It's Not Their Fault

By Daniel Kadlec

Wall Street analysts have a credibility problem. No question. But this silliness about tech analysts' causing the stock market to inflate and then burst has got to stop. It's way too convenient. The lesson here isn't that the analysts are shills. It's that greed and speculation come disguised, and if you don't accept your own failure to unmask those wealth raiders, you're bound to fall victim next time around too.

In the post-bubble witch hunt, two Internet analysts are getting most of the blame--Henry Blodget at Merrill Lynch and Mary Meeker at Morgan Stanley Dean Witter. They're natural targets. Both work at influential brokerage firms. Both reportedly made $15 million, give or take, as Internet stocks soared in 1999. And both now concede the obvious: they were too slow to downgrade dozens of stocks. Their bullishness in the face of impending disaster has riveted attention on the analyst's role across Wall Street. It's not a pretty picture.

JP Morgan, for example, instructs analysts to tell a company when its rating is going down. The company can then ask for a change in the accompanying research note. And the analyst must give a reason for declining to do so. That sorry procedure came to light last week. It casts analysts as puppets of the companies they follow. Meanwhile, brokerages routinely pay them to land underwriting deals, a sale most easily closed with a glowing research report in hand.

So glaring are such conflicts of interest that Byron Wien, stock-market strategist at Morgan Stanley, took the system to task in his research report: "It is clear that the profession has some serious work to do to rebuild confidence," he wrote, urging analysts to be "intellectually honest and independent." My favorite criticism comes from the stock jocks on CNBC--the very same folks who made stars of bulls like Blodget and Meeker by putting them on the air day after day while the bubble was still bloating. These watchdogs now insist that analysts answer for their miscalls. O.K., but who's insisting that the TV folk answer for airing this stuff ad nauseam and without balance? The print world isn't blameless either. Nobody wanted to hear that Net stocks were incendiary. Audiences would have tuned out.

But can you really blame analysts for what happened with VA Linux Systems? The software company filed to go public at $12 a share in 1999. Before any analyst had a chance to publish a word, demand enabled underwriter Credit Suisse First Boston to raise the IPO to $30. Maybe it should have stuck to the initial price, which in theory anyway was based on some valuation model. But it scarcely mattered.

Investors wanted the stock so badly they bid it up to $239 in a day. Bullish analyst reports came in weeks later, and guess what? The stock fell steadily. It's now under $4. That pattern was not unusual. It suggests that the only thing investors were paying attention to was their dreams. And that's the best disguise of all, really. You tell yourself instant wealth makes sense; it's your turn to hit the lottery. But of course we can't all hit the lottery together. In the end a dream is exactly that, whether there's an analyst in it or not.

See time.com/personal for more on the market. E-mail Dan at kadlec@time.com See him Tuesdays on cnnfn at 2:15 p.m. E.T.