Maintaining Control & Learning From The Fall Of Enron

Maintaining Control & Learning From The Fall Of Enron

On today’s show, Jason Hartman discusses Commandment #3: Thou Shalt Maintain Control and how maintaining control in real estate and other aspects of our lives matters. He talks about the Enron collapse and ties it deals has been discussed quite a bit before, but its not just real estate where control matters. Jason explores the collapse of Enron and why it was such a surprise and why Commandment #3 is crucial even in those scenarios.

Investor 0:00
To get some other people who might be on the fence out there, it took me a while to buy into the concept of buying out of state. And that’s really one of the things that I really attribute to you guys all the podcast and then just kind of working through that and how the numbers worked and the comfort level of it. But you know, one of the things that I think the best for me is, after talking extensively with him, I think he might have paired me up with, you know, like almost like a match. com like he paired me up with the perfect local market specialist to fit my personality and my investment philosophy. And so I kind of attributed to him, but I’m very happy with the way the transactions go and the way the interactions kind of all fluidly occur with me and a local market specialist and it really has been a pretty seamless process.

Announcer 0:48
Welcome to the creating wealth show with Jason Hartman, you’re about to learn a new slant on investing some exciting techniques and fresh new approaches to the world’s most historically proven asset. That will enable you to create more wealth and freedom than you ever thought possible. Jason is a genuine self made multi millionaire who’s actually been there and done it. He’s a successful investor, lender, developer and entrepreneur who’s owned properties in 11 states had hundreds of tenants and been involved in thousands of real estate transactions. This program will help you follow in Jason’s footsteps on the road to your financial independence day. You really can do it. And now here’s your host, Jason Hartman with the complete solution for real estate investors.

Jason Hartman 1:38
Welcome to Episode 1342 1342. Thanks for joining me today. And I am coming to you from home here in Palm Beach County, Florida and I got to tell you, Florida is just spectacular. Right now it’s absolutely beautiful. I just got back from a beautiful lunch at the breakers hotel. I was there last week and I tell you, I could hang out there a lot. It’s a beautiful place beautiful property. And you know, you can really see why Florida is this destination for people all over the world. As soon as the weather gets nice here in the fall and, you know, up until really late spring, they’re just people from everywhere coming here. It’s really amazing. I haven’t seen anything like it. When I lived in Scottsdale, Arizona, you know, the population would vary when the snowbirds are in town to you know, when they’re not that and that’s a big tourist destination also, but not as much of an international one as Florida is. And it would vary by about 25% of the population would vary quite a bit. I don’t know what that stat is in Florida, but it is pretty significant. For sure. I’m on my way to Phoenix, actually speaking of Scottsdale, which is a suburb of Phoenix. I’m on my way there tomorrow and then on my way to Las Vegas, have a conference and meeting Looking forward to that trip. I haven’t been back to Las Vegas since I moved out of the place just over a year and a half ago. So it’ll be interesting to go back and see my very brief hometown there for for a year and a half. But hey, what does this all have to do with real estate investing? Well, you know, all of these areas, they’re driven by all of these different things, the real estate prices, the real estate, rents, and so forth. And very especially the vacation rental market, the vacation rental market. I think that the Airbnb trend is very interesting. We’ve commented on it many times over the years, many, many times. You know, there are a lot of people pursuing this strategy. And I just want you to temper that strategy. That’s all. I think you should do it. In fact, we offer some great short term rental properties. And you can check those out at Jason Hartman, calm, talk to our investment counselors. They can help you with that. But just remember something I was thinking of this morning and I’ve said it Before and I’m going to say it again and that is Airbnb has yet to go through a recession. Airbnb has yet to go through a recession so there’s a lot of stuff we don’t know that hasn’t been priced into the market yet and when you’re speaking of pricing into the market I’m sure the vast majority of you know what that means. And that is when a certain widget a stock a commodity in economic unit currency dollars yen, Brazilian Rielle whatever it is what the Euro whatever any currency right the peso doesn’t matter, right? Things are priced into the market sometimes, but not always priced into the market. Right. So any marketplace is really the sum of future expectations. So do investors think that the economy will be good year from now? Well, one way to get the pulse of what they are thinking is to look at an indicator of the commodities market, the stock market, the housing market, the employment market, the Consumer Confidence Index, also the PPI, the producer price index. So there are all these different indicators we have, and just one of them can certainly be wrong. Putting many of them together can still be wrong. And this is why nobody can exactly predict I was watching some real estate guru on on YouTube this morning. And he was saying, I don’t know why people think it’s so hard to predict the real estate market. It’s really so easy.

Jason Hartman 5:45
Oh, you young fool. It’s too young for it’s not so easy. He was talking about his successes. Right? And you know, this was a young guy. Okay. He was talking about his successes in in different markets around the free, but he could have easily come into that market too late or sold too soon. So clearly, he was not any pro at predicting the markets. Okay, yeah, you can sort of get the vibe as to the overall of what’s going to happen next. But that’s a lot different between knowing the exact entry and exit time. Okay, so the subject of today’s show, I want to talk to you about a deeper dive into something we have talked about many times. And by the way, if you’re new to the show, and you want to really just dive into the basics, the fundamentals of real estate investing of how to build a great income property portfolio, be sure to check out my quick start Podcast, where we have surgically copied episodes from this podcast and I know if you’re just coming in and you think I don’t have time to go back to listen to 1300 and 41 prior episodes at the moment, I know you’ll get through them. You know, so keep listening. You’ll get through them, believe me, other people have done it other people before you have done it. they’ve listened to every episode twice. Okay? So you can do it. But if you want to get the fundamentals, be sure to listen to my quick start podcast. So whatever podcast platform, you’re listening on iTunes, Stitcher, radio, whatever, just go there and type in Jason Hartman quickstart. And you can get the Quick Start podcast, which will focus on the fundamentals. I know, sometimes we do some fundamental oriented shows. And sometimes we do some more esoteric shows on here because many of you been listening for 10 1314 years, right. And so there’s a lot of ground to cover. But today, this will be sort of fundamental in the sense that I want to talk about commandment number three, which of course says Thou shalt maintain control, but not in the usual way that we’ve talked about it before. I want to take a deep dive into it. And I want to take a deep dive into it by looking at a very infamous, I was going to say famous then I caught myself in infamous, a terrible, awful company. I remember years ago after this company had its absolutely epic fail. It’s tragic fall from grace. I saw a documentary about them a film called Enron, the smartest guys in the room. Now maybe you saw this film too. I saw it in the movie theater and gosh, that must have been a maybe 2002 shortly after it happened. I’m not sure exactly when the film came out. But shortly after the collapse of Enron, I saw this film and I watched a good infographics video on this In fact, it’s entitled The infographics show and I want to play it part of their video because they did a great job of explaining this. Now, thou shalt maintain control. commandment number three. Of course you veteran listeners know what I’m going to say you new people don’t. But why should you follow my commandment number three of my now 21 commandments of successful investing? Well, if you don’t follow commandment number three, if you don’t maintain control of your money, when you invest, you leave yourself susceptible to three major problems. Number one, you might be investing with a crook. That was Enron. That’s the Enron story, okay, and we’re going to dive Take a deep dive into that in a moment. Number two, you might be investing with an idiot, and you’re going to lose your money by their cookery and their criminality or their stupidity, but assuming they’re honest and competent. The third problem you can become the victim of is that if they’re honest and competent, they take a huge management fee off the top for managing the deal. Now when I say the deal, it could be just a real estate deal that you’re going in on through a private placement memorandum, private offering. Or it could be a big deal like a company, where they have an army of investment bankers and an army of brokerage houses, and an army of financial advisors, all recommending their stock. And then they have an army of auditors who are supposed to be doing their job, and an Enron case, who was that firm? Well, my cousin and Jones son used to work for this firm. And this is a very respected firm that had been in business I believe, for over 100 years. And they also had their fall from grace as part of the Enron debacle. In fact, they were famous for using paper shredders, and shredding the evidence. It’s like when the cops knock on the door, and the drug dealer flushes the drugs down the toilet Well, Arthur Andersen, the accounting firm, the very well respected accounting firm that had been in business for like 100 years or something like that. I don’t know, begin look it up. Don’t google it because Google is evil. Okay. Listen, I use Google products all the time. But that doesn’t make them any less evil. They’re not alone. I’m not just picking on Google. Sorry, Googlers. I know we have a lot of you as clients and we appreciate you. But all of these big tech companies abuse their power, Facebook, Amazon, doesn’t matter. Doesn’t matter. It’s the nature of the beast. Look at Hey, was it Voltaire? Who said, here’s the famous quote, I think it was Voltaire. I don’t know. By the way, if you have questions or corrections for anything I say on the show, or comments in general, go to Jason Hartman comm slash ask and tell me but what is the famous quote? It is, power corrupts, and absolute power corrupts absolutely. Power corrupts and absolute power corrupts and Absolutely. Okay. And this is true when anything gets big and powerful, and in the bully pulpit position, whether it be a big tech company, a big company of any kind, or a big government, whatever big leads to that corruption of power, right? And this is certainly true in the case of Enron. Now, let’s listen to some of this and discover how will orchestrated and how interesting, the Enron fraud was, and try to put yourself back in time to before any of this happened. Because one year before the company collapsed, its stock hit an all time high of just about $90. And a year later, it was gone. And this was one of the most renowned companies in the world. You don’t think it can happen to those other companies you might be investing in? Or that that deal. I mean, look, before Bernie Madoff was Discovered or confessed was kind of a blend of the two. He was super well respected. If you ran a background check on Bernie Madoff, you would have found that this guy was like, super respected. He was the president of NASDAQ. He was on ethics committees for I think the New York Stock Exchange or some stock. Maybe it was NASDAQ. I don’t know which one. But you know, this guy was like super renowned. He was like super well respected. MF Global. Remember that fraud? JOHN core design? He was governor of New Jersey, okay. Your resumes don’t get much better than this. Or Kim lei and Jeffrey skilling of Enron the resumes don’t get much better, but eventually the House of Cards it falls to expose the fraud. Okay, let’s listen to a little bit of this. I think you’ll find it to be quite fascinating.

The Fall of Eron 13:54
An American worker named George had his sights set on a comfortable retirement, perhaps some home He’s in the zone, relaxing in the garden with good novels and the gin and tonic by side. And then when the company he worked for the energy giant called Enron Corporation collapsed in front of his eyes, those plans went up in smoke. Years later, he was mowing pastures when he should have been living on his retirement savings, which had mostly been tied up in Enron company stuck. No one ever thought such a behemoth of a company could just go belly up. It was a story that shocked the world, one involving mismanagement, corruption and greed. This is what happened. in its heyday, Enron was one of the largest companies in the USA. At its peak, its shares reached $90 and 75 cents. And when it declared bankruptcy in 2001, they were worth 26 cents few saw.

Jason Hartman 14:43
So that was just about a year in $2,090 in 2001 26 cents, and listen to how reputable this company was. This was like v company right everyone I was so impressed with it. And here we go. So the question is who, in terms of a person? Or who in terms of a company, are you so impressed with now? You know, what entity do you think is so credible, that you would just be loved to own their stock? What person promoting a deal is so credible that their background check would be perfect. And like Bernie Madoff or john designs, or probably Ken Lay and Jeffrey skillings, or any of these fraudsters, right, they’re all golden until they’re discovered, right? Yeah, here we go. Listen to how they did this. It’s truly amazing.

The Fall of Eron 15:46
I’ve coming into this day, the downfall it’s a reminder to all of us that indeed, giants can fall and on top of that, giants aren’t always what they see. The story starts in 1985, when two companies merged They were Texas based Houston natural gas company and Omaha based inter North Incorporated. At the beginning, the new Enron was simply a very big natural gas supplier. But then in 1989, it turned a leaf in its book and began trading natural gas commodities. In 1994. It also began trading electricity. These changes took place under its new CEO Kenneth lay, who had formerly been in the big chair at Houston natural gas at the time and run was said to be one of the most innovative companies in the USA. But at the time of the downfall, The New York Times wrote, Enron is a new economy company of thinking outside the box, paradigm shifting market making company it added to the end of that paragraph. It’s also at this point in time, a bankrupt company as the story.

Jason Hartman 16:44
So notice something remember I’ve said to you over the years, that whenever you hear, usually the Wall Street folks talk about financial innovation. That’s when you better hold on your wallet. Because think about it Enron was just a normal energy company. And then Ken Lay came along, and he decided to financial eyes, turn their energy into an instrument into a financial instrument. That was financial innovation. And then look at what the New York Times was saying about them. Now, before before they went bankrupt, I bet the New York Times was writing glorious things about them. And if you were back then looking for a place to invest your retirement money, boy, you would have thought, hey, The New York Times, you know, that’s a credible newspaper that by the way, just completely admitted after the election of Trump that they were so biased and so disgusting and so wrong about really the sentiment of America. And this is not a political statement. It’s just look at the lack of credibility of a lot of these media outlets is absolutely pathetic. So anyway, let’s keep listening

The Fall of Eron 17:56
goes before Enron got started, gas and electricity were produced in sold by state regulated monopolies. But then there was deregulation and as the times right, Enron used Wall Street magic to transform energy supplies into financial instruments that can be traded online like stocks and bonds. Prior to this, those energy monopolies were always under government scrutiny. But after deregulation, Enron had more freedom and so started trading energy online, such as stocks and bonds, and also placing bets on future energy prices. Enron started selling contracts called energy derivatives to investors. Soon, Enron was called America’s most innovative company, and it won that accolade for a number of years at the top.

Jason Hartman 18:38
Now remember, my simpleton definition of a derivative, right? What is the derivative? According to Jason Hartman. It’s the thing about the thing. The derivative is the thing about the thing now, what’s even more and more and more scary about derivatives is that it can be the thing about the thing about the thing about the About the thing about the thing about the thing, it’s like you have in our marketplace in our crazy, super symbolic economy, these things that are so downstream that are so unattached, anything real, that it just becomes this massive shell game or Ponzi scheme really, maybe not exactly a Ponzi scheme, but certainly has some of the characteristics.

The Fall of Eron 19:24
If this looks good for the consumer, because with supply and demand taking over fixed prices by monopolies, the prices for customers seemed fair, it seemed like a dream story for capitalism. There was a problem though, and something didn’t quite add up. You see, Enron thought that if it could trade energy, then why not trade all kinds of other things, such as insurance or advertising, and then turn these into contracts and sell them as derivatives to the company poured billions into these new trading ventures, but not everything turned into gold. It later turned out that while Enron was winning on some levels, it was losing Others but the problem was it wasn’t always coming clean about where was losing, it was kind of fixing its accounts and reporting false trading revenues, as one person pointed out some of the schemes traders use.

Jason Hartman 20:11
So Enron was using these things that aren’t inherently bad. They were just using them in a bad way called SPV, or special purpose vehicles SPV. And what they would do is they would set up a company and they would bury debt into the company. And that was an SPV, a special purpose vehicle now, you know, lots of companies and business people use special purpose vehicles. Usually that implies that it’s sort of like a single purpose entity, right? So you might get like an apartment syndicator that creates an SPV for one deal. And then for another deal, they create another SPV, but Avalon was burying all of its problems into these SPV, these special purpose vehicles. And they wouldn’t trickle up to show on their main set of books. That was part of the fraud, but the fraud was a lot bigger than that. Okay, so it’s something that could literally take days to explain. I mean, college courses could be made out of Enron alone. It was such a sophisticated fraud,

The Fall of Eron 21:23
picking up a buyer and a seller for a future contract and then booking the entire sale as Enron revenue. Enron was also using his partnerships to sell contracts back and forth to itself and booking revenue each time. It was in fact creating imaginary revenues. If that’s confusing to you, The Wall Street Journal gave an example of one such piece of Enron subterfuge, Enron got into a deal with blockbuster, those guys whose stores you go into in the past and rent out a movie. The new deal with blockbuster was to do this online, but it didn’t work out in eight months. The business was a total flop while this was going on, and Ron had made a deal with it. Bank if the bank loaned in around $115 million, and Ron would then handle for its video deal profits for the first 10 years to the bank, as you know, and Ron made no cash from this online video renting business with blockbuster, but it still wrote the $150 million down as part of its revenue, not a massive loss. The Canadian bank was owed money, but on paper things didn’t look bad for Enron. According to The New York Times, Enron did a fair bit of shady accounting and still Wall Street bankers at JP Morgan and others were gung ho about the company and it stuck. Some people however, began to smell a rat. The thing was and run was also seen as a fairy tale winner in the years when deregulation and online trading embodied by a get rich quick culture were admired by everyone leave the innovators alone. This is the future but things got out of hand as they tend to do when in hopsie in terms the Leviathan goes missing, and no one’s watching over the people to ensure nothing terrible is happening.

Jason Hartman 22:57
Okay, so that con What they were just explaining is where you have this system, this marketplace where it goes upward or downward push or pull in that supply chain doesn’t matter which way it goes. The problem is that nobody is there to put the brakes on anything. Every company, every person along the way is incentivize to be excited about the company, to speak highly of it to push the stock. No one, no one is incentivized to say, Hey, wait a minute, put the brakes on this deal. This doesn’t look good. Even if they smell a rat. They won’t admit that they smell it because nobody wants to. It’s amazing how blind people can become when their own self interest is at stake. And so, you know, this is not true of just Enron. It’s true of lots of marketplaces. It was true of the real estate mortgage market. Back In the early 2000s, leading up to the mortgage meltdown, and then later leading up to the Great Recession, there were really again, two causes of the Great Recession. At first, it was the mortgage market. And that was kind of the front end of it, as I’ve explained this before, but then it was the backend, the insider dealings that you couldn’t see. And that was the Wall Street shenanigans. Two good movies for that are, of course, The Big Short, or the book by Michael Lewis, and then margin call, which I talked about just last week on the show here, which is a fantastic movie.

The Fall of Eron 24:36
And Ron also invested heavily in high speed broadband telecom networks, but the company saw no profits from that either the most innovative company in America was on a losing streak, but still, those losses were not reported. It was hiding all its financial losses using something called mark to market accounting. investopedia explains that like this, this technique measures the value of a security based on its current model. Value instead of its book value. This can work well when trading securities but it can be disastrous for actual businesses. Another example given up the Enron way of hiding its losses is this if the company bought,

Jason Hartman 25:12
see the security is nothing more than a derivative of sorts, okay? It’s not called a derivative, but it is a derivative. Because it’s a thing about a thing. Whenever you have a thing about a thing, you have a derivative, okay? Doesn’t matter if that’s not what it’s called. That’s what it is. What it is, is what’s important. And you want to be as an investor, as close to the thing as possible. You don’t want to be downstream and have the thing about the thing about the thing. When you buy properties through our network, you actually own the thing, versus having the thing about the thing about the thing about the thing about the thing, you don’t want to be so downstream and so disconnected. You want to own The thing and if you don’t own the actual thing, you want to be as close to the thing as possible. Okay, you get what I mean about the thing thing is the true economic asset, the thing that actually produces the value that produces the ROI, the return on investment. That’s the thing. People get a little detached from the thing. Just don’t be too far detached. Try to be as close to the thing as possible. That’s the point. Making Sense? I hope so. Hope so.

The Fall of Eron 26:27
A power plant, it would first put the projected profit on its books. That’s a projected profit, meaning nothing has actually been made. If then Enron actually didn’t make a profit but a loss it would transfer the loss to an off the books Corporation somewhere no one would find it this way. Enron’s bottom line didn’t look affected, and everyone still thought the company was booming, when in fact, heavy losses were being incurred, and then hidden, like soiled underwear at the bottom of a laundry

Jason Hartman 26:54
basket. That’s the SPV is the special purpose vehicles I talked about a moment ago.

The Fall of Eron 27:00
use something called off balance sheet special purpose vehicles or SPV to hide these failures. But all you need to know is that this is a technique that can be used to fool investors and creditors. The experts tell us this is not illegal, but it can be dangerous. At the same time not everyone understands how they work. So it could be said to be slightly unethical if companies are not completely transparent about it, and then the bubble burst as bubbles tend to do. By April 2001. analysts were on to Enron they saw what was happening realizing that accounting wizardry had been creating a company not unlike the fantasy city of Oz. behind the screen, Enron was crumbling, and by summer 2001, the company was in freefall, its stock was downgraded sinking like a stone into the abyss. By 2000, it was revealed that Enron had losses of $591 million and $628 million in debt in 2001. The company filed for bankruptcy and a lot of for folks whose pensions were tied up and company stock were going to have to cancel their vacation in the Caribbean from 2004 to 2011. The company paid Oh, it was so bad they’d have to cancel their entire retirement. I mean, this stuff is so significant look,

Jason Hartman 28:10
remember back to the this name you may not remember you younger people certainly won’t. But Charles Keating, that was another scandal years before with the Lincoln savings and loan scandal. Hey, being it, look it up being it. See that’s needs to be the way Google is used just being it. Right. And so Charles Keating, same kind of story. These people people died, okay, people died, people committed suicide, or they died in early death because of these disgusting scumbags who manipulated the truth and told their lies and manipulated the accounting and use their big PR firms and their lawyers and their investment bankers and the financial advisor networks out there to just simply steal money. That’s the best thing Wall Street does. Wall Street is fantastic. It’s separating people from their money. Now the insiders, they don’t get separated from their money. But the investors, the outsiders, you and I, Wall Street’s very good at separating us from our money

The Fall of Eron 29:18
$21.7 billion to its creditors. It said shareholders lost in total around $74 billion, and employees lost billions and pension benefits with one such person being the guy we mentioned at the beginning of the story. There were many, many more like Him. Some of the executives who were charged with conspiracy insider trading and securities fraud. The CEO we mentioned died of a heart attack before he could face any prison time. Others did time for facilitating corrupt business practices. Another CEO Jeffrey skilling was only just released from prison. Do you think government regulation of markets

Jason Hartman 29:53
so Jeffrey skilling is out on the speaking circuit now, you know, so anyway, there you have it. That was the infographics show. And they did a great job just kind of giving an overview of that. But see that movie the smartest guys in the room. Also be sure to see margin call. And of course, many of you have probably seen The Big Short, but that’s one to see as well. You know, a lot of times I watch these movies twice, and you really pick up a lot of stuff you didn’t pick up the first time. So anyway, they’re they’re definitely worth it. In either case, the lesson the moral of the story is, thou shalt maintain control. commandment number three, be as close to the thing as possible, the actual thing that creates the revenue, the wealth, the return on investment, and that is the property the income property. Okay. And you can find lots of those at Jason Hartman calm. I’m really excited to say that we have made a significant effort over the past six months or so, to bring you a bunch of new home inventory beautiful brand new properties. These are exclusive to our network sometimes. So talk with our investment counselors, go to Jason And you can reach out through any web form there. If you don’t have an investment counselor yet, if you do you know how to reach them already, and you can always call us to, by the way, our phone number and I never say the phone number. I always give out the website, but our phone number is easy to remember. It’s one 800 Hartman, that’s one 800 h AR t ma n one 800 Hartman, so you can get us there or at Jason Hartman, calm. Thanks for listening today. Happy investing and we will talk to you tomorrow. Thank you so much for listening. Please be sure to subscribe so that you don’t miss any episodes. Be sure to check out the show’s specific website and our general website heart and Mediacom for appropriate disclaimers and Terms of Service. Remember that guest opinions are their own. And if you require specific legal or tax advice or advice in any other specialized area, please consult an appropriate professional. And we also very much appreciate you reviewing the show. Please go to iTunes or Stitcher Radio or whatever platform you’re using and write a review for the show we would very much appreciate that. And be sure to make it official and subscribe so you do not miss any episodes. We look forward to seeing you on the next episode.