Boom and Doom
posted by Frank Pasquale
“The overvaluation of stocks is more extreme than the 1929 high,” said Robert R. Prechter Jr., an independent market forecaster. . . . Now, Mr. Prechter is suggesting that the country is facing not just a market crash, but also a depression. On every measure, he says, the market is more overvalued than it was in 1987 before the reversal. The price-to-book ratio of the S.&. P 500-stock index today is 4.04, compared with 1.73 in 1987.
Has lack of regulation helped pave our way to this parlous state? Robert Kuttner thinks so, as related in testimony before the House Committee on Financial Services. He sees “alarming parallels” between 1929 and 2007, based on “excessive leveraging, misrepresentation, insider conflicts of interest, non-transparency, and the triumph of engineered euphoria over evidence.” He gives several parallels, but I found this one the most troubling:
In the 1920s, the corrupted insiders were brokers running stock pools and bankers as purveyors of watered stock. 1990s, it was accountants, auditors and stock analysts, who were supposedly agents of investors, but who turned out to be confederates of corporate executives. . . . In this decade, it remains to be seen whether the bond rating agencies were corrupted by conflicts of interest, or merely incompetent. The core structural conflict is that the rating agencies are paid by the firms that issue the bonds. Who gets the business — the rating agencies with tough standards or generous ones? Are ratings for sale? And what, really, is the technical basis for their ratings? All of this is opaque, and unregulated, and only now being investigated by Congress and the SEC.
In response to the backlash against SarBox, many are now saying that the crisis of corporate governance never went away. It’s hard to see why conflicted ratings agencies should remain such pivotal players here as valuation becomes more and more difficult.