Thursday, August 20, 2009

Lessons from Crazy Eddie

Voltron says: Anyone who lived in the New York City area in the 1980's remembers "Crazy Eddie". It was an electronics store chain with an ad campaign featuring a frenetic radio show host . . . Their prices were "Insaaaaaaaane!". The company was also a massive fraud from the beginning. NPR's "Planet Money" interviewed their CFO Sam Antar

Crazy Eddie was underreporting their sales and skimming the New York City sales tax (a whopping 8.5%). Their CFO said, the joke at the time was that if New York City eliminated their sales tax, half the mom and pop shops in the city would go out of business, implying that skimming sales tax was how most small businesses stay solvent! This flies in the face of academic economic wisdom, which is that eliminating the sales tax would be good for businesses. It reminds me of the scene from "Back to School" where Rodney Dangerfield is explaining why his business professor's example construction budget is bunk: "Well, first of all, you're gonna have to grease the local politicians for the sudden zoning problems that always come up. Then there's the long-term costs, such as waste disposal. I don't know if you're familiar with who runs that business, but I assure you it's not the Boy Scouts." After Crazy Eddy became publicly traded, they slowly moved their off-the-books business back on the books to give the illusion that their business was growing in order to inflate the stock price.

I'm always fascinated by frauds. I've become convinced that the economy is completely dominated by fraud and criminal activity. The biggest cash crop in the United States is Marijuana. Credit Card fraud is larger than the entire illegal drug trade. During the S&L crisis of the 90's almost every bank committed fraud. When Fitch recently looked at individual mortgage files, they found "the appearance of fraud or misrepresentation in almost every file." I'm certain that all the major banks are insolvent and have committed massive frauds. After all, how can you compete with frauds when the government is complicit? To paraphrase Balzac: "behind every great fortune lies a great crime."

Former S&L regulator William Black has done a lot of great work on this. One of the first things he did was limit the growth of S&Ls. This seems counter-intuitive, but makes sense because all ponzi schemes must grow otherwise they implode, so it's a very easy way to ferret them out and limit the damage. With the current banking crises, the FDIC is doing the exact opposite by giving banks a pass to allow them to "earn their way out" of the red (i.e. grow). By the time the FDIC finally takes action, the losses are huge.

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