The Bookmaker of Business: A Financial Tale (2 page)

2

Wall Street.

That was the street sign Sean and Colby passed as they made
their way through the financial district in downtown Manhattan. Sean was
excited about meeting this mystery man whom Colby spoke of so highly. He
wondered if he was some famous Wall Street tycoon like Bernard Baruch or Jesse
Livermore.

As they walked through the bustling crowd, Sean, as a
lifelong New Yorker, could not believe he had never been to this famous part of
town before. He felt like he was in a different world. Not just an outsider,
but an objective observer viewing an alien habitat. He noticed something
different about the people he encountered. They were more similar to the
children of his neighborhood than to the adults where he lived. But he couldn’t
put a finger on the reason why. Not only were they immaculately dressed in fine
clothing, but they seemed happier.

The two men passed the New York Stock Exchange, walked
around a corner and entered the lobby of the First National Bank.

“Good morning,” Colby said as he addressed the attractive
young receptionist. “I have an appointment to see David.”

“Yes sir. One moment please,” the receptionist said as she
arose and disappeared into the large corner office.

“This way, gentlemen,” she said when she returned. They
followed her back to the lavish corner office.

The office was ten times larger than Sean’s residence. The
high walls were adorned with large, breathtaking paintings unlike anything he’d
ever seen. The fragrance of cedar and potpourri complemented the beautiful
works of art.

“Colby! Get over here!” David said as he got up from behind
his mahogany desk.

“How are you David?” Colby said as they embraced like best
friends who hadn’t seen each other in a long time.

“Have a seat gentlemen.”

His two guests promptly seated themselves in the leather
chairs across from the mahogany desk. Sean had never sat in a chair so
comfortable. He could even smell the quality of the fine grain leather.

“So, Colby here tells me you’re seeking the answer to why
the rich get richer and the poor get poorer. Is that right?”

“Yes sir. That’s correct.”

“And why, may I ask, are you seeking this knowledge?”

“So I may become rich myself.”

“That’s an admirable goal. But to become rich requires
knowledge as well as discipline. The rich know and do things that the poor do
not. They’re smart when it comes to money.”

“So are you saying it’s the smart who get richer while the
dumb get poorer?”

“Well, sort of. We can narrow it down even further than
that. Down to a specific action. The rich are doing something completely
opposite of what the poor are doing.”

“And what’s that?”

“What do you think?”

“Well, Colby says it’s something similar to what a bookie
does, where you play both sides of a bet and keep some for yourself.”

David and Colby made eye contact and both cracked a smile.

“That’s correct. But do you know how?”

“No, but I’m sure you’ll tell me.”

“Not so fast. The reason why the rich get richer and the
poor get poorer is very simple. It has been used by the rich from ancient times
to increase their wealth exponentially. It is common knowledge, but for some
reason it remains a secret to the common man. That is the great mystery.”

“How do I learn this secret?”

“Do you know how banks make money?”

“Well, I know they earn interest off loans that they make.”

“Correct. But where do they get the money to make loans?” 

“From depositors I guess.”

“Right. And how do they attract depositors?”

“By offering them a rate of interest to hold their money?”

“You’re on the right track. But how do bankers get
depositors to put money in their bank instead of another?”

“I guess by offering higher interest.”

“You’re getting warmer. And how high of an interest rate can
banks offer?”

“I’m not sure.”

“I mean, is there a limit to the rate of interest they can
pay before taking a loss on that deposit?”

“Oh I get it,” Sean smiled.  “The bank can’t pay any more
interest than what they charge for loans.”

“That’s where you’re wrong. A bank can still make a profit
even if they charge less for loans than what they pay for deposits.”

“What? How d’ya figure that?” Sean asked.

“I’ll get to that later, but that is one of the many
misconceptions about banking that the general public does not understand.”

“But how do banks play both sides of a bet like a bookie?”

David and Colby glanced at each other and grinned.

“You know how bookies cover bets, right?”

“Well, yeah.”

“Well, banks do the same thing in the business world by
making loans. When people take out a loan, they are essentially making a bet.
Banks make loans to many different businesses as well as consumers. Some
businesses succeed, some fail. But bankers get their cut regardless, and that
is interest.”

“But what if a business fails? Don’t you lose money when
that happens?”

“Not if the loan is secured. When we make loans we usually
ask for some type of collateral before we extend credit. That way we are
covered in case of default. When someone takes out a business loan, they are
betting on themselves and their idea. But not all bets win. Some businesses
fail. By making many different loans we are playing different sides like a
bookie. We also make consumer loans to cover our risk in case some of our
business loans don’t pan out.”

“What about home loans. Does it work for them too?”

“Of course. When someone takes out a mortgage, they are
betting that they can both keep up the payments and that the value of their
property increases. Unfortunately for the homeowner, that doesn’t always work
out. Sometimes they lose the bet and fall behind on their payments and the
property value decreases. If they default on the loan, we take possession of
the house. For banks, real estate loans are some of the best because they’re
secured by real assets.”

“But aren’t some loans unsecured?”

“Yes, but we don’t make too many of them and we charge a
higher interest rate on them to cover losses in case of default. We make
unsecured loans to consumers and businesses alike based on their income,
assets, and credit history.

“Think about all the goods and services produced in society.
Debt finances a large portion of that production. Now think about all the
interest earned from business, consumers and government. That is the lenders’
cut.”

“OK, fine. But what’s the real reason why the rich get
richer and the poor get poorer?”

 David leaned back in his chair and smiled.

“The borrower is slave to the lender.”

“I’ve heard that before. Where’s that from?”

“That’s from the Bible. From the Book of Proverbs. That
quotation captures in a single sentence why the rich get richer and the poor
get poorer.”

“How so?”

“Shall I explain?”

“Please do.”

“Everyone knows that borrowers pay interest on their loans.
But what they don’t understand is that if they never pay off their loans they
become indentured servants to their lenders. For example, everyone pays taxes
to the government. This can’t be avoided. Whatever the tax rate is that is what
we pay. We pay our taxes from wages and earnings, and it’s the same with debt.
The difference is that while taxes are mandatory debt is not. Debt is a choice.
In other words, borrowers pay their lenders by their own design. No one forces
people to take on debt and pay interest unlike taxes. If you have a lot of debt
at a high interest rate, a large portion of your hard-earned wages will go
toward interest payments. That is money that could be spent on yourself, or
better yet, building up a nest egg that you could loan out at interest.” David
paused. “What is your trade, may I ask?”

“I used to work construction but now just hang out by the
docks looking for jobs. Sometimes I get work, sometimes I don’t. It’s tough
these days.”

“I bet you work hard and are exhausted at the end of the
day. Aren’t you?’

“Yeah. At the end of a shift I can barely stand. Sometimes
I’m so tired I don’t even go home. I just sleep out there.”

“That sounds rough,” David said as he continued.

“But the real difference between the rich and the poor is
how they use debt. And the poor are on the wrong side of it. As their income
increases they take on new debt instead of building up their savings. The rich
do the opposite. They avoid personal debt and instead loan their excess capital
out at interest. People who are financially wise, though not necessarily rich,
do what the rich do and put their money to work for them. They avoid debt and
control their expenditures while building a capital base that compounds with
interest. Over time, their nest egg grows. Eventually, the interest they earn
will cover their living expenses, and if enough time passes they end up with
more money than they can spend, more money than they know what to do with.

“The great tragedy is that most people work their entire
lives and have nothing to show for it at the end. This is because they never
got ahead of the game. They continually revolve their debts going from mortgage
to mortgage, loan to loan, but never paying them down. When they reach
retirement age they wonder why they’re broke despite earning a lot of money
through the years. Yet they never stopped to ask themselves if what they were
doing made sense. They never questioned their own behavior. Some will even
blame society for the fact they’re broke instead of themselves.”

“Do you have any outstanding debt now?” David asked.

“Actually yes. I owe about two hundred bucks to this bank.”

“Did your loan originate with us?”

Sean shook his head. “No. I got it through the credit union.
I had about two hundred bucks saved up. Took out a loan against it but lost it
all when the credit union went under. It’s funny, but I thought if a bank goes
under that loans would cancel out too, but I’m making payments here instead.

“Funny how that works, isn’t it? When your bank goes belly
up you lose your savings, but if you took out a loan you still have to pay.”

“Yeah. It doesn’t seem fair.”

“It’s not fair. But I remember that deal very well. When
your credit union went into receivership, we were able to purchase its entire
loan portfolio for pennies on the dollar.”

“Sounds like you got a good deal.”

“We did. We got a lot of great deals like that because we
had the cash reserves to do so. But the important thing to remember is this:

“Debt, especially revolving consumer debt, is a bottomless
pit. Avoid it like the plague. It is financial poison.”

“But if debt is so bad, why do so many people use it?”

“It’s kind of like the confectioner’s shop. There’s not a
doctor on earth who will say that stuff is good for you, yet people still eat
it. Why?”

“I guess because it tastes good.”

“Exactly! Like confection, debt is enticing. Debt appeals to
the vanity and self-gratification of man. Retailers and finance companies say
you can have this exciting new product now so long as you pay interest for the
rest of your life on the loan balance. Most people are seduced by the emotional
gratification of the here and now even if it means paying a lot more later.
This is a mistake.

“Speaking of which, all this talk of food is making me
hungry. Would you gentlemen like to join me for lunch? I know a great place
nearby.”

As they left the bank the three men looked as different as
the worlds they came from. David dressed like a typical Wall Street banker with
his black suit and derby hat. Colby looked very gangster-like with his gray
double-breasted suit and fedora hat, and Sean was unpretentiously working class
with his tweed overcoat and flat cap. A fancy, black limousine greeted them and
took them promptly to lunch.

3

“And for you, sir?”

Sean perused the menu looking for something reasonably
priced.
These prices are outrageous
, he thought. He looked around the
restaurant and couldn’t believe there were so many people living large like
this in their city despite the economic depression the rest of the country was
enduring.

“Nothing for me, thank you.”

“Nonsense,” David said. “Lunch is on me today. Get whatever
you like. Try the filet mignon. It’s the best in the city.”

“Are you sure?”

“Absolutely!”

“OK,” Sean said, reluctantly. “I’ll try the filet.”

“Excellent choice, sir,” the waiter said. “And how would you
like that prepared?”

“Preferably cooked.” Sean said as they all laughed,
including the waiter.

“I mean, would you like it medium or rare?”

“Medium-rare please.”

“Now there’s a man who knows how to eat filet mignon,” Colby
said as the waiter collected the menus.

When the entrées arrived, Sean looked at his steak and,
admiring its presentation, wished he could send it back and get the money
instead. The cost would have bought a lot of food.

“If I were as wealthy as you, I think I would eat filet
mignon every day,” Sean said.

“I used to,” David said as he took another bite of his
succulent steak. “But even filet mignon gets tiresome. You can’t eat it every
day. A man needs variety.” Sean had never heard anything so arrogant. He
couldn’t decide if he was more annoyed by or envious of this aristocrat.

As Sean devoured his steak, he realized that this was the
best steak he’d ever eaten. The flavor was unlike anything he’d experienced
before. The texture was perfectly tender.
Not a trace of gristle
. And
the juices seemed to dance on his palate, eliciting a Pavlovian response that
made him anticipate the next bite even more.

“I think that was the best steak I’ve ever had,” he said as
he finished the last morsel.

“They say that hunger is the best sauce,” David said as he
turned to Colby.

“Has he been eating OK?”

“Well, he’s definitely thinner than the last time I saw
him,” Colby replied.

“Have you been eating regularly?” David asked.

“Not as much as I would like. They let me eat at the soup
kitchen but I can’t get there every day.”

After they returned to David’s office, Sean thanked him for
lunch.

“It’s no problem, really. I’m happy to do it considering you
paid for it.”

“What?”

“Well, if you say that First National owns your loan now,
then you’ve probably paid enough interest to cover the cost of lunch.”

“No way. It can’t be that much.”

“Whatever you say,” David said as he seated himself behind
his desk. Sean and Colby followed suit and seated themselves in the comfortable
chairs in front.

“How often do you make sports bets?” David asked.

“I dunno. At least once a week, I guess.”

“What’s your win-loss record?”

“Whaddya mean?”

“I mean, have you won more money than you lost?”

“Honestly, I think I’ve lost more money than I’ve won.”

“And that’s normal for your typical gambler. The way the
game is set up the odds favor the bookie, not the gambler. A bettor may go on a
winning streak for a while, but eventually he will lose more than he wins. It’s
only a matter of time. The odds are against him.”

“But there’s gotta be some people out there who can pick
winners and have won more than they lost.”

Sean and David both looked at Colby.

“Is that true?” David asked.

“No,” Colby said as he shook his head. “None of my
customers, if they’ve used me for any length of time have won more than they
lost. The only winner in this game is me.”

“But if nobody wins, then why do so many people bet?”

“You tell me,” David said as he leaned back in his chair.

There was an uncomfortable silence as Sean stared back at
them. He was perplexed. The expression on the faces of David and Colby was a
combination of pity and repose. Sean couldn’t take the silence anymore.

“But it makes no sense. The odds can’t be that bad. If so,
why would anyone wanna play? There’s something you’re not tellin’ me.” He
fidgeted in his chair.

“There’s really nothing else to it,” David said. “But let me
ask you this. If one wants to make money do you think it makes more sense to
engage in enterprises where the odds favor the player, or games where the odds
are against the player?”

“Obviously games that favor the player.”

“Then why do you keep gambling? It’s a money game where the
odds are clearly against the player.”

“I dunno. I guess it’s more fun to watch a game when there’s
money on the line.”

“But is it more fun when you win or when you lose?”

“It’s more fun when you win, of course. I hate losing.”

“But you said earlier that you lose more than you win. So
according to that logic, if you gamble for fun and you lose more than you win,
it doesn’t sound like much fun at all. It sounds foolish.”

“What are you trying to say?” His voice rose.

“Well, considering the fact that you gamble and have a lot
of debt at a high interest rate, it’s easy to see why you’re poor. And if you
don’t change your ways you will remain so. If a large portion of your income
keeps going to your bookie and your creditors, how do you expect to ever get
ahead? But what I really don’t understand is why you continue to gamble
considering your financial situation and the fact that you’re almost starving.
Wouldn’t it make more sense to spend your money on food and paying down your
debts so you wouldn’t be paying those high interest charges? What do you think
Colby?”

“It’s pretty dumb, pal.” Colby said as he looked directly at
Sean.

“I can’t believe this!” Sean said as he jumped to his feet.

“You’re both just a bunch of crooks who are swindling
people! The government needs to do something about both of you!”

Sean stomped out of the office in disgust. He couldn’t
believe that he had just subjected himself to this insulting scrutiny.

“What a bunch of jerks!” Sean said to himself as he passed
the New York Stock Exchange. As he made his way back home he was still upset,
but kept thinking about their conversation.

When Sean returned home he quickly found some old bank
statements and checked the interest he was paying on his debts. He added up
several months of interest charges and realized the total was many times more
than their extravagant lunch. He realized he’d also been paying these interest
charges for several years. He was dumbfounded.

The next day he visited Colby at his place of business.
Colby said nothing as he entered. Sean had a look of humility about him to
which Colby remarked, “I told you the truth would be hard to take.”

“You were right. He was right. About everything.”

“What made you see the light?” Colby asked as he lit a
cigar.

“Let’s just say I looked at my debts and did some
arithmetic.”

“Numbers don’t lie.”

“No they don’t. Is there any way you can get me in to see
him again? I want to apologize.”

“You were pretty rude when you left, and he was just trying
to help you.”

“I know. I’m sorry.”

“Well, I won’t make another appointment for you, but you can
go downtown with a bottle of Scotch and try to make amends. That is, if he’ll
see you. He’s very busy.”

“Scotch?”

“Right. He drinks straight malt.”

“That’s an expensive drink. Not sure I can afford that.”

“It’s your call.”

“All right. I guess that’s fair.”

Sean went home and found some money. He bought a bottle of
straight malt Scotch on the way downtown and later strolled into the lobby of
the First National Bank. He found David’s receptionist and presented the bottle
to give to him.

“One moment, sir,” the receptionist said as she arose and
went into the large corner office.

“He’s very busy today,” she said when she returned. “But he
might be able to squeeze you in if you don’t mind waiting.”

“I don’t mind.”

About thirty minutes later, the receptionist brought Sean in
to see David. He was surprised when he saw Colby there and they were both
laughing and drinking the Scotch. The bottle was almost empty.

“Pull up a chair,” David said. “You passed the test.”

“What test?”

David threw some ice in a glass and poured some Scotch for
Sean.

“The test of self-illumination. My friend Colby here went
through the same thing when I revealed the truth to him a few years ago.”

“What truth?”

“That cause and effect are as absolute in the realm of
finances as they are in every other facet of the universe. You wanted to know
why the rich get richer and the poor get poorer. Getting richer or poorer is an
effect. Compound interest is the cause.”

“The wealth secret of the ages is simply this: The rich get
richer through compound interest while the poor pay interest.”

“That can’t be the only reason.”

“Think about it. If you have one group of people paying
interest to another group who collects it, then a good portion of a nation’s
income will funnel into the hands of the people who collect the interest. As
they continually roll over their interest earnings into more loans, it will
compound exponentially. Some describe it like a pyramid. At the bottom are the
people paying the interest, whereas the people at the top are collecting it.
This is how the wealth of society concentrates into the hands of a few. This is
how the rich get richer.”

Sean was astonished.

“That’s shocking. It almost doesn’t seem fair to the rest of
us.”

“There’s no question that owners of capital have a tremendous
advantage in our society. But that doesn’t mean the rest of us are at a
disadvantage. Unlike gambling, this is not a zero sum game. We live in a free
country and no one is forcing people to take out loans. Going into debt is a
choice. You said yesterday that I was swindling people and that the government
should do something about it. Do you remember?”

“I’m really sorry about that. I didn’t know what I was
saying.”

“That’s OK. A lot of people think that way. They believe
that if the government somehow evens everything out that we will all be better
off. Unfortunately, they tried that in Russia back in 1917. The result was the
Soviet Union and look where they are today. Joseph Stalin is now starving and
murdering his own people in the name of income equality. So the question is:
Would you rather live in a free country like the United States, or a country
like the USSR where everyone is ruled by an iron fist?”

“I definitely prefer to live in the USA.”

“You and me both. But the important thing to remember is
this: lenders must have new borrowers to make loans to. They could not exist
otherwise. And fortunately for them, the public is happy to oblige. They have
an almost insatiable thirst for more and more debt.

“Most people take on additional debt as their income
increases. They buy bigger, more expensive homes and fancier, more expensive
cars. They may buy a boat, or even a second home. These purchases are all
financed using debt. Yet they never thought about saving their increased income
and putting that money to work for them, which would compound exponentially
over time. If they had done so early on, they would have been amazed at how
quickly their assets would have grown. After a while, they would have been able
to purchase all those nice things in cash, owning them free and clear.

“The rich, on the other hand, have very little personal
debt. They own their homes, cars, boats, and everything else free and clear.
They can pay for their kids’ college tuition in cash instead of using loans.
Rich people are doing the exact opposite of what poor people are doing. One
group is collecting interest while the other group pays it.”

Sean said nothing as he continued listening.

“A great anecdote to illustrate this point is the story of
the Rothschilds. They are the great banking dynasty of Europe. The story goes,
that toward the end of the eighteenth century a banker in Frankfurt, Germany
named Rothschild had five sons and sent them to the commercial centers of
Europe to open banking branches. He sent one each to London, Paris, Vienna, and
Naples, while the eldest stayed home in Frankfurt. The London, Paris, and
Vienna houses are still in operation today despite all the wars and political
turmoil of the last hundred plus years. They financed all the great wars of the
nineteenth century including the Napoleonic Wars, and through multiple
generations amassed the greatest fortune the world has ever known. They built
palaces and estates in Europe so ostentatious that even kings were envious.
This is the power of compounding interest.

“But here’s the bottom line: people either work for their
money or their money works for them. This is the difference between the rich
and the poor. The poor are both working for their money and paying interest to
their lenders. So before you take on any new debt you should ask yourself if
you really want your hard earned wages paying for some banker’s filet mignon.”

“When you put it like that, it doesn’t sound like a smart
thing to do,” Sean said. “I think I would rather save those interest charges by
not taking on new debt, and buy myself filet mignon instead.”

“Now he’s wising up!” Colby said.

“I think you’re right,” David said as he could see the
illumination on Sean’s countenance.

“When you have no money it’s easy to get into debt especially
if you’re hungry. But you must resist this temptation because you’re just
digging a deeper financial hole that becomes more difficult to dig out. Find
work instead of borrowing.”