Commandment 3 – Thou Shalt Maintain Control

Commandment 3 – Thou Shalt Maintain Control

In this episode, Jason Hartman starts by discussing how Airbnb has not been through a recession yet. He explains 3 major problems when you give up control in an investment. He explains Commandment #3: Thou Shalt Maintain Control a lot deeper. Jason illustrates this with an infographic called The Business Deception That Cost $60 Billion. He cautions us to be more alert when you hear the phrase “financial innovation.”

Announcer 0:01
This show is produced by the Hartman media company. For more information and links to all our great podcasts, visit Hartman

Announcer 0:17
Welcome to the young wealth show where you’ll truly learn how to make, spend and invest money for an awesome life. Get the real life stuff that wasn’t part of your school curriculum. Young wealth gives you innovative new ways of dealing with your finances, as well as the skills and tools you’re going to need to survive and be successful out on your own. Let the young wealth show be your GPS to take you from clueless to clued in. Here’s your host Jason Hartman dunwell

Jason Hartman 0:49
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 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 Next, I’m on my way there to Morrow. 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 a year and a half. But hey, what does this whole 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 talk Your 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 gonna 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 a widget a stock, a commodity, in economic unit, currency, dollars yen, Brazilian real, 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 a 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. Oh, you young fool. skew younger young for it’s not so easy. He was talking about his successes right and you know, this was a young guy, okay was talking about his successes in in different markets around the country, 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 quickstart podcasts Podcast, where we have surgically copied episodes from this podcast on 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, though, 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, Quick Start 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’ve 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 is 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 it’s 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 a 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 gonna 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 in Enron’s 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. Bring it, look it up. Don’t google it because Google is evil. Okay. Looks and 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, wasn’t Voltaire who said here’s the famous quote, I think it was a 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 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 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 well 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 them. 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 Corazon. He was governor of New Jersey, okay. Your resumes don’t get much better than this. Or Ken Lay 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.

Jason Hartman 13:01
An American worker named George had his sights set on a comfortable retirement, perhaps some holidays in the sun relaxing in the garden with good novels and a gin and tonic biocide. 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 you saw

Jason Hartman 13:50
so that was just about a year in $2,090 in 2001 26 cents and you Listen to how reputable this company was. This was like the company, right? Everyone 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 love to own their stock? What person promoting a deal is so credible, that their background check would be perfect. And like Bernie made offs or john corazones, 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.

Jason Hartman 14:53
I’ve coming into this day, the downfall it’s a reminder to all of us that indeed giants can fall On top of that, giants aren’t always what they see. The story starts in 1985 when two companies merged, they were a Texas based Houston natural gas company and Omaha based enter 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, Enron 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

Jason Hartman 15:50
as the story 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 to 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’re 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. Absolutely pathetic. So anyway, let’s keep listening

Jason Hartman 17:03
goes before Enron got started, gas and electricity were produced and sold by state regulated monopolies. But then there was deregulation and as the times rights 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 and Ron 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 time.

Jason Hartman 17:45
Now remember, my simple definition of a derivative, right? What is a 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 thing 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

Jason Hartman 18:31
of this looked 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 pour 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 on 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 19:18
So Enron was using these things that aren’t inherently bad. They were just using them in a bad way, called SP V’s, or special purpose vehicles, SP V’s 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 spvs 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,

Jason Hartman 20:30
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 a Canadian bank if the bank loaned and around $115 million, and Ron would then hand over 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, and Ron 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, Enron 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 of love, thing goes missing, and no one’s watching over the people to ensure it nothing terrible is happening.

Jason Hartman 22:04
Okay, so that concept, 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 incentivized 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. Have 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 the back end, 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 on the show here, which is a fantastic movie.

Jason Hartman 23:43
And Ron also invested heavily in high speed broadband telecom networks, but the company son 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 mark Get accounting investopedia explains that like this, this technique measures the value of a security based on its current market value instead of its book value. This can work well when trading securities, but it can be disastrous for actual businesses. Another example given of the Enron way of hiding its losses is this. If the company bought a

Jason Hartman 24:18
seed, 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. Now people get a little detached from the thing. Just don’t be too far detach, try to be as close to the thing as possible. That’s the point. Making Sense? I hope so. I hope so.

Jason Hartman 25:34
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’s still thought the company was booming, when in fact, heavy losses were being incurred and then hidden like soil underwear at the bottom of a laundry basket.

Jason Hartman 26:02
That’s the SP V’s the special purpose vehicles I talked about a moment ago.

Jason Hartman 26:06
Don’t use something called off balance sheets, special purpose vehicles or spvs 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 two thousand one, the company filed for bankruptcy and a lot of poor folks whose pensions were tied up and company stock, we’re going to have to cancel their dream vacation in the Caribbean from 2004 to 2011.

Jason Hartman 27:10
The company paid Oh, it was so bad, they’d have to cancel their entire retirement. I mean, this stuff is so significant. Look, remember back to the previous name. You may not remember if you were younger people certainly won’t. But Charles Keating, that was another scandal years before with the Lincoln savings and loan scandal, Hey, bring it, look it up. Bring it. See that 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 They’re lawyers, and they’re 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

Jason Hartman 28:25
$21.7 billion to its creditors. It says 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 were charged with conspiracy insider trading and securities fraud. The CEO we mentioned died of a heart attack before we 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 29:00
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 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 signal nificant 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 A RT ma n one 800 Hartman, so you can get us there or at Jason

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 and 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.