Quote of the Week

...is from The Intelligent Investor, Rev. Ed (2009) by Benjamin Graham and Jason Zweig:

“About a half century ago the “miracles” were often accompanied by flagrant manipulation, misleading corporate reporting, outrageous capitalization structures, and other semifraudulent financial practices. All this brought on an elaborate system of financial controls by the SEC, as well as a cautious attitude toward common stocks on the part of the general public. The operations of the new “money managers” in 1965–1969 came a little more than one full generation after the shenanigans of 1926–1929. The specific malpractices banned after the 1929 crash were no longer resorted to—they involved the risk of jail sentences. But in many corners of Wall Street they were replaced by newer gadgets and gimmicks that produced very similar results in the end. Outright manipulation of prices disappeared, but there were many other methods of drawing the gullible public’s attention to the profit possibilities in “hot” issues. Blocks of “letter stock” could be bought well below the quoted market price, subject to undisclosed restrictions on their sale; they could immediately be carried in the reports at their full market value, showing a lovely and illusory profit. And so on. It is amazing how, in a completely different atmosphere of regulation and prohibitions, Wall Street was able to duplicate so much of the excesses and errors of the 1920s.”

Graham was talking about the late 1960’s, a period few recall today, that presaged nearly 16 years of a sideways stock market. Now another full generation later, these insights are once again especially relevant. New “hot” issues within technology (ie. Facebook), fraudulent practices in mortgage lending, debt-heavy capitalization structures and the continued absence of mark-to-market accounting are the new means of portraying illusory profits. Graham then continues:

“No doubt there will be new regulations and new prohibitions. The specific abuses of the late 1960s will be fairly adequately banned from Wall Street. But it is probably too much to expect that the urge to speculate will ever disappear, or that the exploitation of that urge can ever be abolished. It is part of the armament of the intelligent investor to know about these “Extraordinary Popular Delusions,” and to keep as far away from them as possible.”

The Dodd–Frank Wall Street Reform and Consumer Protection Act represents the most recent set of regulations intended to prevent, or at least limit, the most recent forms of abuse. Just as the reforms of the 1930’s, 1970’s and even 2000’s have failed to alter this dominant cycle, the current efforts are almost certain to follow the same path. Regulations may prevent a repeat of the exact actions previously abused, but may also provide the loopholes necessary for the next semi-fraudulent scheme. Both investors and policy markers should be wary of these historical lessons when approaching future actions.