The bottoming process is a long, messy affair. It frays the collective psyche as immense amounts of capital get destroyed. Eventually, as the fear of ever greater loss of assets turns acute, a catharsis overcomes the crowd. The crescendo is a frenzied wave of panic selling.

At least, that's the way its supposed to happen.

In the post-bubble, post terrorism, post-Enron, post-analyst scandal environment, we seem to have moved beyond fear as the sell off has become interminable. To determine why the bottom remains so elusive, researchers have been searching for the differentiating factors of this Bear market: Is it any different from other cyclical sell offs, and if so, how?

In my opinion, the single most differentiating factor of this crash is the peculiar emotional tenor of investors: Unlike most cyclical lows, where the dominant emotion is fear, this sell off is characterized by investor anger. There is far less panic -- and far more disgust -- than typical.

Its one thing to take a loss 'cause you made a bad stock pick; Its something entirely different to lose money because someone else is cheating at the game. Given the incredible run of scandals, its easy to inderstand that perspective. What was once perceived as a difficult game is now seen as corrupt, and therefore impossible to win. Investors -- especially those overseas -- have decided that since the Coaches and Managers and Umpires cannot be trusted, they'd rather take their ball and simply go home -- repatriating billions of dollars in capital in the process.

Indicators of the Bottoming Process
Technical analysts track extremes in broad market sentiment to help determine market bottoms. This technique gives traders objective signals. Major sentiment indicators include volatility indexes, mutual fund outflows, put/call ratios, investor sentiment surveys, the Arms index, valuation models, percentage of stocks below their moving averages, and up/down volume ratios.

These indicators are usually very helpful when groping for a bottom. Unfortunately, many of them have been flashing their signals for some time now, and their reliability is now in question.

The failure of the typical measures of "Fear and Greed" suggests one of two things: either an intermediate bottom is forming (belatedly), or a qualitatively different factor is at work.

Missed Opportunity?
On July 9, President Bush presented to Wall Street what was to be a major policy speech on the current crises of confidence. There was great hope that he would use the "Bully Pulpit" to address many of these issues, and allay the angst of the investing public.

Unfortunately, it was a missed opportunity. The President's speech could have potentially put a floor under the market. Instead, it started a cascade of selling, and began a new leg downwards.

Obviously, Wall Street did not like what it heard. Corporate execs got a slap on the wrist, and the proposed 20 million dollar increase in SEC funding still leaves its budget below the level it received in 2000.

Complicating the matter is this administration's close ties to many of the present debacles -- President Bush had a close relationship with Harken Energy and Enron, Vice President’s tenure at Halliburton.

The President had a grand opportunity to demonstrate political independence and show leadership in restoring investor confidence. Wall Street would have bought into strong Presidential guidance on that issue; Instead, it sold off the moment the speech on "Corporate Responsibility" was done.

Obviously, the Street was not impressed with what it heard.

What needs to be fixed
After the crash of 1929, the public's revulsion with Wall Street reached unprecedented levels. The government's response -- while not exactly swift - was at least decisive: The Securities Acts of 1933, 1934 were passed, and the S.E.C. was created.

These major pieces of legislation helped to reassure a disgusted public. Unfortunately, corporate lobbyists have over time, whittled down the protection of these acts. It is now past the time to reinvigorate the legislation, and put some teeth into the enforcement and punishment process. Here's what needs to be done -- and soon:

--Remove the Incentive to Cheat
The primary reason for all the accounting shenanigans was the outrageous option packages executives lavished upon themselves. By owning millions of zero cost options, unscrupulous management had all the incentive they needed to get their stock price up by all means and at any cost.

Its no coincidence that the list of executives who were paid in excess of 100 million dollars in annual options overlaps with the list of companies who cooked their books.

The solution? Make options an expense. Require shareholder approval for all executive option compensation packages, including "loans" to executives. Would WorldCom have "loaned" Bernie Ebbers nearly 400 million dollars to buy stock if shareholder approval was needed? Could the Rigas family have "borrowed" billions of dollars -- and ultimately bankrupt Adelphia Communications -- if it had been put to a shareholder vote?

If executives want loans, they can do what everyone else does: go to a bank.

-- Aggressive Enforcement MUST be the SEC's priority
The SEC has become a feeble, toothless tiger.

The present SEC Chairman – Harvey Pitt – was a corporate defense attorney. An aggressive prosecutor would be a better choice to restore investor confidence.

The SEC has been sluggish in its reaction to a variety of scandals. Their lack of enforcement was put into sharp relief by the aggressive investigation into the analyst scandal by Elliot Spitzer, the New York Attorney General. Spitzer uncovered a frightening litany of misdeeds and corruption. He forced some very embarrassing admissions by Merrill Lynch, and negotiated a $100 million dollar fine.

Just this week, Morgan Stanley received a document request from the NYAG, and I promise you they are none too happy about; I’d bet they’d have much preferred that the request came from SEC instead.

Spitzer, with a staff 1/100th size of the Pitt's, belies the under funded / understaffed excuse proffered by the SEC. If 9 state attorneys can bring Merrill Lynch and the rest of the big wire houses to their knees, the SEC must be doing something wrong.

If we really want to restore investor confidence, than the current SEC chair shouldn’t be a defense lawyer; Instead, the President should appoint a career prosecutor. If the administration really wants to reassure the American public, here's an idea: Name the beloved former New York City Mayor Rudy Giuliani as head of the SEC. That will not only restore investor confidence, it will put a real fear into wayward corporate executives.

-- Reverse the Litigation Reform Act of 1995.
Much of the present accounting debacle traces its roots to this terribly cynical piece of anti-investor legislation. Under the spurious guise of reducing litigation expenses, the '95 act gives free pass to big accounting firm malfeasance.

It is a bipartisan piece of trash. Sponsored by Republican Congressmen and signed into law by a Democratic President, the act shielded big accounting firms from liability for their own incompetence and corruption. Class action lawsuits are an enormous disincentive to sloppy auditing and corrupt consulting; The 1995 act removed the fear of litigation from the (then) big 6 accounting firms.

I believe that the catastrophic frauds are the direct result of this legislation.

The solution? Release the hounds! Set the private Bar loose on criminal accountants. I have much greater faith in the free market action of self interested lawyers than I do in legions of government bureaucrats. The careerist hacks supposedly working on the public's behalf have already failed us miserably as they pursued their own political careers. Let the free market do its job.

-- Don't let White Collar Crime Pay Off so Handsomely.
Here's an ugly reality check: Crime pays. At least, the white collar variety does. Not only is there practically no jail time, but the criminals get to keep their ill gotten gains.

This is totally unacceptable.

CEOs who loot their investors and then run off to a life of landed gentry must be forced to disgorge their plunder and booty. The consulting riches which flowed to accounting firms needs to also be disgorged.

Unfortunately, their is little in the way of seizure or forfeiture penalties in present SEC legislation (that needs to be fixed).

I doubt the present administration has the stomach to use the Racketeering (RICO) laws to pursue the current crop of criminal executives. They should be prosecuted with the same zeal the Feds usewd to go after the Mafiosa.

A CEO or CFO who cooks the books needs to have his swindled goods repossessed. His house (and 2nd and 3rd vacation homes), Gulfstream, and numbered Swiss bank account all need to be seized. Any exec caught cheating must be barred from serving on the Board of Directors of any public companies -- for life.

Conclusion
Decisive leadership is required immediately.

The crash in 1929 created an entire generation of people who swore off investing in the market forever. It wasn't until an entire new generation of investors were born and entered the work force decades later that the Dow returned to its pre-crash levels.

We are now flirting with that same danger. The government must step in to undo the damage it has wrought: The bad legislation, lackluster enforcement, and non existent punishment must be reversed. Failing to do so could lead to another Depression, rivaling that of the 1930s.

After the September 11th terrorist attacks, the President recognized the long term threat to the nation and rose to the occasion. This crisis is potentially even larger. The same danger recognition and response is needed. Fighting a war against terrorism will be nearly impossible if a scandal plagued country is plunged into a major depression.

The Wall Street crisis is now a matter of National Security. All that is needed is strong Presidential action.

Barry Ritholtz is the Market Strategist at Ehrenkrantz King Nussbaum, a N.Y. Brokerage firm. In a prior life, Ritholtz was an Attorney, and a Federal Mediator for the Second Circuit Court of New York. At time of publication, Ritholtz had no positions in any of the stocks mentioned, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to ritholtz@aol.com.

Barry L. Ritholtz
July 12, 2002

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