In the last days of the Dot-Com bubble, when wild share price swings and high leverage levels were becoming synonymous with the internet sector, there were a few financial players who exhibited prudence. Salomon Smith Barney for instance, raised margin requirements on at least 85 web stocks, with the aim of decreasing risks to the firm should stocks fall.
Some of that, naturally, was out of self-interest for the broker itself. If the Dot-Com bubble suddenly burst, a firm like Salomon could potentially be on the hook for its customers’ losses. Those customers had something like $13bn in margin loans at the time. But at the same time, the move effectively limited trading activity – and profits – for the broker. Something missing perhaps, from the actions of most financial firms ahead of the housing crash and credit crisis.
In any case, there was another — now infamous — financial player exhibiting restraint in the Dot-Com environment. One Bernard Madoff.
From a 1999 Wall Street Journal article extracted in Michael Lewis’s highly-readable ‘Panic: The story of modern financial insanity‘.
The same volatility and heavy trading by individuals convinced a market veteran, Bernard L. Madoff, that his trading firm should stop making a market in four wild Web stocks. “You’re literally seeing hundreds of thousands of orders in these stocks,” Mr. Madoff says. “That puts a strain on everybody’s systems. And on the way down, it’s always more extreme.”
Throughout late 1998, Mr. Madoff, at his trading desk in Manhattan, watched tiny orders scroll across his monitor for stocks like Amazon, Yahoo, Infoseek Inc., and Egghead.com. Then, he saw IPOs skyrocketing. But what did it for him was the action in Amazon mid-December. An analyst from CIBC Oppenheimer Corp., Henry Blodget, issued what seemed an outlandish price “target” of $400, which equals $133 today after a 3-for-1 split. The stock leapt 19% in one day. Then Merrill Lynch analyst & Co.’s better-known Jonathan Cohen struck back with a price target of only $50, or $17 after the split. The stock whipsawed back down.
To Mr. Madoff, “it was insanity. This thing was getting out of control.” In January, his New York firm, which bears his name, dropped Amazon, Yahoo!, Infoseek and Egghead, even though trading them had been very profitable. Interestingly, shares of Amazon now trade at a bit over $115 a share -or presplit, very close to Mr. Blodget’s forecast. Mr. Cohen has since left Merrill. Mr. Blodget is now expected to take his job.
But Mr. Madoff lived through the October 1987 crash in stock prices – as Nasdaq’s chairman. “I had to field all the unhappy phone calls when people felt the Nasdaq market had pretty much shut down,” he says. “My attitude was, I do not want to relive that event.” And now, even more of the trading is done by individuals.
There’s irony galore in the above passage — not least the interaction between Madoff and Blodget, who did go on to join Merrill Lynch and is now at financial blog Clusterstock, having fallen from grace somewhat as an internet analyst. And, given that Madoff was cooking the books in his fund management business, why bother to be fiscally conservative in his market making one? Interesting behaviour, to say the least.
Related links:
Ten principles for a Black Swan-proof world – Nassim Nicholas Taleb in the FT