Henri Reynard Speaks Out

Deregulation And Bust?

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The greatest flaw in deregulation theory responsible for lax reviews of companies like Enron is that it ever existed. The idea that industries and individual companies are free to behave in any way that they desire in areas as vital to all of us as the electrical power market is not new. It was part of the process that led to the downfall of our economy in the crash of 1929, it was there in the heyday of the railroads and the Robber Barons and it existed in Europe before we became the greatest mercantile nation on earth. "Your money just wants to be free to earn returns", always leads to your money being freely redistributed among the select few who are in positions to profit from deregulation. We universally seem to fall for the idea that deregulation is always good for business, but the facts are substantially different. When regulation is lax or nonexistent bankruptcies rise, profits are higher for a time but then the temptation gets too great and the fleecing of the sheep starts. The sheep are the investors who clamber on the turnip truck so they can fall off again after it takes them down the road away from their goal of easy wealth.

The process either starts with too much regulation and ends up with not enough or it starts with too little regulation and ends up with too much. Simple isn't it? Like most business cycle inputs regulation has its life cycle too. We are at the point where the forces moving us toward deregulation are peaking, or at least I hope they are peaking. We really can't stand a lot more destruction of wealth right now. Yes runaway deregulation destroys wealth. Most often it is the wealth of our middle classes held in mutual funds, pension funds and insurance funds, but a lot of it also belongs to individual middle class investors. Some of it even comes from the classes above the vast American middle class. The middle class investors buy high and sell low in the time of bubbles nearly every time. So do a lot of the funds they put their money into when they invest. Is the market rigged? That question is rigged. All markets are rigged in one way or another and those who can manipulate the rigging get the ship of money moving in their direction.

How do I know this? Because I have been an entrepreneur for a lot of years and business is one of my great interests. I have watched in wonderment as the money flowed from the hands of investors into the hands of unscrupulous managers at Enron, Global Crossing and others too numerous to mention. I have watched in amazement while stocks were pumped and sold at prices far greater than any value that could be created by the company issuing the stock. I have watched while the same stocks were "shorted" on the way down by the same brokerage firms that pumped them in the first place. On broker called it, "milking the same cow twice". I looked at his lily-white hands and knew that he had never touched a cow in his life. But he touched a lot of money every day and the dirt on his hands always came off on that money. It never worked the other way around.

I believe that regulations regarding the business practices of brokers are as vital as regulations regarding the behavior of anyone who handles other people's money. Can some people be trusted? Yes, but most of them will not survive swimming in the sewers with the sharks on Wall Street. The attitude of most brokerage firms goes far beyond "let the buyer beware" into the realm of "never give a sucker an even break". If you doubt that then you haven't paid attention to all of the things that have happened in the last three years. The brokerage firms on the street all have the same characteristics. They are composed of brokers, analysts, traders and phone drones who are used to get new suckers to replace the old ones. Cynical? You bet I am cynical! I have met one honest man on Wall Street and he is in his seventies. He really tries to make money for his investors and use the money to buy stock in companies that will provide a real return on their investment. I am sure that there are others out there but they are hidden behind the walls of offices that most investors never get to enter. They cater to the big investor; the wealthiest funds and the richest individuals get their services. The rest of you are left with the fast buck artists and hucksters who peddle stock and bonds not fit for wallpaper.

The money trail is interesting because it includes the venture funds that are a substantial part of why the recent bubble got so large in the first place. Venture funds are not available to investors with a few bucks to invest. Regulations prevent that money you have hidden in your sock from flowing into the hands of those who administer those funds. They pick companies to invest in based on their exit strategy. That is how do you get your money out of the investment after it has tripled or quadrupled in value and before it is worth less than it was when you put the money in the company. There is some art in this in normal times, and some benefit in the expertise that venture capital brings to the table for the entrepreneur. For the most part however venture capital has one set of objectives, buy low, sell high and get out early. When the crash came the venture funds were stuck owning a lot of equity in companies that could not be sold to the public. They are in bad shape today. They bought their own mantra of "greed is good" and got too greedy.
How venture capital worked before the crash was this. Venture funds bought stock in companies that had an idea, product or service that looked like it would drive substantial growth in the value of the stock. They provided the first two stages of capital for a lot of good companies in the early days of venture funding. The key to success was always how they got additional capital, money beyond their own investment, into the hands of the entrepreneurs building that value. The system worked often enough to make their returns on investment among the highest attainable. As it should, that worked to attract more capital into venture funds. That was how venture funds were supposed to work.

During that early period in venture capital funding the most attractive returns came from Initial Public Offerings (IPO's), where stock was sold to the public market. This allowed the venture fund to eventually sell their stock in the investment for large returns; sometimes as much as twenty or more to one. Other exit strategies, such as acquisition by a larger company were available but usually offered less substantial returns. Gradually, as regulations eased, the time the venture fund held the stock after the public offering grew shorter and shorter. In some cases part of the stock held by the venture fund was even sold in the IPO, although this was rare.

Once this pattern was established it led to venture funds that knew how to do one thing, take companies public. Instead of helping the entrepreneur create value for investors the funds became a means of helping the venture fund and sometimes the entrepreneur get more and more value out of their stock earlier in the life cycle of the company. They began to take companies' public that had no product or service, only an idea. The hype machine was thus created between the efforts of the brokerage firms and the venture funds. That hype machine magnified the prospects of companies, many of which had little hope of success. A lack of respect for regulation combined with greed turned deadly. Regulation after regulation was taken off the books until the hype campaigns dominated the market for new stocks. There was a whole publishing industry supported by the hype machine that talked incessantly about the merits of greed and raved about the success of entrepreneurs who created companies that lasted less than five years. The bubble grew from the hot air emanating from that machine. And then it burst.

It got so bad that for a while a lot of people were banning their grandchildren's soap bubble toys because it reminded them of what had happened to their life savings. Naw, I just made that up but the rest of this is too true to be anything but painful. The number of people who believe that greed is good is now on the decline. So is the number of people who can retire as planned. The number of venture funds is shrinking as is the total amount invested in new enterprise. This is seriously impacting new job creation. People are now talking about new regulations. Washington isn't hearing them yet, but they will. It may be a long time before we begin to create a "New Economy" again. That phrase will go down in history with "prosperity is just around the corner", whose time has just come around again. Will the endless wars we are now engaging in delay that change? Maybe but if they do things will get still worse before we see the end of the move towards deregulation. Me? I'm going to walk out and look at my mountains before I come back and write some more. God bless and keep you safe in these trying, unregulated times.