3 colossal collapses and what you can learn from them

David Guy

Leithner & Company Ltd

There is a well-known proverb (perhaps well known to everyone except George W. Bush):

Fool me once, shame on you, fool me twice, shame on me.

Which I have taken to mean that we should learn from our mistakes. And this is especially true in financial markets – where we will all keep making mistakes! I want to focus on those special scenarios where blow-ups should have been avoidable.

Let’s start with one that is close to home; Bond Corporation. Readers of a certain vintage will already know the background: family emigrate from England to Perth, their boy with a gift of the gab (Alan Bond) ventures from signwriting to property development to brewing to television - always funded by enormous levels of debt. That Alan Bond achieved an enormous amount in his life almost goes without saying (first non-American to win the America’s Cup, being voted Australian of the Year in 1978 after having only been an Australian citizen for 3 years 8 months, developer of Chifley Tower in Sydney and South 32 Tower in Perth, world’s fifth largest brewer amongst many others.) On the other hand, he went to jail for four years for taking $1.2 Billion from Bell Resources, had his honour as an Officer of the Order of Australia stripped from him and changed the brewing of XXXX from Milton to Perth. So, let’s call it a chequered history.

But all of this was known by pretty much everyone! Bondy always sailed close to the wind (I had to add at least one sailing metaphor), regularly running into financial difficulties but still people were prepared to back him. Fortunately perhaps, his penchant for debt and desire to retain control of Bond Corp meant that banks rather than Mum’s and Dad’s funded most of his adventures and hence lost the most when he eventually imploded.

My favourite tale? As referenced in Trevor Sykes’ brilliant book “The Bold Riders”:

“One of the best stories is told by Barry and concerns the days when Bond was stuck with Yanchep (a development north of Perth). Even Australia’s best salesman never managed to persuade enough buyers to invest in building blocks on this scruffy bunch of sandhills. One day Bond drove John Bertrand, the helmsman who won the America’s Cup, to the putative resort. As they approached, Bertrand was amazed to see that the barren coast had suddenly turned green. “Christ!”, Bertrand exclaimed. “Have you put in irrigation?” “No”, replied Bond. “I’ve painted the sandhills to make the brochures look better”.

Lesson 1: Feel free to share a beer with a natural salesman, be much more careful investing with them.

Moving on from Bondy, let’s have a look at Enron Corporation Inc. This was basically a pipeline company formed from the merger of Northern Natural Gas Company and Houston Natural Gas into InterNorth. The mergers’ midwives decided that the name “InterNorth” wasn’t exciting enough, so they went for a “corporate rebranding.” Initially deciding on the name “Enteron” (until they found out that this meant “digestive tract”), they finally settled on “Enron.” In view of the crap that would be spun by this company over the subsequent years, the initial name would have been more appropriate!

Running a gas pipeline should be a boring job; it’s all about incremental operating improvements and managing the capital structure and stakeholder relationships (in particular, regulators). Important, indeed essential, but reasonably boring. So how did Enron get voted “America’s Most Innovative Company” six years in a row by Fortune magazine?

Well, Warren Buffett has said that there are three traits you should look for in people, integrity, intelligence and energy – but that without the first one the last two will kill you. The senior management of Enron were intelligent. Founding CEO and Chairman Ken Lay had a PhD in economics, subsequent CEO Jeff Skilling had a Harvard MBA, was a Baker Scholar and one of the youngest ever McKinsey & Co partners. They also had heaps of energy but must have been absent when integrity was being handed out.

Perhaps the best example is Enron Energy Services: this was created to trade energy markets (the idea presumably being that they had better knowledge of supply/demand, etc.) and it subsequently did do some of that stuff. But when it started things were a little slow. When Wall Street analysts had their yearly onsite visit to Enron, the senior management arranged for a fake trading floor to be created so that it looked busy; complete with fake traders taking fake phone calls from fake clients.

Lesson 2: When a company in a boring industry heavily promotes its innovative or forward-thinking ideas, investors should be very careful.

Finally, there is a saying that is particularly relevant at liquidity-driven market peaks like we have now: a fool and his money are soon invited everywhere.

Like the “crane index” that measures peaks in construction activity in CBDs there should be an index for garbage IPOs (or perhaps garbage ICOs …). Until recently “peak garbage” in my humble opinion was reached during the South Sea Bubble in 1720. I will hand over to Charles Mackay from his Extraordinary Popular Delusions and the Madness of Crowds:

“The most absurd and preposterous of all, and which showed, more completely than any other, the utter madness of the people, was one started by an unknown adventurer, entitled “A company for carrying on an undertaking of great advantage, but nobody to know what it is.” Were it not the fact stated by scores of credible witnesses, it would be impossible to believe that any person could have been duped by such a project. The man of genius who essayed this bold and successful inroad upon public credulity, merely stated in his prospectus that the required capital was half a million, in five thousand shares of (£100) each, deposit (£2) per share. Each subscriber, paying his deposit, would be entitled to (£100) per annum per share. How this immense profit was to be obtained, he did not condescend to inform them at that time, but promised, that in a month full particulars would be duly announced, and a call made for the remaining (£98) of the subscription. Next morning, at nine o’clock, this great man opened an office in Cornhill. Crowds of people beset his door, and when he shut up at three o’clock, he found that no less than one thousand shares had been subscribed for, and the deposits paid. He was thus, in five hours, the winner of (£2,000). He was philosopher enough to be contented with his venture and set off the same evening for the Continent. He was never heard of again.”

And I would have hoped that we have learned at least something in the last 300 years – but have we?

When I see garbage NFT’s selling for astronomical amounts and joke cyptos providing 10’s of thousands of percent “returns” I know that we are close to peak madness but, alas, it is impossible to know exactly when it will end. That it will end is not in doubt though and I suspect when a future history book is written I will have a new example of “peak garbage.”

“There are 1011 stars in the galaxy. That used to be a huge number. But it’s only a 100 billion. It’s less than the national deficit! We used to call them astronomical numbers. Now we should call them economical numbers.” – the late, great Richard Feynman

Lesson 3: When markets are driven by excess liquidity, lots of garbage will present itself for investment; it is essential to keep your head at these times lest you lose your shirt later.

Final note: It is as close to a “law” as there is in economics – when the cost of production of an “asset” approaches zero and the potential supply of that asset is infinite then the value of that asset will also approach zero. That the price of some such assets is currently relatively astronomical says more about the gullibility of the purchasers than the value of the asset.

Wealth creators. Value investors.

At Leithner & Co, we believe in creating wealth through long-term consistent growth, built on trust and transparency. Our value investing approach allows us to learn from the past but keep an eye firmly on the future.

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David Guy
Joint Managing Director
Leithner & Company Ltd

David has both a Bachelor of Laws and a Masters of Applied Finance. He is also a Solicitor of the Supreme Court of Queensland. David’s career started in law in 1994 before devoting his focus to financial services from 1996. Since then, his career...

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