The Casino Economy: Using Other People’s Money to Become a Millionaire

Listener 5 December, 1998.

Keywords: Business & Finance

Use $20,000 to deposit on a $100,000 house, borrowing $80,000 from the bank. Get a friendly valuer to say the house is worth $200,000. Get the bank to lend you another $80,000 against the value of the house (so you have a mortgage of $160,000). With the $80,000 of cash the bank has just given you, buy another four $100,000 houses, borrowing another $80,000 on each house. Get your pet valuer to double the price of the four new houses, so your houses are now worth a $1,000,000. You can borrow an extra $320,000. Repeat.

After the third round of this magic you will own $10.6m of buildings, have debt of $8.48m, and equity of $2.12m. You are a millionaire, and you only started with $20,000! If the reader is a little lost trying to follow the sums, dont worry. Some who worked the system, candidly admit that they lost track of their finances too.

It is not quite that simple. You will have to pay your helpful valuer, various bank fees, interest charges, and so on. But it illustrates how by revaluing assets, and raising debt on the new value, the business can obtain cash for repeating the miracle.

Hire a public relations specialist, who will convince the financial journalists that you are a terribly clever fellow, with a knack for spotting commercial opportunities. The lenders will be impressed and come beating at your door. Do another round. (You will have to diversify into property and shares.)

Now you have $42.6m of assets, $34.08m of debt, and $8.52m of equity. Your picture is on the financial pages. You are asked for advice on things which you know nothing about, like the economy. (Your PR adviser says “praise free enterprise”.)

People clamour to have a share of your wizardry, so reluctantly (of course) you agree to float on the sharemarket a portion of your private company. Suppose you sell off half the shares at a 50 percent premium. (And again for simplicity ignore the costs of PR, merchant bank, share broker, and financial journalists. The journalists get free trips to your meetings, dinner and wine, but usually not cash like the others.)

Immediately after the float you have $6.39m in cash and shares worth $6.39m which retain a controlling interest in your company. The day after the float the share price leaps another 50 percent, The stags who bought the shares, sell them at a tidy profit, and happy share punters find themselves owning shares in a company at more than twice the net (already grossly inflated) value of its assets.

The story keeps going but eventually it comes out your business is a fraud, the share price dives, and the company becomes worthless. The banks foreclose. The assets are still there but their true value is about half of what was in the company books, there is no equity left. Just a lot of debt. Still you have the $6.39m of cash from the float. Invest it wisely.

Grimy details aside, the point is the $6.39m cash return from the original $20,000 comes from other people’s savings. (The banks have made a loss too, which does not affect their depositors, but the shareholders in the banks also take a lost.)

I tell this fable, because I continually meet people who expect to make fabulous returns on their investments, but who never ask what is the underlying process which generates the return. Where does the cash come from? During an asset (property or equity) boom revaluation gives fictitious profits, which only become real when the asset is sold and turned into cash. Now the overvalued asset is owned by some other investor who has given up the cash, but hopes to do the same. It can be like passing a parcel which contains a bomb.

Of course there are some genuinely high returning investments, but they are few in number. The typical investment gives a return of 3 percent above the rate of inflation. By a bit tweaking you might get it a little higher, or avoid paying tax. Promises of easy 20 percent annual returns, say, in the current low inflation climate are – well – problematic. You may be cleverer than the average investor, or luckier. Then again you are more likely to be below average (because the return is skewed). High investment returns are often at the expense of ordinary investors, who find their savings consumed by other investors. Keynes once described the sharemarket as a casino. Casinos randomly redistribute people’s savings, less a margin for the dealer.

The Following Books Fill in the Details
The Ariadne Story: The Rise and Fall of a Business Empire by Bruce Ross.
Bond by Terence Maher.
Crash! Corporate Australia and New Zealand Fight for Their Lives by John McManamy.
The Hawk: Alan Hawkins Tells his Story to Gordon McLauchlan by Alan Hawkins.
Lost Property: The Crash of ’87 … and the Aftershock by Ollie Newland.
Report of a Special Investigation into the Affairs of Ariadne by R.W. Gotterson.
The Rise and Fall of Alan Bond by Paul Barry.
The Rise and Fall of JBL by Reg Birchfield.
Too Good to be True: Inside the Corrupt World of Christopher Skase by Lawrence van der Platt.