Cookin' the Book$: Say Pasta la Vista to Corporate Accounting Tricks and Fraud - Softcover

Don Silver is a personal finance columnist, writer, editor and the author of eight highly praised books including Baby Boomer Retirement ("Astute and provocative"—Los Angeles Times), The Generation X Money Book, The Generation Y Money Book and A Parent’s Guide to Wills and Trusts ("Excellent book...What also differentiates this book...is the writing itself. It is clear. It is concise. It is clever."—Los Angeles Times).

Silver passed the written CPA examination and practiced law for over two decades before devoting all of his time to writing.

As a regular ongoing columnist on Quicken.com’s Retirement Channel and Microsoft’s MoneyInsider, Silver wrote about important personal finance and retirement topics with a wry sense of humor. He has been featured on the NBC Network News, CNNfn, Associated Press, USA Weekend, Reuters and American OnLine.

Silver is also an educational consultant for The Wall Street Journal Classroom Edition Teacher Guide.

English Fishy and Chips

My dad and I were walking silently along a Southern California beach watching the waves come in. My dad bent down to get a closer look at the bubbles you see at the shoreline as the waves leave the shore and go back out.

He watched them pop, one by one. Then he started talking.

"Sea bubbles. Sooner or later, bubbles pop and deflate. Let me tell you a story about bubbles.

"A new stock comes on the market with exclusive rights in a hot area with tremendous potential. There’s a public offering of the stock. Based on the accounting records, the company appears to be doing well.

"A frenzy develops and the stock jumps to ten-fold its original price. But the insiders know the company isn’t really making profits. The directors start selling the stock when the price is high. "The truth about the company’s unprofitable operations becomes public knowledge. The stock price collapses and smaller investors are hurt or ruined."

Then he turned to me and said, "Name that stock."

Actually, I gave him the names of several com-panies. Each time he said, "That’s right but it’s not the one I’m thinking of."

When I ran out of guesses, he looked me in the eye and said, "Welcome to the South Sea Com-pany Bubble of 1720.

"You can change the names, the dates and the details of the techniques, but the underlying greed of some people stays the same."

I asked him, "What was the story of this bubble of 1720? Did they even have stocks to bubble in 1720?"

This is what he told me.

"Two stockbrokers in England formed a new company known as the South Sea Company. The main asset of the South Sea Company was exclusive trading rights from England in the distant lands being ‘discovered’ around the world.

"Everyone wanted to get in on the ground floor of the New World Economy and the company raised lots of money selling its stock.

"The trading rights that the South Sea Company owned sounded better in the advertising than they were in reality.

"To keep the company going, fresh cash was needed to pay the bills. Its trading business wasn’t going so well but the company decided there was no sense in telling people bad news about the accounting books and records. So they disguised what was going on.

"The best source of new money continued to be selling more stock. To encourage more demand for its stock, the company allowed investors to buy on the installment plan. This helped drive up the stock price even more since more buyers could buy additional stock.

"Investors were very happy as the stock price of the South Sea Company kept climbing.

"As the price of the stock went up, the company made investing even easier by allowing current investors to borrow against their existing stock to buy even more company stock. This cycle of a higher stock price, more loans and issuing more stock repeated itself again and again. And the stock price kept rising.

"Investors forgot or ignored that it’s the flow of current and future profits that makes a company an attractive investment. Although the South Sea Company had trouble making profits, it was very good at having new stock certificates printed up and taking in the proceeds from new stock sales.

"The share price went from 100 in January, 1720, up to around 1,000 by July of that year.

"Then the directors of the company sold their shares and cashed out with big profits. Royalty and government officials were in the thick of it, too, as investors who knew the right time to sell.

"The last ones to find out the company had no real economic substance were the rest of the investors. By the time they realized that the emperor had no clothes in September, the stock price had crashed. "Among those other investors was Sir Isaac Newton. Newton invested two times. On his first investment, he made a 100 percent profit. But after he sold his shares, the stock kept climbing in value. The thought of missing out on even bigger profits became too much to bear so he invested again at what turned out to be the top of the market.

"He lost a fortune the second time around and said, ‘I can calculate the motions of the heavenly bodies, but not the madness of the people.’"