by Scott Fearon
Every year I go back to Evanston, Illinois, and give a talk to the students of Northwestern’s Kellogg School of Management, my graduate school alma mater. During a meet-and-greet event there in 2011, I found myself standing next to the new dean of the school and decided it was a perfect opportunity to bring up an idea I’d had on the plane ride out from California. Just a few weeks earlier, Citibank had agreed to pay almost $300 million for knowingly selling its clients toxic subprime mortgage bonds. The year before, Goldman Sachs had paid the largest fine in history, $550 million, for engineering similar deals.
“Why don’t you ban Citi and Goldman from recruiting at Kellogg for three years?” I suggested to the new dean.
She nearly spit up her drink. “Excuse me?” she asked with a nervous smile.
“They blatantly scammed their own clients,” I went on. “They shouldn’t have access to your students.”
After a very awkward moment of silence, the dean patted me on the shoulder and stepped away into the crowd. “Nice talking to you, Scott,” she said as she passed me by.
In retrospect, it was probably unfair of me to put the dean on the spot like that. She’d only taken the job a few months earlier. Even if she had liked my idea, I’m sure she wasn’t anxious to take such a radical step so early in her tenure. But the fact remains that Wall Street essentially owns business education now, and it continues to buy off academics and universities by hiring graduates, awarding professors lucrative consulting jobs, and sponsoring seminars. As if to hammer this point home, when I flew back to the Bay Area the day after chatting with the new dean at Kellogg, the top letter on the stack of mail waiting for me in my office was an invitation to “The First Annual Goldman Sachs Global Education Conference” down at Stanford, my undergraduate alma mater.
They say that the cover-up is often worse than the crime. And the measures our government took in the wake of the crisis have amounted to a giant, ongoing cover-up that may have done more damage to our financial system than the original crimes. We as a society and our government had a chance to live up to our free-market principles; unfortunately, we torched them instead. Rather than sending the banks into receivership and breaking them up, we poured vast amounts of money into them, which has only made them bigger and less accountable than ever. Then by slashing rates and keeping them near zero for years on end, we’ve killed any incentive to save and created a kind of undead corporate culture with hundreds of zombie businesses still limping along that, in a truly free market, would have gone through bankruptcy long ago. This is not how prosperous economies function.
Most unconscionably, in my opinion, the government also rescued the bondholders of failed financial institutions like Washington Mutual (WaMu). These bondholders were not mom-and-pop investors. They were sophisticated institutional investors who knew the risks they were taking in purchasing those debt securities. Incredibly, former Treasury secretary Henry Paulson wrote in his book On the Brink that when WaMu was seized and sold to J. P. Morgan, he wanted to give its bond investors even more taxpayer money—up to one hundred cents on the dollar as opposed to the far lower amounts the bonds had been trading for the day the bank was seized. Paulson claimed he was seeking to allay “uncertainty” in the markets.† I’ve read that paragraph in Paulson’s book over and over again (it’s on page 293 in my copy), and it still astounds me. I don’t think he is a bad person for holding these opinions. I just think he is profoundly wrong. Bailing out politically connected bondholders while millions of struggling homeowners got nothing wasn’t just unfair, it was destructively unfair.
We heard a lot of talk about “moral hazard” during and after the financial crisis. But I don’t think people really understand what that phrase means, or at least how truly dangerous it is. If you prevent failing businesses from restructuring—not just small businesses, but large and important businesses as well—then the managements of those firms lose any incentive to make smart, prudent decisions. They know they can take all the risk they want because they’ll never have to suffer the consequences. That’s bad enough. But moral hazard has had an even more pernicious effect than corrupting the behavior of our business leaders. It has corrupted the very purpose of our financial system.
In a healthy economy, capital markets fuel growth by allocating resources to smart ideas and well-run companies while starving out less-deserving ventures. But by protecting investors in the stocks and especially the bonds of failed companies, we’ve warped that process. Capital increasingly flows to politically favored businesses instead of innovative and well-managed concerns. That’s not a free market; it’s crony capitalism—a surefire way to hamper growth, job creation, and economic vitality.
I know it sounds contradictory, but I believe that if we want to return to a growing and dynamic economy, we have to learn to embrace failure again. We have to let the markets get back to their normal function of elevating good ideas and eliminating bad ones. I’m not saying this book can single-handedly accomplish this or undo the damage that’s been done. But I hope it will help change people’s perceptions of what creates growth and a healthy financial sector. I want to take away the stigma of failure. It’s nothing to be ashamed or afraid of. If anything, we should celebrate the people who are brave enough to risk everything, even if they fall short. They’re part of a long, rich tradition in this country. And our future prosperity depends on carrying on that tradition.
Notes
*“‘Inside Job’ Director Slams Wall Street,” Marketwatch, February 28, 2011.
†Henry Paulson, On the Brink (New York: Business Plus, 2010), 293.
Acknowledgments
Four years ago I gave a talk to a class of graduate students at UC Berkeley’s School of Journalism on unethical behavior in the money management world. After class, I told Lowell Bergman, the course professor, that I wanted to write a book about my investment adventures. A week later, journalism fellow Matt Issacs introduced me to his friend Jesse Powell, who agreed to help me out. And so our book-writing adventure began. Over the ensuing months and then years, Jesse and I met nearly one hundred times and hammered out every word of every sentence. As the work evolved, my father and two friends of mine, Mike Wilkins and Professor Robert Korajczyk of Northwestern’s Kellogg School of Management, read early drafts and gave insightful feedback. Once the book was “in the can,” we started searching for an agent and a publisher. With the help of Mickey Butts, we were lucky to find Elizabeth Kaplan, who directed the book to Palgrave Macmillan. Without Jesse, Elizabeth, and my editor, Emily Carleton, this book would never have been published. I am eternally thankful to all of them.
This book was also made possible by the many friends, analysts, and money managers who have helped me during the last three decades. My own analysts, former and current, set up many of the meetings described herein. Marty Carrade, Jeff Edman, Paul Flather, Brian Freckman, Pat Gaynor, Ben Sandler, and Mike Weil arranged a good number of these interviews. All had helpful insights, which we often debated at watering holes afterward. Other money managers attended meetings as well. These included Carlo Cannell, Fred Clark, Carter Dunlap, Mark Friedman, Dan Mendoza, Georgina Russell, Craig Stephens, and Greg Wettersten in California and Rob Alpert, Blair Baker, John Myers, Reid Walker, Wilson Jaeggli, and Nelson Jaeggli in Texas. Their questions and insights improved my decision-making ability. I am grateful for their help and thankful for their friendship. I also relied on consultants for identifying companies to visit. Wyatt Carr, Scott Cummings, Bill Fellows, Bryan Luter, and Chris Mooney are friends who enjoy interviewing managements almost more than I do. Their help has been invaluable.
The staff at Banyan Securities, where I sublease office space, have always been helpful and fun to talk with through the years. Gary Smith and Dick Banakus helped me set up my hedge fund. They, along with Dan Gressel, were also my first investors. Other investors on day one were Shelly Wolk, Larry Levitt, John Tom
lin, Bob LeDoux, and Andre Robert. Amazingly, all still have money in my fund. I am grateful for the faith they, and all of my investors, have placed in me. Big thank-yous also go to my trader, Wendy Gee, and my administrative assistant, Cathy Pozo. Their tireless work and dependability has made my job and life much easier.
I would also like to thank my family—my parents; my brother Rick; my wife Jennifer; and my kids, Michael, Caroline, and Nicholas—all of whom bring me happiness and make my work easier through their support. While not discussed in this book, my life and life’s focus changed dramatically on March 4, 1994, when my twins, Caroline and Nicholas, were born. Caroline, like her older brother, Michael, is a smart, kind, and confident young adult. But Nicholas has presented us with more than the usual challenges. At four months old, he was diagnosed with cystic fibrosis. By age three, he was diagnosed with moderate to severe autism. In his teens, Nicholas became epileptic. Thankfully, we have been able to stop his grand mal seizures with medication. While barely verbal, Nicholas laughs endlessly and finds happiness in simple activities like eating ice cream, watching Disney videos, and playing in hot tubs. I think I have helped Nicholas be happy and learn life skills. I know I have learned much from him. He has taught me patience, compassion, and the satisfaction that can be found from helping people who at times cannot help themselves. Everyone who works with Nicholas, from his home aides to his doctors at the University of California San Francisco Medical Center, has been amazing. Thank you.
Because of Nicholas, our family has become involved with charities that help the disabled. My wife and I started a school for autistic kids. We have thirty-seven students today, and I have been a board member for over a decade. One hundred percent of all profits I earn from this book will be donated to these charities.
Last, I am thankful I was born in America and grateful for the front-row vantage on its dynamic private sector that I have enjoyed. Despite its faults, this country remains a truly exceptional experiment in human history. Our nation’s companies, big and small, its workforce, and its incredible entrepreneurs have made our economic engine the eighth wonder of the modern world.
Index
The index that appeared in the print version of this title does not match the pages in your e-book. Please use the search function on your e-reading device to search for terms of interest. For your reference, the terms that appear in the print index are listed below.
50-Off Stores, 154–55
401(k) accounts, 203
Ackman, Bill, 107, 149
Advanced Marketing Services (ADMS), 47–49, 51–53, 59, 73
airline industry, 20, 36, 46, 57, 64, 128, 132, 134–35, 138–40, 163
Alex Brown & Sons, 165
alienating customers, 5, 67–68, 174, 182
Amazon, 78–79, 83, 102, 122, 212
America’s Cup, 90–94
American Electronics Association (AEA) Conference, 50–51, 156, 225
Android, 164
Apple, 24, 33, 67, 84, 98, 147, 179–80
area developers, 46
Arthur Anderson, 84
averaging down, 100, 157, 195, 206, 208
Babson, 58
Bally Technologies (BYI), 192–93
Bank of America, 165
Bank of Lichtenstein, 54
bankruptcy
alienating customers and, 149, 182
attempting to avoid, 185, 188–89
BMHC and, 141, 146
Cal Coastal and, 19–20, 23–24
credit and, 178
debt and, 158, 163
energy companies and, 2
excuses and, 152, 154–55
fads and, 72
failure and, 5, 46–47, 91, 112, 114
flexibility and, 170–71
formula and, 128–33
fraud and 151–52
Global Marine and, 11–12
investing and, 3, 19–20, 42, 53, 97, 118–21, 134–37, 202
mergers and, 59
reorganization and, 57
Shaman and, 102–3
shock therapy and, 138–40
short-selling and, 158–59
trends and, 126, 128
TXU and, 17
Bennigan’s, 17
Bensinger, Greg, 123
Bezos, Jeff, 83
Big Short, The (Lewis), 25
Bing, 129
biotech industry, 97
Black Monday, 55, 114, 204
Blair, William, 43
Blockbuster (BBI), 115–24, 131–32, 166, 180, 193, 228
Bogle, John, 206–8, 212
Boise Cascade lumber company, 141, 144
Bolsa Chica Mesa, 20–22, 25, 56
Borders Books, 84
Brightwater community, 20–23, 56, 143
Buffett, Warren, 14, 16–17, 111, 131, 139
Building Materials Holding Corporation (BMHC), 141–49, 151, 157, 162–63
cable television, 118
Cadillac, 68–69
California Coastal Communities, 19–21, 23–24, 32
capitalism, 4, 57, 78, 92, 128, 130, 138–39, 197, 229, 234
Carano, Bandel, 87–89
Carnegie, Andrew, 165
casinos, 188–92
cellular technology, 124–25, 180
Chapman, Robert, 145
Chase Manhattan Bank, 27
Chemical Bank, 27
Chemtrak, 74–77, 81, 100, 228
Circuit City, 120–21
Cisco, 154
Citibank, 7, 187, 232
CML Group, 72
Consilium (CSIM), 152–57, 159, 176
Continental Airlines, 20, 132, 134–38, 140
Cost Plus World Market (CPWM), 172–80, 182–83, 188, 193–94
Costco, 33, 36, 38–42, 47–48, 88, 126–28, 173, 179
coupons, 66–68
creative destruction, 4, 138
Credit Suisse First Boston, 88
Cuban, Mark, 61
CVS, 76
cycles, 10, 13–14, 25, 145, 170, 182, 221
Cygnus Therapeutics (CYGN), 97–101, 104, 119, 172
Daily Beast, 121
Dell, 180
Dendreon (DNDN), 157–58
Dex Media (DXM), 59
Diller, Barry, 121
DiMaggio, Joe, 26–28
dotcoms, 78–80, 84–89, 91–92, 104, 155, 173, 205, 217, 228
Dubai, 12
EBITDA (earnings before interest, taxes, depreciation, and amortization), 56–58, 131
elite infallibility, 29–33
elitism, 31, 148
Ellison, Larry, 93
emotion, 6, 69, 74, 77, 100
energy industry, 2, 8, 12–13, 15–17, 26–27, 94, 132, 199, 201, 213, 223
Energy Future Holdings Company, 16–17
Enron, 5, 15, 29–30, 32, 51, 160
Enron: The Smartest Guys in the Room, 160
Everything’s a Dollar stores, 43, 45
Extraordinary Popular Delusions and the Madness of Crowds (MacKay), 85
Facebook, 94
fads, 5, 18, 58, 69–74
faith, 27–29, 31, 35, 45, 48, 57, 74, 92, 101, 104, 131, 203, 230, 236
falling stocks, 110
Fama, Eugene, 208–9
FDA (Food and Drug Administration), 74, 99, 102–3, 157
Fidelity, 50, 58
First Data Management Company (FDMC), 198, 200–2
First National Bank and Trust Company of Oklahoma City, 198–200
First Team Sports Inc. (FTSP), 70–71
fitness fads, 71–72
flexibi
lity, 56, 170
Ford Motor Company, 153
Fortune Sellers, The (Sherden), 204
frauds, 5, 30–32, 51–52, 58, 151, 181, 205, 207, 212, 222, 231
Fresh Choice (SALD), 95–97
gambling, 188–89, 191–93
Gates, Bill, 61, 160
Garzarelli, Elaine, 204–5
GE, 58
Global Marine (GLM), 8–14, 16–17, 21, 27–28, 35, 132, 171, 228
GlucoWatch, 98–100
Goldman Sachs, 58, 113, 202, 232
Good Guys electronics, 126
Google, 4, 56, 84, 129, 192
Granville, Joe, 204–5
Great Texas Oil Bust, 18, 22, 53, 104, 114, 150
see also oil
Greenspan, Alan, 88, 142
Grocer, Stephen, 17
groceries, 81–83, 120, 161
Groceryworks, 81, 83
groupthink, 41, 109, 206
growth at a reasonable price (GARP) investing, 40–42, 47–49, 51, 56, 73
growth funds, 55, 221
Grubman, Jack, 205
GT Capital, 53–55, 62, 111, 137, 201, 210–11
Hambrecht, Bill, 150
Hambrecht & Quist, 70–71, 150–52, 165, 201
health care, 77, 107
Hemingway, Ernest, 7
Herbalife (HLF), 105–7
Hewlett Packard (HP), 164
Hislop, Mike, 64
Hollywood Video, 120–21, 166
Hoover, Herbert, 197
housing market, 20, 22–23, 25, 85, 141–43, 145, 163, 174, 182, 193
Houston Natural Gas, 15
Hughes, Howard, 8
Hughes, Mark, 106–7
Hughes Tool Report, 26
hypercompetitiveness, 71, 206, 208
Icahn, Carl, 118–23, 134, 139
Idearc (IAR), 56–59, 128, 131
Il Fornaio, 64, 112
“immersive viewing,” 90, 93
initial public offerings (IPOs), 17, 40, 97, 160, 181, 200, 205, 217
insider trading, 54, 151