Hangover Effect Follows Market's Euphoric Party

Monday, March 5, 2001
by Marc J. Lane

Reprint permission from the March 5, 2001 issue of Crain's Chicago Business.

The hungriest of investors, many never having lived through a bear market, were unshakable in their belief that tech stocks could only go up.

They bought into Federal Reserve Chairman Alan Greenspan's suggestion that a new economic paradigm might be taking shape. They adopted his vision as their own. And they made something of it he never intended — an absolute conviction that unprecedented corporate productivity would clear the way for ever-soaring stock prices and unimaginable wealth. All bets
were on.

But then the unthinkable happened. The unduly optimistic investors' exuberance proved irrational, as Mr. Greenspan feared it would.

The tech-heavy Nasdaq Composite Index, which peaked last March 10 at 5048, has been going lower ever since, and has given up more than half its value.

For too many, the pain has been severe. For others, it's life-altering. Baby boomers' retirement accounts have been savaged, and day traders have been forced into other lines of work.

Tech issues may rebound and even surge again, but the evidence is irrefutable: The business cycle wasn't repealed, after all. And diversified, counterbalanced portfolios, as it turns out, are where the smart money was all along.

But there is more to the story and, sadly, there are more surprises in the offing. Especially for those who were counting on non-stop appreciation in tech stock prices.

Take the desperate technology entrepreneur whose cash-strapped public company is shut out of the capital game now that the market is finicky. He may see no way out but to take on so-called "death spiral" debt, where the lender is to be repaid in the company's common stock. The lower the stock's price falls, the more shares the borrower must deliver.

Some cynics contend that unethical lenders might sell shares short to depress the stock's price and "earn" more shares. And they could very well be on to something.

The National Assn. of Securities Dealers has recently adopted special rules for companies that raise capital by issuing such "future priced securities," including a shareholder approval requirement. Failure to comply might disqualify them for a Nasdaq stock market listing, but it's their shareholders who would really pay the price.

And then there are the tens of thousands of shareholder-employees who may soon find that they were mugged by stock options. Many of them joined go-go companies, forgoing traditional career paths for their
once-in-a-lifetime chance to cash in on a tech jackpot.

What they didn't consider is that recipients of stock options, the currency that probably hooked them, are taxed when options are used to buy stock. And the law makes no exception when the stock's price drops. For that reason, many stunned employees will end up owing more in taxes next month than they will have earned on their stock options.

Cautious financial advisers encouraged stock option recipients to play it safe in 2000. They fought against the prevailing euphoria and urged their clients to sell their shares before panic set in and stock prices plummeted.

The clients who followed their advice prospered. Others waved them off and will soon face a tax bill they didn't bargain for And some, those hurt the worst, borrowed heavily against the stock they bought with options. Their fast-buck strategy: to compound their returns by investing borrowed money in other high-growth ventures. But, as the tech market collapsed, the very greediest leveraged themselves into bankruptcy.

So, the careful investor marshals his assets, deploys them deliberately, sees them grow and sleeps at night. The speculator takes big risks on big bets and, if the fates see fit, incurs big losses.

The incentives are all in the right places. And, although one may sympathize with those who overreach, it's hard to argue with the fairness of the results.

Marc J. Lane ( is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law.

Copyright © 2001 by Crain Communications Inc.

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