The Fraud and Greed Around Us Makes Business-by-the-Book Stupid
The other day, it became my function to once again explain to my now-adult sons the value of humility when it comes to “smart” investing. Given my background--honor graduate in economics, a lawyer and the founder of some 13 different corporations--my sons’ unstated question was: “How could you be so stupid?”
The unstated answer: “It’s easy.”
And it’s getting easier every day to be stupid in a corrupt and dishonest world.
How smart do the honest and hard-working defense contractors feel when they learn that their superior product and production capabilities meant nothing in the face of dishonest Pentagon bidding practices? How smart do the safe-product manufacturers feel when they discover that kickbacks will win out over product performance nine times out of ten? How smart can the good conservative bankers feel when they are asked to pick up the tab for their corrupt high-flying brethren? What good did education, experience and ethical standards do any of these people when they tried to conduct business honestly and sensibly?
This essay could be titled “How My Smart Father Got Taken by the Boys in Texas” or, to depersonalize the issue and broaden its scope, perhaps “Why the Federal Savings and Loan Insurance Corp. Is Going Broke.” Looking back, I can see how easy it now is to be “stupid.”
In 1980, after considerable research, a group of us decided to invest in apartments. We chose the sixth-fastest-growing metropolitan area in the United States: College Station, Tex. The hometown of Texas A&M;, it had a fast-growing campus, a rich and expanding economy and low vacancy rates.
We also saw a virtual guarantee of no immediate competition, largely because mortgage interest rates for new buildings were in the 16%-18% range, and we had assumed mortgage rates of only 8%.
We reasoned quite logically, in accordance with recognized economic principles: No one could replace a $5-million set of apartments after 12 years for less than $10 million, and interest at 16%-18% would add about $1.2 million per year to the costs of operating a 350-unit apartment complex. This would require a whopping monthly rent increase of almost 80%. Who would pay $810 per month when rents were averaging $450 per month? The answer, of course, was “no one.” The answer, even in hindsight, turned out to be 100% right. The smart investment, however, turned out to be 100% wrong.
One morning we awoke to find that the apartment supply in College Station and other Texas towns had doubled and quadrupled almost overnight. This development couldn’t be justified on logic. Had the world gone crazy? Nope, just a little more sleazy.
How could we have predicted that some builders would take control of some S&Ls; and make ridiculous loans, rake in the huge construction profits and then leave the S&Ls; with the vacant apartments?
Why, we asked, did lenders allow the Austin rental market to go from a steady 1,300 per year of new apartment units, constructed during the boom years, to 43,000 new units in a 2 1/2-year period? Why did they lend 18% money on these unneeded units? Why were all of the legitimate “smart” investors being forced to meet the competition of 99-cent first-month rent?
The standard answers just don’t wash. That’s because the real answers won’t be found in economics.
This was a case of greed and corruption whose victims were the investing public, the honest entrepreneurs and finally, now that the bills are coming due, the savings and loan companies that didn’t take risks and the American taxpayers.
To the list of defense fraud and $500-million planes and $650 coffee pots and insider-trading fraud, we now add savings-and-loan fraud on a scale that staggers the mind. In Texas alone, the costs to the federal insurance fund, now estimated at $15 billion, could reach more than $60 billion, and there’s only $30 billion in the nation’s deposit insurance to cover it.
Con men have always been with us, but when we teach economics to our children, we don’t offer courses called “Beginners Con,” “Advanced Con I and II,” “Institutionalized Con.” Such courses would, of course, totally invalidate the rest of the curriculum. After all, why teach “Product Development” or “Marketing I-A” when “Bribery I-A” eliminates the need to have either a good product or a good sales program?
They say that in Latin America it’s not your product that counts so much as your payoff. Perhaps it’s time we stopped pointing our fingers south and pointed them at our own chest, our executives, our lawmakers and our business managers.
Such unrelieved pessimism tends to have a soporific effect on my sons. Their nodding eyes brought me to a halt. They got up to leave.
“Where are you going?”
“To the beach, Dad, but don’t worry, you already talked us out of going into business.”
“Wait a minute, boys, I’ll go with you.”
I’m not stupid.
