Martha Stewart Sends Us a Message

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media giveth, and the media taketh away. Cursed be the name of
the media.

No Job 1:1

Martha Stewart
has become the most publicized CEO in the world. Unlike most CEO’s,
millions of people recognize her name and her face. Even men recognize
her. In the funniest scene in Dave Barry’s novel, "Big Trouble,"
a crook hiding on the ground encounters a rare breed of frog,
which then sprays him in the face with a hallucinatory liquid.
The crook then encounters a dog. The dog has the face of Elizabeth
Dole. Problem: Elizabeth Dole’s face is not recognizable to most
people. So, in the movie version, we see Martha Stewart’s face
attached to the dog.

Mrs. Stewart
is one of those rare CEO’s who has been created by the media.
Oprah Winfrey is another. Bill Gates is famous, but he was not
created by the media. Warren Buffett is not a household name.

When her
conviction was announced, it was front-page news. It was lead
story news on the evening TV news and the "Today Show."
Women know who she is, in the same way that they know Oprah. When
Mrs. Stewart hit the judicial brick wall, the whole country heard
the crash.

We are getting
all sorts of messages by way of the media.

  1. She is
    a control freak who lost control.
  2. She was
    greedy, and her greed cost her a fortune.
  3. The bigger
    they are, the harder they fall.
  4. No one
    is immune to the Federal government’s long arm.
  5. Mean
    gals finish last.

There is
a far more important message from this incident. The message is
applicable to tens of millions of Americans. This message has
not gotten through and is unlikely to get through.

It is this:

The perceived
capital value of the stock market is an illusion, and that illusion
can be exposed at any time by a seemingly trivial event.


When Martha
Stewart sold her ImClone shares, the capitalized value of her
own company was somewhere in the range of $2 billion. Today, it
is closer to $500 million. Yet there has not been a wave of panic
selling. The reason why we know there has not been a wave of panic
selling because the biggest holder of the shares is Martha Stewart.
She is not selling.

The sell-off
has taken place, in the language of economists, at the margin.
There have been more sellers of shares at the pre-ImClone scandal
price than buyers at that price. So, the price of her stock has
fallen, sale by sale.

Each time
a sale takes place, it establishes a new price, or at least adds
pressure to establish a new price. Each new price for one share
establishes a new price for all of the existing shares. This in
turn establishes a new capitalized value for her company. The
capitalized value of her company is the price of the block of
shares sold most recently multiplied by the number of shares outstanding.

As the bad
news about her future has been released, headline by headline,
the number of shareholders who are willing to accept a lower selling
price increases. But the vast majority of shareholders in her
company are not willing to accept a lower price. They think that
things will turn around. They think that this is the bottom. Headline
by headline, they have been proven wrong. But they still refuse
to sell. So, there has been no panic sell-off.


Which piece
of information would have been more valuable to a portfolio manager
of a large mutual fund located in (say) the Bahamas, who was willing
to break U. S. securities law and operate with inside information,
which is illegal? (If you want to read a book on why it should
not be illegal, read Henry Manne’s "Insider Trading and the
Stock Market," which was published in 1966 and which hardly
anyone has read — unfortunately.)

  1. ImClone’s
    cancer drug has just been turned down by the FDA.
  2. Martha
    Stewart has just sold her ImClone shares.

There is
no question that the second piece of news would have been more
valuable to anyone with an entrepreneur’s abilities. The fund’s
manager would know that word would get out fast about ImClone.
He would be unlikely to be able to sell enough shares fast enough
to make any money. But the news about Martha Stewart could have
been easily converted into money. Sell her company short. The
hit to her company would probably be greater than the hit to ImClone:
larger capitalization. No one would know about her illegal action
for weeks. "She is going to get caught eventually."
So, day by day, sell her company short. He would have made a fortune.

The loss
of capitalized value to Martha Stewart’s company has been dramatic.
ImClone has bounced back. Hardly anyone got hurt when she sold
her shares of ImClone. That was the point made by Prof. Manne
[MANee] almost four decades ago. The person who acts on inside
information has an information advantage over the handful of people
he sells his shares to, but the vast majority of shareholders
do not suffer from this sale. If they do suffer, it is from the
facts on which the insider was selling his shares. This bad news
would have gotten out anyway. But in the case of shareholders
in Martha Stewart’s company, they have been badly hurt by the
prosecution of Mrs. Stewart for something that seemingly had nothing
to do with the company.

Of course,
it had everything to do with her company. She is the company,
in the same way that Oprah is Harpo, Inc. The company’s capitalized
value is the expected stream of net income to be produced by her,
discounted by the prevailing rate of interest. The company branded
her. Then she got branded by the government: "convicted criminal."


The government’s
prosecutors have tried to send a message to corporate leaders:
"Don’t break the law." They sent a much louder message
to the stock market: "Don’t expect us to make any legal decision
in terms of its likely effect on capitalized value." The
prosecutors are more interested in scaring senior corporate officers
than they are about scaring investors. Yet they do this officially
in the name of investors.

The number
of people who can say they were harmed by Martha Stewart’s sales
of $60,000 of ImClone shares is hardly worth comparing to the
portfolio effects of the government’s prosecution of Mrs. Stewart.
If the insider trading law had specified that Mrs. Stewart must
pay double restitution to the people who bought shares from her,
they would be happy. The millions of investors who were holding,
and are still holding, shares in her company would also be happy.

The great
irony is that the insider trading laws do not compensate the supposed
victims of the illegal transaction: those few people who bought
their shares from the insider. Instead, the government imposes
fines on the seller. Then the government pockets the money —
a tiny fraction of the money spent to prosecute the seller. The
victims must then sue the seller in civil court to recover damages.
But mere double restitution will not be enough to compensate the
trial lawyers, who demand one-third of everything collected. (Note:
the Bible specifies double restitution: Exodus 22:4. But the Bible
isn’t good enough for the trial lawyers.)

If you think
the American justice system is messed up, you have understood
one of the messages from Martha Stewart. When we call it the criminal
justice system, we have used the correct adjective. When we call
it civil justice, we haven’t.


I have said
that there has not been a wave of panic selling. There should
have been. The company’s capitalized value has collapsed. The
source of the company’s expected stream of net income is going
to jail.

I suppose
I should bewail the loss of $1.5 billion in capitalized value.
On paper, this is what the Martha Stewart affair has cost investors,
of whom Mrs. Stewart is the largest. Investors who had shares
in their retirement portfolios are now going to have to work an
extra month or year or decade to make up for the losses they have

Yet I can’t
get too excited about this. Why not? Am I a cold-hearted man?
Can’t I see what has happened? Can’t I feel their pain?

The answers
are no, yes, and no. No, I am not cold hearted; yes, I can see
what has happened; and no, I cannot feel their pain. That is because
I feel too much pain on behalf of tens of millions of lambs headed
for the slaughter, who are going to feel a lot more pain than
Martha Stewart’s investors did. The pain that the Stewart investors
have felt is going to be multiplied across the boards. I will
not be one of them, I hope, but the economic fall-out will be
unavoidable for most Americans. I will get hit by the after-effects.

The disappearance
of $1.5 billion has received little media attention. The media
focus on Martha the control freak, Martha the crook, Martha the
liar, Martha the emotionally distant. What really bugs me is Martha,
the woman who is as old as I am but who looks ten years younger.
But none of this is either here or there in the larger scheme
of things.

What should
be in every discussion of her case is the ease with which $1.5
billion in capitalized value went poof. No muss, hardly any fuss,
and whammo: the wealth disappeared. Or did it? Was it wealth?
Or was it the illusion of wealth?

I think it
was the latter. It was the illusion of wealth created by a stock
market where investors assume that most people will never sell.
"The market always goes up in the long run." Really?
If so, then what has happened to Martha Stewart’s shares had better
be an anomaly. The disappearance of all that capital was so easy,
and it happened so quietly, while everyone was discussing Martha
the Whatever, that those who think the stock market always goes
up had better show us why this case really is an anomaly.

Yes, the
company had capitalized one person’s income-producing ability.
But didn’t the experts know that this was a risk? Didn’t they
know that people get old, die, and make other mistakes? Didn’t
the mutual fund managers know enough not to buy the shares of
a company that hinges on one person? Of course not. They bought.
They used formulas. "Random walk giveth, and random walk
taketh away."

It did not
take a wave of panic selling to whack the dreams of everyone who
owned shares in her company. All it took was a series of headlines.
These headlines convinced a tiny minority of share owners to sell.
Down, down, down went the price of the marginal shares, the imputed
value of the remaining shares, and the capitalized value the company.

What if there
had been a real panic?


does not take a large number of sellers to collapse the value
of a company." This is the message from Martha Stewart.

The creation
of stock market profits for tens of millions of American families
has been the accomplishment of these factors:

  1. Federal
    Reserve System money-creation
  2. Federal
    securities laws that reduce the number of legally eligible investments:
    thin markets
  3. Short-term
    investment tactics of mutual fund investors
  4. Short-term
    investment tactics of mutual fund managers
  5. Accounting
    practices that meet the immediate demands of investors and fund
  6. Actual
    increases in productivity, which were about 30% of the annual
    compound growth of share values since 1982
  7. The
    spread of the familiar refrain, "This time, it’s different."

my 30% figure may be too high. It’s a guesstimate. I
am open to correction.

The illusion
of the stock market’s capital value, meaning wealth, is today
universal. Analysts look at Martha Stewart’s case and conclude,
"It’s an anomaly." Buy why is it an anomaly? Did too
many people buy shares based on the expected net income of one
person? Yes. But they did invest. Nobody warned them of the risk.
Nobody imagined that the company could be hit this badly. If something
is inherently risky, as the investment in one person’s brand is,
then why doesn’t common sense prevail? It did not prevail. The
portfolio managers blew it.

It took few
sellers to inflict horrendous losses on the investors who decided
not to sell. The buy-and-hold people sat there and did nothing.
The result was a disaster.

People are
looking forward to their retirement. They have great expectations
regarding their future net income. Yet they are paid dividends
that are not much higher than mutual fund expenses. They are as
blind to the implications of this as the investors were who bought
and held shares in Martha Stewart’s expected net income stream.

Can’t they
see what is coming? No. They know that they cannot live on dividends.
They know that their future income from their stocks will depend
on their ability to sell their shares into that legendary market
that always rises. They do not apply their knowledge of what happened
to Martha Stewart’s shares to their own portfolios. They have
not received the message from Martha Stewart. And what is that
message? This:

It does
not take a large number of sellers to collapse the value of
a company.

The perceived
capital value of the stock market is an illusion, and that illusion
can be exposed at any time by a seemingly trivial event.


People believe
what they want to believe. Stock market investors want to believe
that they will be able to live off of their dividends, which are
zero now, plus the capital value of their sold shares. They think
that there will be buyers for their shares when they retire. What
buyers? Most people who own shares own them in their retirement
funds. It is the baby boom generation that was sufficiently future-oriented
to bid up the price of the shares. "Sell!" "To

of investors also believed that the Martha Stewart brand name
was somehow separate from Martha Stewart. They assumed that Martha
Stewart was as permanent as a Kennedy in politics in Massachusetts.
She wasn’t.

Be realistic.
As Will Rogers said about stocks: "Buy stocks. They’re going
up. But if they don’t go up, don’t buy u2018em." Or words to
that effect.

13, 2004

North [send him mail]
is the author of Mises
on Money
. Visit
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