fed hiked interest rates six times between June 1999 and May 2000. Nevertheless, smack in the middle of that period, at the very end of 1999, he pumped $100 billion in new credit into the economy.

  Greenspan fretted over inflation because he feared that soaring stock prices were generating a “wealth effect” that, in turn, was fueling consumer spending at a rate that could create an inflationary spiral. But in that case, “the great mystery,” remarked Newsweek and Washington Post columnist Allan Sloan, “is why Greenspan hasn’t attacked speculation directly by raising initial margin requirements”—the amount of stock an investor must have as collateral when borrowing from his broker to buy additional shares.

  As noted, in 1996, Greenspan himself had acknowledged that if he wanted to prick the bubble, boosting margin requirements would do the trick.13 Why, then, hadn’t he tried it? “Greenspan has said repeatedly that raising margin rates would hurt only small investors, because big investors have plenty of ways to get around margin requirements, such as dealing in stock options or futures rather than owning stocks directly,” Sloan reported.

  But in Sloan’s view, this was not the major reason why the Fed avoided stiffening requirements. “My feeling…is that Greenspan is also looking out for the well-being of brokerage houses, which make huge profits on margin loans.”14

  This Fed chairman was not about to cut off the liquidity that keeps a bull market party going. Lower rates made it easier to raise money for projects like Gary Winnick’s 100,000 miles of fiber optic cable. The fact that the world had no need for so much cable did not concern either Winnick or his promoters on Wall Street.

  Meanwhile, Alan Greenspan caught millennial fever. Responding to apocalyptic fears that as the world’s clocks changed from 1999 to 2000, computers worldwide would crash, the Fed chairman once again rode to the rescue, cushioning the expected crash with cash. “In the run-up to the millennial-liquidity-crisis-that-did-not-happen, the Fed created more than $100 billion of new credit, thereby stimulating a stock market that hardly seemed to need any additional encouragement,” Jim Grant noted in an op-ed piece that he wrote for The Financial Times.15

  Washington, by contrast, was impressed. On January 4, 2000, President Clinton nominated Alan Greenspan to a fourth term as Fed chairman, and “Greenspan’s Senate confirmation hearing—a tense scene on previous occasions—was more like a coronation this time around,” noted Justin Martin, author of Greenspan: The Man Behind Money. Indeed, Martin reported, at about the same time, “Americans were treated to the spectacle of the leading presidential candidates for the 2000 election falling all over one another to see who could heap the highest praise on Greenspan. The prize went to John McCain. During a primary debate, [McCain] gushed: ‘And by the way, I would not only reappoint Alan Greenspan—if he would happen to die, God forbid—I would do like they did in the movie Weekend at Bernie’s. I would prop him up and put a pair of dark glasses on him.’”16

  Not everyone was bowled over. Some, like Acorn Funds founder Ralph Wanger, believed that by keeping the bubble afloat, the Fed chairman was only postponing disaster. “In the end, what the market is valuing is the economy—and if the economy grows 6 percent and the market is going up 12 to 18 percent, after 10 years you’ve got an unstable situation. It reminds me of the conditions that lead to an avalanche,” he continued. “Once enough snow has accumulated, it’s hard to know what will trigger the avalanche. It can be almost anything—a tree branch, a deer, a skier—what really causes it is that you have an unstable snow buildup and any damn thing is going to trigger it. It doesn’t matter what the final trigger is—unless it happens to be you. In which case it becomes an overriding concern, for a short period of time.

  “When the avalanche comes crashing down, it takes everything in front of it.”

  In Wanger’s view, Greenspan committed his final, fatal mistake by bringing a snow-making machine to an avalanche. At the time, a blizzard of buying had already created the instability that inevitably would lead to disaster: “What Greenspan should have done,” said Wanger, “was to act like he was head of the ski patrol. You handle an unstable situation like that by setting off the avalanche under controlled conditions. You take care of the situation by having the avalanche earlier rather than later.

  “That last slug of liquidity in the last quarter of the year” helped send stocks to the moon, Wanger observed. “Biotech stocks went up eightfold. There was money all over the place, money flowing into sector funds—and sector funds set up the potential for disaster.”17

  MARCH 2000

  Many of those sector funds were technology funds. 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. Individual investors were still following the momentum. During the first three months of 2000, roughly two-thirds of the cash that individual investors shoveled into mutual funds was tagged for tech funds, helping to drive the benchmark technology index past yet another much ballyhooed barrier: on March 10, the Nasdaq crossed 5000.

  Then, on Monday, March 13, the trouble began. The New York Times called it “a small speed bump.”18 And so it seemed. Granted, the Nasdaq had lost 9 percent of its value in the first three days of the week, but then the tech index rebounded nicely. The next week, the Nasdaq took another hit, and once again bounced back. Investors took the swerve in stride. “Bull’s Retreat Doesn’t Cause a Stampede,” the Journal declared in the final days of March.19

  By year-end, The Wall Street Journal would take a very different view of the events of March 2000. Looking back on the “tech wreck” that began that month, Wall Street’s paper of record compared it to “one-third of the houses in America sliding into the ocean.” For by then, the index had fallen 54 percent, peak to trough, and investors had lost $3.3 trillion in paper wealth—the equivalent of the loss of said houses, “in dollars if not in effect,” the Journal added, allowing for the fact that people might well have a sentimental attachment to their homes—not to mention a fondness for family members who could be trapped inside.20 Then, too, these were only paper losses. But most 401(
k) investors thought of the money as theirs even though they had not yet sold their shares, and had planned their retirements accordingly.

  In retrospect, many observers would believe that the bear market began in March of 2000. That, after all, also was the month when the S&P 500 peaked. But market historians who stepped back to take a broader view realized that the Greek Chorus was right: the bear came on stage sometime in 1999.

  You only had to do the math. By March 1, 2000, stocks trading on the Nasdaq had climbed $3.1 trillion in 12 months, Jim Bianco of Bianco Research pointed out. Over the same 12 months the total value of all U.S. stocks—including Nasdaq shares—rose by only $2.1 trillion. Anyone who subtracted the Nasdaq’s gain from the total realized that by March of 2000, the overall market had fallen by $600 billion.21

  “Bears,” Peter Bernstein later observed, “are people who do their arithmetic.”22

  In other words, the bull did not suddenly roll over and die in the spring of 2000. What seemed a sudden shocking drop on the Nasdaq was part of a larger process that embraced not just the technology index but the whole market. The broad market had lacked support since the end of 1998, when just six stocks carried the S&P 500 over the finish line into positive territory. Gail Dudack was right: it was a “stealth bear market.” And the bear would continue to take his time. “The dollar did not break down until May 2002,” Dudack added three years later. “The unwinding of this bubble is like watching a movie in slow motion. The trough may be similar.”23

  Nevertheless, individual investors continued to trust stocks for the long run. Over the course of 2000, they would pour $260 billion into U.S. equity funds—up from $150 billion in 1998 and $176 billion in 1999. Of the $259 billion invested in 2000, $130 billion, or roughly half, went into what the Investment Company Institute characterized as “Aggressive Growth” equity funds. This was three times more than they had invested in 1999. Nearly $120 billion went into the somewhat less aggressive “Growth” equity funds—about twice the amount invested in these funds in 1998, and up roughly 20 percent from 1999.24