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[At what rate] was it actually growing?
Oh, it was roughly doubling every year. Now the difference is: If you double every 90 days, that is a 1600 percent annual growth rate, when data traffic was actually growing at 100 percent. So the hype was implying that it as growing 16 times faster than it actually was.
... What about the investment banking side? What do they do with the hype? What's their role in this game, in terms of expectations, and in terms of the mentality of the late 1990s?
Think of the investment bankers' role in the telecom Internet bubble as endorsers and translators. Essentially, they endorsed it, and put their credibility and their brand name behind it to give it credibility. Then they were the translators. They took this technical concept, put it into great sales language, and got people excited about it. They were essentially the most sophisticated enablers of the bubble, and deserve a whole bunch of the blame.
Why are banks the enablers?
... The Internet boom couldn't have happened without the investment bankers, and that's because they are the ones that put it all together. They are the ones that took an idea, hyped it, put the glitz, put the credibility on top of it, then created the market and the distribution and the publicity so that it could take off.
To get the rest of us hooked in?
Yes, and the real insidious problem was that everybody was feeling like a schmuck, because in their cocktail party circuit, everybody else's tech portfolio had been rocketing up more than someone else's had. So everybody had tech envy. People that shouldn't have been investing in tech were loading up in tech, because there was so much credibility behind the people that were hyping the story.
... What are the banks supposed to be doing?
Investment bankers can play a very critical role in our economy. Essentially, they raise capital for companies when companies can't borrow money from banks. They enable companies to get the capital, so that they can expand and grow. That function is very important in our society. However, it's also a critical point of responsibility, and that responsibility can be abused. During the bubble, it was totally abused.
What's the point of responsibility? [Are] the investment bankers supposed to put the Good Housekeeping Seal of Approval on debt offerings, on stock offerings?
Well, under regulation, investment bankers are supposed to do the due diligence on a deal to say, "Is this real? Are the facts that are being represented by this company accurate?" Then they're supposed to have some judgment that, "Yes, this company has a future, and will grow and succeed."
So certainly we look to investment bankers to be kind of auditors, to vouch for the credibility of what companies are telling us?
Yes. I mean, they are a due diligence, where they check like an auditor to see if the company is for real. They also are an endorser and a marketer for that company to the investing public. ...
But you think of Wall Street, and you think [that] Wall Street's job is to look at fundamentals -- revenue, costs. You think of them as being fair, and supposed to be fairly tough minded. Yet there seems to have been a romance with the stock price. Is there a dichotomy here between fundamentals and stock price, and did we go from one system to another? What happened in terms of the whole value system?
What the average investor didn't realize was that the Wall Street firms that have the great brands that are advertised on TV every day -- those companies are not working for investors. They're primarily working for companies. Most of the profitability comes from representing companies to investors. So a lot of reason why most investors got taken is they didn't know that these researchers were misrepresenting themselves as representing investor interests, when they were actually representing the company.
You say most investors got taken. How badly did we get taken?
... In the case of telecom companies like WorldCom, the average investor got taken to the cleaners. We did a study. There were 14 companies that, [in] 1996, were worth about $100 billion. Four years later, during the bubble, they were worth about $1.4 trillion. Now they're back under $200 billion. So they went up a trillion, then down a trillion -- in about four years.
And was that phony? Was that real, or was that all puffed air?
We called that the "trillion-dollar fib," because those 14 companies had one investment story that drove their stock up by a thousand-fold -- and that was that data traffic was growing exponentially, when in fact it hadn't been for three or four years.
You call it a trillion-dollar fib. They knew it was phony?
Oh, I think the companies knew that data traffic wasn't growing that fast. But they knew that everybody believed it, and no, it wasn't in their interest to let people know that data traffic was no longer growing that rate.
So you mean they knew it, and they deliberately didn't tell us, because they were making so much money?
In my opinion, WorldCom knew that data traffic was not growing as fast as the conventional wisdom believed. But they weren't about to pop their own bubble. ...
Let me ask you whether or not Wall Street at that point was really interested in the fundamentals. Were they interested in something else?
Well, Wall Street was interested in stock prices going up. It wanted to make money, and how it would make money is by having the stock market go up. So that was its basic interest. It really wasn't interested in disseminating any information that would pop the bubble.
You're a CEO. What's the investment banker to you? I mean, I've heard this phrase that investment bankers will say to the CEO, "I'm your problem solver, I'm the CEO's best friend." If you're a CEO like Bernie Ebbers, what does a Jack Grubman, what does Salomon Smith Barney mean to you?
I think Jack Grubman was to Bernie Ebbers someone who could make it all happen. They were the point person, whose judgment their company and the market would trust. They were the person that could bring a whole series of people and experts to a problem to solve the company's problems and needs.
Who's coming up with the ideas? I mean, if Bernie Ebbers is buying WilTel, if Bernie Ebbers is buying UUNet, is that Bernie Ebbers' idea? Is that WorldCom's idea? Or is Salomon Smith Barney and Jack Grubman coming up with the idea?
Generally, the ideas come from investment bankers. They're the ones out there that are thinking of deals, because they're the ones that will benefit from a deal. So you know to give Bernie Ebbers credit. He had an eye for a deal, and he became a serial acquirer. For a time period there, his stock rose more than any other stock in America over a 10-year period, and he came through an acquisition strategy. ...
Let's go back in time to the late 1980s, early 1990s. What's the atmosphere in telecom? What's the climate, what's the competitive environment?
Back in the early 1980s, it was after the breakup of AT&T, it was a dawn of kind of opportunity and people had to see things that really weren't there. So at first, Bernie Ebbers was a visionary. He saw value where other people didn't.
Meaning?
He realized that, if he could aggregate telecom revenues and telecom customers over a leased cheap network, that he had a business and a growing business.
How does a guy like Bernie Ebbers and his partners who have been in the motel business, Bernie Ebbers, a former high school or college basketball coach, teacher, not a telecom geek, not a technical guy -- how do these guys get into something that looks to the rest of us like a very complicated high-tech industry? How do these guys do it?
I think, to Bernie Ebbers' credit, he saw things clearly. He saw the kind of the simple basic truth underlying all the fancy technology and all the difficult antitrust and regulation issues. What he saw was, "Here is a business that, if I can buy revenues or find revenues and keep my costs lower or cut them, then I've got a very rapidly growing business." So he saw it quite clearly.
But he doesn't do any building. I mean, somebody runs a gas station, you got to build a gas station. Somebody builds a manufacturing plant, you got to build a plant. Somebody runs a telephone company, you got to lay telephone lines. He doesn't go out and lay telephone lines.
Yes, but what we're talking about is a business that wasn't a real marketplace. It was something that was created as an anomaly, because of the breakup of AT&T. ... Bernie Ebbers got into this in the beginning by leasing a network on the cheap, and not having to put down a lot of capital into a network. ...
His idea for a long time is: Don't own any assets. Lease them and resell them.
Bernie Ebbers was a roll-up artist. And what that is, is he realized if he took a fragmented industry and he rolled it up, essentially rolled the revenues into one big pot, he could dramatically lower costs. That's the simple math of Bernie Ebbers. He was a roll-up artist. And the story ended when he tried to roll up one big last company -- Sprint -- and the government said no.
So this roll-up artist strategy, where it required ever and ever-larger mergers, at one point would run into a wall. He hit an antitrust wall with trying to acquire Sprint.
And that was the end of his strategy?
Yes. The beginning of the end for WorldCom was when he couldn't buy Sprint, because how WorldCom kept the story going is, they would have a big acquisition. Then they would do the accounting magic, where they would increase their reserves and write things off, so that they hid what was going on. Then they'd move on, and operate until they had the next merger.
So what happened is, when the Sprint merger was denied, the beast couldn't get fed again. They didn't have another opportunity to cook the books, and that's when they were discovered.
So what you're saying is, even before there was this issue of fraud in the late 1990s, there was kind of bookkeeping gimmickry to make things look good for Wall Street?
Once you have acquired a few companies, it becomes increasingly difficult to do the accounting to backtrack where the real value is. So whenever you're a roll-up artist -- essentially acquiring companies, a serial acquirer -- it gives a company enormous latitude to account for the revenue and the costs in whatever way it wants. Essentially, it's an investment banker's dream, an accountant's dream -- to create value. It's also a fraud person's dream -- to hide what's really going on.
Can we separate that? I mean, we don't know how far back the fraud went. I'm just trying to establish that, even before there was a question of fraud, the simple process of mergers and acquisitions provided enough flexibility in the bookkeeping so that Bernie Ebbers and Scott Sullivan could make Wall Street think things were just swimming.
Yes. I mean, you have to realize that when you do many acquisitions after one another, there is enormous latitude that the financial people have in recording costs and revenues in certain time periods, and to create reserves, so that you can bank on money that you can feed to earnings in order to keep the growth going. It gives you enormous latitude to cook the books or represent your company as a fast grower, when it may not be, because there is no real easy way to audit it and track it.
But can't guys on Wall Street, can't stock analysts spot it when somebody is playing games with reserves?
What you have to realize is that, after a while WorldCom became the fastest-growing stock in the entire country over a 10-year period. So people said, "Why question a good thing? I mean, this person made an enormous amount of money for investors. Why are you questioning it?"
Don't rain on the parade?
Exactly. Well, actually, I don't know if it's don't rain on the parade. It's: Why question a winner? Winners deserve slack. So that was part of their downfall, in the sense that, because they were so successful, people believed them and trusted them. It's a little bit like Enron. This is that success gives credibility, which implies trust.
You keep coming back to this notion that the WorldCom stock was the fastest-rising stock in a decade. But does that mean that Wall Street was really much more concerned with how the stock price was going than whether or not the company was really performing well?
If you really want to understand the bubble and the cult of Wall Street, stock price was everything. If the stock price went up, and if it went up fast, you were a genius. So Bernie Ebbers was a genius's genius, because for over a 10-year period, his stock was a rocket.
And so they didn't care about the fundamentals of his company so much?
No. It came to the point his success was so long-standing and so spectacular, that Wall Street and the institutional investors gave him wide latitude and cut him a whole lot of slack. If you held WorldCom stock, you could have had a very high multiple, and you had a lot riding on it continuing to succeed. So there weren't many people who were willing to question it. They didn't have an incentive to.
If you were an investment house mutual fund, pension fund, even if you had your doubts, you rode with it, because you were making money?
Absolutely. If you were an institutional investor and you had your doubts about WorldCom, you had a real tough choice. You'd say, "I don't believe it," and so you step [off] the rocket; and the rocket continues on, and all your peers outperform you. Or you ride along with the rocket with everybody else, and if it goes down, everybody goes down with it. That was the psychology.
In this period of Bernie Ebbers' heyday, did you ever see Ebbers up close? Did you ever see him in a conference? Would you have any personal impressions of Ebbers or any stories about him that kind of capture how he came across?
I was on a panel with Bernie Ebbers, I think it was maybe back around 1995, before he really became the wunderkind that he was before. And I was kind of surprised. He was a kind of very simple basic kind of straight-shooting guy, who wasn't anything like you would think a normal CEO would be.
Then what happened?
In 1996, he bought MFS. He bough the first local upstart, and that's really when kind of WorldCom got put on the map. With the Telecom Act passing, he was the one that moved first, grabbed big, got the headlines and really become kind of a leader. Everybody thought, "Hey, this is the guy that's figured out, not only the Telecom Act competitive advantage, but also figured out the Internet. ...
What was the impact of [the Telecom Act]? I mean, what did [it] do for a guy like Bernie Ebbers? What did he actually do? Did it give him freedom? Did it attract money? Did it throw open the marketplace? He himself has talked about the Telecom Act of 1996 as a very important source of his success. What was it about the act? Was it the economics? Was it psychology? Was it finance? What was it about the act that had so much importance?
The Telecom Act created opportunity, where there was a 60-year old monopoly that was thrown open for competition. The Congress decided they wanted to experiment and say, "Could competition work after a 60-year monopoly?
On the local phone?
On a monopoly for local phone service. Bernie Ebbers saw that opportunity, and he went for it faster and with more zeal than anybody else. So the Telecom Act was enormous opportunity, for both Bernie Ebbers and investment banking. Why opportunity for investment bankers? It was the opportunity to sell a lot of stock, because telecom companies must raise a lot of capital in order to pay for their infrastructure.
As I recall, Bernie Ebbers and WorldCom paid about $15 billion for MFS and UUNet. Money comes from the bankers, Salomon's the lead. How important is Jack Grubman? How important is Salomon in Bernie Ebbers taking off right after the Telecom Act of 1996?
Jack Grubman and Salomon Smith Barney were essential enablers for WorldCom to take off. It took a rising stock price. It took some very good investment banking, and some very good salesmanship, in order to sell the marketplace. ...
Talk a little bit about Grubman's role. One of the things that he did was to host these annual telecom meetings. People have called them the "telecom mafia," the telecom bashes at Palm Springs and resorts in California. Talk about that a little bit, about Jack. Was Jack a rainmaker? Is he a dealmaker? Is he the emcee? What's Jack Grubman's role?
Jack Grubman really redefined being an analyst and being an investment banker. He could attract more heavyweight CEOs to one gathering than anybody else. He had a rolodex and a network that was the envy of every other analyst on Wall Street. He was one of a kind.
Somebody called him the Pied Piper of telecom. Does that fit?
I think he was the Pied Piper of a post-Telecom Act, Internet telecom sector, yes. He understood the magic that was necessary because of the Internet and because of the Telecom Act.
You're an analyst, right?
Right.
You call yourself an analyst. Jack Grubman calls himself an analyst. What's the difference between your kind of analysis and Jack Grubman's kind of analysis?
We analyze and try to predict what will actually happen, what the truth is. I think an investment banking analyst doesn't care so much about the truth as long as the stock goes up.
But is he a dealmaker? Is he just a storyteller?
Jack Grubman was more than a storyteller, more than an analyst. He was a one-of-a-kind investment banking analyst, who had a command of an investor audience, a command of a company, CEOs that wanted to work with him, and a command of the press. He was an extraordinary person at an extraordinary point in time.
How extraordinary was it that he went to the meetings of the WorldCom board of directors?
It's highly extraordinary for an analyst to go to a board meeting, let alone more than one. It's conceivable that an analyst would go to discuss one specific deal. But to be invited back showed a level of closeness that was the envy of most every other analyst.
To what extent do you have a sense that Bernie Ebbers and Jack Grubman had a special relationship beyond what most analysts have with CEOs?
I think Jack would let clients know how close they were, how they talked, that he was invited to Bernie Ebbers' wedding. I mean, it was made very clear to institutional investors how close Jack Grubman was to Bernie Ebbers. ...
Was MCI a sensible company for Bernie to buy?
... When WorldCom bought MCI, it was the goldfish swallowing the whale. I mean, WorldCom was nowhere near the size of MCI. It surprised everybody that they had the audaciousness to try and they pulled it off.
Did it work?
No. The deal closed, and the stock rocketed for another couple of years, even though as we now know it was all fraud. And if we'd have connected the dots -- I mean, MCI was in trouble. That's the reason why they needed to be acquired. What happened was WorldCom bought them, and led everybody to believe that, through this management magic of lowering costs and integrating these networks, that they were able to post huge profit gains. And poor companies like AT&T were trying to match fraudulent performance measures. ...
Nobody suspected that this was the world's biggest fraud. Everybody had a suspicion that it didn't add up within the industry. But nobody was able to pull it all together and discover that it was fraud.
... Even without finding the fraud, what does this say about Wall Street and what it was doing? What does this say about the investment community? What did we learn from it?
Well, I think the simple thing that we learned about WorldCom is: If it looks too good to be true, it is too good to be true. Now what do we learn about Wall Street? We learned that they don't work for us, the investor. They work for the company, and it should be "investor beware."
Investor beware. What's the difference between what the investors on the outside know and what people on the inside know? I mean, you can tell investors to beware until you're blue in the face. But if they don't have any idea how the game is played, how can they beware? Aren't there two different realities here? ...
Generally, the average investor comes in after it's all over. Essentially, the last ride of a bubble or the last ride on a stock comes from the investor who wanted to believe that they've seen a long trajectory, it's going up and it'll continue to go up. So the advice is that the average investor should be most likely using a professional investor to manage their money or their retirement money, because the average investor, even with full disclosure, isn't going to have as good a sense of what's really going on as professionals.
And in this case, with WorldCom, the professionals were largely hoodwinked.
... How much is Wall Street actually a partner to all of that, in terms of partners, in terms of helping to finance the strategy, going and finding the deals, putting people together? Does Wall Street really want to find that there's something wrong with Bernie Ebbers' WorldCom books?
No. I mean there is really no incentive for Wall Street to burst its own bubble. WorldCom was a gravy train for almost everybody. It was a gravy train for the investment bankers. It was a gravy train for the stockbrokers that were advising it. It was a gravy train for investors who owned it and benefited from its skyrocketing stock price. ...
Gravy train for everyone, but particularly gravy train for Citigroup. What do they get out of it? What happens? As a matter of fact, maybe I ought to ask you what difference did it make that Glass-Steagall was repealed, and you could put these megabanks together?
The repeal of Glass-Steagall was a big deal. It enabled kind of colossal combinations that just weren't envisioned before, where you brought the savvy of an investment banking house like Salomon Smith Barney together with a Citibank. Citibank could loan an enormous amount of money. So when you put those two things together, it's kind of an unbeatable combination. Saying you can investment bank them and commercial bank them at the same time, it's a very powerful combination.
So Sandy Weill and his team can market across the board to Bernie Ebbers. "You don't need to go anywhere else, Bernie."
It's a one-stop shop strategy. It's very powerful.
How much is that responsible for the kind of collapse that we've got? How much is that responsible for kind of the investment fever, and this get on the team, get on the bandwagon feeling that you've got in the late 1990s?
The repeal of Glass-Steagall was an important contributor to the bubble.
In what way?
Well, it added to the frenzy. It added to the investment banking fervor. It added to the amount of money that was staked on this. Essentially, you had a bigger shoulder pushing that rock up the hill.
Again, back to this question: Who's pushing who? Is Bernie Ebbers constantly pushing the investment banks? Or are the investment banks sitting there, Citibank and its team, Jack Grubman and company, whispering in Bernie's ear? "You can take MCI, you can take Sprint. Go for the next one."
I think it is a combination of Bernie Ebbers and the investment bankers coming together. I think they had a constant dialogue about what the next deal was, because after they had acquired 50, 55 companies, it was very clear that they were serial acquirers and they were looking for the next feeding. That was the modus operandi.
So [when] we see Grubman and Ebbers, we're really seeing a symbiotic relationship?
Well, I think when you put Bernie Ebbers together with Jack Grubman, it is one of the greatest symbiotic investment banking-company relationships the world has ever seen.
Both riding each other's star.
You know, separate, they wouldn't have been what they were together.
Collapsing together. Is there anything more about Glass-Steagall? One of the things that's interesting is that Glass-Steagall gets repealed by Congress, at the end of 1999. The death knell of Glass-Steagall is really the Citibank-Travelers merger, which comes in 1998, through an exception granted by the Federal Reserve Board. If you look back at this, do you see that you understand what Sandy Weill was up to when he was pushing for this merger, and that he was changing the whole landscape of banking?
... No, at the time I don't think people connected the dots. But in hindsight, the repeal of Glass-Steagall was an accelerator for the telecom bubble, because remember, telecom companies need to raise an enormous amount of capital, both through equity and through debt. And these Glass-Steagall-enabled companies were able to provide whatever capital a telecom company could ever hope to raise. ...
WorldCom floats a $12 billion bond issue to the investment public in May 2001. Jack Grubman is saying it's still a great buy, keep going, and Citigroup is behind it. Talk about due diligence. How could a bank like Citigroup go to the investing public and say, "Buy $12 billion worth of WorldCom bonds in May 2001" when they have been declining for 15 or 16 months?
The reason is Citibank was up to here with WorldCom. It was so dependent on WorldCom. It was its number one client on multiple fronts, and so it had an enormous amount riding on WorldCom's continued success. So I can imagine there were enormous internal pressures for them to do a deal, and whatever deal WorldCom wanted done. ...
What do you make of the settlement that Eliot Spitzer and the regulators have made with the Wall Street banks? Is that settlement going to fix the problem for us ordinary investors?
Well, let's put the global settlement on Wall Street research in perspective. One of the reasons the bubble occurred is, for 10 years, the government didn't enforce the law, allowed a lot of misrepresentation and didn't do the appropriate oversight. Now I applaud the government for coming in and now reaching a global settlement, and they're making a serious effort. But whether it's going to work will depend on the next 10 years of whether they diligently oversee it, and make sure that it occurs, because there were great rules on the books the last 10 years, but nobody enforced them. ...
We've had good rules for a long time. The only thing that's going to make the situation get better is if those rules are enforced and they have bite.
What does that mean? Somebody's got to go to jail?
If there is misrepresentation and fraud, people should go to jail.
But just company people, [or] are you talking about Wall Street people, as well? Obviously, nothing happens without proof. You can say that, but there is a sense that, if there's a fraud in the company, somebody may go to jail. There is not a sense that on Wall Street anybody is going to go to jail. There is a different liability if you are Scott Sullivan than if you are Jack Grubman.
Yes, and that is because this is a regulated system, where the regulators did not make sure that the rules were followed. So there's a little bit of regulatory cover for people who commit misrepresentation and fraud. There is a kind of a dual standard for people on Wall Street and for people in companies. You know that rules against fraud in a company are more severe than necessarily within Wall Street.
Are regulators like Eliot Spitzer pulling their punches? Should they be hitting harder?
Wall Street is a very powerful entity, and I think they deserve a lot of credit for taking Wall Street on. But the proof will be: Are they diligent overseers in the years ahead? Because the only way this market is not going to return to where it was is if it's constantly overseen, with a fear that it might return to where it was.
What's going to put the fear in them?
The real concern many of us have is, when the market comes back and the economy comes back, memories will be short. So that's the time when the government needs to make sure that people are not misrepresenting companies and also looking for fraud.
We've heard for years about the Chinese wall that keeps analysts out of investment banks. We have lived through a period where that wall was obviously very porous, if it existed at all. Can there be a real separation between analysts and investment banking? Can investors can trust [analysts'] being honest, unless you totally separate the source of income for analysts from investment banking.
The Chinese wall was a joke. It turned out to be a Chinese shower curtain. That is because you have people that are literally in the same room, or one or two walls apart who are trying to keep things separate, when the financial incentive is to bring them together.
So there is a question whether or not investment banking or research can be done in the same house. I think as long as everybody is well aware of who the investment banking analysts are working for -- that they're working for the company and not the investor -- then it's the investor beware.
The problem in this instance was is it the investment banking analyst was able to convince the investor that they were working for them, and not the company. That was the real fraud.
So now we all know we're all OK?
No. I think there needs to be an ongoing effort to educate investors about who Wall Street really works for, because there's all sorts of entities that they can go to, to get straight advice that are aligned with investor interests. ...
Some people have called the late 1980s, early 1990s period in telecom like the western land rush -- that suddenly there was an opportunity with the ruling against AT&T and the breakup of the Bells for new folks to come and stake out claims. Does that image work for you? Is that how you see what was going on in the late 1980s and early 1990s?
What was going on in the 1990s with telecom was like a combination of the Oklahoma land rush with the Alaskan gold rush. It was bigger than just about anything we've ever seen before.
So much money to be made.
We're talking you know billions, tens of billions, hundreds of billions of dollars that were being made.
In the Wall Street banks, they're banking on this. I mean, the banks themselves are making enormous sums. What's the investment banks' role in the whole telecom bubble?
They were really the glue that brought it all together. They were the enablers. If you didn't have Wall Street, you wouldn't have had a bubble, because you wouldn't have been able to bring together all the pieces necessary -- the hype, the analysis, the credibility, the distribution system, the smarts -- it wouldn't have happened.
And the money? Big, big money?
And the money. Big money. ...
If you were a banker like Sandy Weill, you brought together the megabank, you put together investment banking and commercial banking, what does a client like Bernie Ebbers and WorldCom look like to you?
If you're Citicorp, you see WorldCom as a meal ticket. It is the perfect quintessential client. They have tons of investment banking needs and tons of debt needs. You can't find a better client than a telecom serial acquirer.
Needs hundreds of millions of dollars in fees?
It needs hundreds of millions of fees. It needs hundreds of millions of dollars' worth of financing. I mean, it's a financier's meal ticket.
What are the lessons of the telecom bubble?
I think there's multiple lessons. For investors, the lesson is, if it looks too good to be true, it is too good to be true; for the government, a lesson of hubris, of trying to turn a monopoly into a competitive marketplace overnight; and for technologists -- usually with the Internet -- while the technology might have been extraordinary, change takes time.
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