The Great Wall Street Flood : Investing: As bank savers get fed up with meager yields, an unprecedented flow of capital into stocks and bonds is helping build young companies nationwide

By TOM PETRUNO

Oct. 3, 1993 12 AM PT

TIMES STAFF WRITER

Within a few weeks, Atlanta will get its first taste of Evelyn Overton’s cheesecakes. And if residents like what they find on their plates, their thanks should go partly to a few million disgruntled savers.

One year ago, Calabasas-based Cheesecake Factory Inc. sold stock to the public for the first time, raising $21.9 million. With that cash in hand, the 15-year-old, family-run restaurant chain launched a nationwide expansion that this month will take the Overtons’ cheesecakes and other fare into the Deep South.

Like hundreds of other young companies, Cheesecake tapped into an unprecedented wave of capital that has flowed into stock and bond markets since 1990.

Much of that money has come from average Americans fed up with miserly 3% yields on bank accounts. Yanking their savings from the safe embrace of federal deposit insurance, many people have turned to stock and bond mutual funds in search of higher returns.

Though that asset shift by now is well known, its full impact--on the economy, and on investors themselves--won’t be completely understood for years.

By the numbers alone, the change has been historic. Since 1990, the sum of small savings certificates in the nation’s banks and thrifts has dropped by nearly one-third, or $361 billion, to $811 billion now.

Many of those dollars--along with cash from myriad other sources--has wound up in one or more of 4,000 stock and bond mutual funds. They have sucked in an astounding $467 billion in new investment since 1990, driving total fund assets to a record $1.9 trillion.

As fund managers have channeled this river of cash into financial markets, they have pumped up stock prices and driven bond yields to 20-year lows. And in the process, the funds’ voracious demand for securities has given young businesses like Cheesecake a first chance to raise public money.

One result is that a fresh crop of small-company millionaires has sprouted overnight. More important, Wall Street’s financing party has funded thousands of new jobs, paid off high-cost corporate debt and in general helped keep the wobbly economy moving ahead.

But there also is a dark side to this capital boom. The frenzy for stocks and bonds raises fears that the bull market is near a peak. And if that is so, history suggests that a frighteningly high proportion of the new securities that today seem so promising to investors will end up crashing and burning.

For now, however, bank savings yields remain at 30-year lows, the stock market is near all-time highs and the public’s willingness to take a chance on stocks and bonds has guaranteed that 1993 will shatter business financing records:

* The dollars raised this year in initial public stock offerings--many by young firms--totaled $26.7 billion through Sept. 24, already surpassing the full-year record of $24 billion set last year, according to Securities Data Co.

* Secondary stock issues--that is, additional shares sold by established, already public companies--have raised $29.9 billion year-to-date, well on pace to break last year’s record $32.6 billion.

* Bond issues floated by U.S. companies have raised $221.8 billion this year, as much as was raised in all of 1992. That figure counts only standard corporate debt; many billions more were raised in specialty financings.

To a degree, of course, this is all part of a natural cycle in the economy. It’s what is supposed to happen during the down leg of the perpetual seesaw of interest rates: As the cost of money drops in a recession, it becomes easier for business to borrow or issue stock, setting the stage for new growth.

Even so, Wall Street veterans say they have been shocked by the magnitude of the numbers in this corporate capital boom. “We’ve never had three years in a row like this,” said Dan Case, investment banker at Hambrecht & Quist in San Francisco. “The key to me is the sustainability of this thing.”

Indeed, a major difference in this economic recovery is the degree to which individuals, by fleeing low-yielding savings accounts for capital markets, have substituted for the role of commercial banks.

Rather than rely on bankers to make loans to business, individuals have effectively become financiers themselves, by shifting cash from banks to mutual funds. And by making specific fund investments (in funds that buy small-company stocks, or blue-chip stocks, or technology stocks, etc.), small investors essentially have been able to choose the sectors of business they wish to finance.

Corporate America, meanwhile, is only too happy to compete to fill this new demand for securities.

“Companies are just responding to the market,” said Merton Miller, Nobel Prize-winning economist at the University of Chicago. “The public wants to hold more equity, and so companies are supplying it.”

The migration of money from 3% bank accounts to stock and bond markets may also be viewed in a bigger societal context, said Jay Ritter, professor of finance at the University of Illinois at Champaign-Urbana. “This is a means by which society takes money out of lower-valued uses and moves it into higher-valued uses,” he said.

What constitutes “higher value” today, from investors’ point of view, is a diverse list:

* In Las Vegas, $422 million raised through stock sales is helping to build the world’s largest hotel/casino, the MGM Grand. It will create 8,000 jobs in Vegas.

* In Moline, Ill., farm machinery giant Deere last month raised $465 million by selling 7 million shares of stock to the public, adding to its 76 million shares outstanding. Wall Street expects Deere to pay down debt and boost capital spending with the funds, improving its edge over foreign competitors.

* In Carlsbad, two makers of wildly popular oversized golf clubs--Callaway Golf and Cobra Golf--have created a market where none existed five years ago. Between them, they now employ more than 800. Their growth has been financed in part by stock offerings totaling $53 million.

* In Fountain Valley, health maintenance organization FHP International recently raised $100 million via 10-year notes yielding 7% annually. Part of the proceeds will be used to expand FHP’s program of “24-hour managed care,” which combines HMO coverage with workers’ compensation.

In each of these cases, capital has or will be put to work in something tangible and new. Yet it’s also true that a hefty portion of the money raised on Wall Street in recent years has gone for another purpose: to enrich a relative few individuals or corporate parents.

Two of this year’s biggest new stock offerings, for example, were Allstate Corp. and Dean Witter Discover, the crown jewels of the Sears, Roebuck & Co. empire. By allowing the stock-hungry public to buy stakes in those companies as separate entities, Sears collected more than $3 billion for itself--which it badly needed to cut debt and rebuild its retail franchise.

But the spinoff proceeds allowed Sears to invest in a business that Wall Street, if left to decide, might have balked at financing.

Similarly, stock offerings by smaller firms routinely turn entrepreneurs into instant millionaires by liquefying assets they have worked their entire lives to amass. Whether that sudden wealth is then put to newly productive uses, however, cannot be measured.

Much more troubling is the long-term record of new stock offerings. While they unquestionably create jobs and real wealth in the economy, the payoff to the investors who own them can be dismal.

The University of Illinois’ Ritter studied the overall performance of initial public offerings sold in 1983 and 1986, the two great boom years prior to the current period. The results are hardly encouraging.

An investor who bought all of the 665 new issues of 1983 at their closing prices on the first day of trading and held them for five years would have earned a mere 3.8% in total, Ritter said. By contrast, the return on established stocks in that period was 67%.

Likewise, the entire crop of 1986 new issues, if held five years, yielded a dismal 9.3% return.

What those numbers suggest, obviously, is that the typical new issue turns out to be a horrible investment in the long run. The broader inference is that, in general, investors clamoring for stocks today are making a huge mistake.

But some experts warn that the latter conclusion is far too simplistic, because it fails to account for how real people invest. No one buys every new issue. And most investors are buying stocks through diversified mutual funds, which mix new issues with shares of established companies, thus lowering the overall portfolio risk.

Moreover, advising people not to invest in stocks today is asking them to ignore two basic facts: In the very long term, stocks perform better than any other investment; and as long as interest rates stay low, there are few decent alternatives for savings today.

“Many of these (new stock issues) will fail,” acknowledges the University of Chicago’s Miller. “That’s the way the game is. You don’t expect to win on every card.”

But to say that investors are fools to invest in new companies, Miller said, is “too puritanical a view,” especially for a generation of Americans that has learned that no investment is truly safe anyway--not a home in the suburbs, for example, or a savings certificate at a badly managed S&L.;

Charles Plosser, professor of economics at the University of Rochester, agrees that the current capital explosion inevitably will produce many losing investments. Yet he, too, rejects the idea that this mass shift of assets somehow constitutes a grand mistake.

Investment, Plosser points out, is imperative if the economy is to grow. And by definition, not every investment can pay off. “You’ve got to have turnover of capital--that’s what keeps a capitalist economy lively and forward-looking.”

Shifting Capital Drives Stock Boom

Small investors have been helping feed the biggest business financing boom in the history of Wall Street. As individuals have pulled money out of bank CDs in favor of mutual funds and direct investment in securities, American businesses have issued record levels of stocks and bonds.

Money pours out of banks . . .

Small savings certificates, banks and S&Ls; (in billions of dollars)

1993: $811.0*

* Through mid-September

. . . And into mutual funds . . .

Net cash flow into stock and bond mutual funds (in billions of dollars)

1993: $168.7*

* Through August

. . . fueling record offerings of stocks and bonds.

Stock issues by newly public companies (in billions of dollars)

1993: $26.7*

* Through Sept. 24