Who Needs the Fed?. John Tamny

a habit of searching for those prone to mistakes.

      Richard Noyce and Gordon Moore were Silicon Valley pioneers from the earliest days. In a preview of the “cheap revolution” that personifies the technology sector to this day, they and their cofounders at Fairchild Semiconductor sold microchips to early adapters for less than they cost the company to make them.¹² The idea was to give their customers an incentive to incorporate Fairchild’s “chips” into their products. That the founders of Fairchild grew rich validated their strategy.

      By 1968, they were ready to try something new. When Noyce and Moore approached venture capitalist Arthur Rock (the original investor in Apple Computer¹³), Rock immediately asked, “What took you so long?”¹⁴ Given Noyce and Moore’s sterling track record, Rock couldn’t wait to invest with these two visionaries in what became Intel. Rock was so confident in them that, according Walter Isaacson, author of The Innovators, “He barely asked what they were going to make.” As Rock later explained, “It was the only investment that I’ve ever made that I was 100 percent sure would succeed.”¹⁵

      Success is a magnet for credit, interest rates be damned. While it’s true that the credit constantly migrating to Silicon Valley is of the most courageous kind, truly easy credit is always attainable for those who have already earned their investors a return.

      Thinking about all of this in terms of the Fed and its various attempts to fine-tune access to the economy’s resources, its movement of the fed funds rate up or down twenty-five basis points is of little consequence. The logical response is that potential returns shrink as the cost of credit rises. But as the story of Silicon Valley investing makes plain, most companies that attract capital still implode. It’s already accepted by these intrepid investors that the majority of the time they’ll get nothing back for the credit they offer. The few investments that succeed do so at levels that make prior losses easily digestible.

      The Fed’s machinations are ultimately irrelevant to a sector of the economy that, as Tim Harford wrote in Adapt: Why Success Always Starts with Failure (2011), “has been built on failure after failure after failure.”¹⁶ So, while the Fed’s activity certainly negatively affects the monument to wealth and credit creation that is Silicon Valley, it doesn’t in the way that most would presume.

       CHAPTER FIVE

       Did You Hear the One about Donald Trump Walking into a Bank?

       “Is not commercial credit based primarily upon money or property?”

       “No sir,” replied J. P. Morgan. “The first thing is character.”

       “Before money or property?”

       “Before money or anything else. Money cannot buy it. . . . Because a man I do not trust could not get money from me on all the bonds in Christendom.”

      —H. W. Brands, The Money Men

      IN MANY WAYS, Donald Trump is best known today for his high-profile 2016 run for the office of president of the United States. But back in the 1980s, Trump was most famous for his skills in the area of property development. Those skills made him very rich.

      What is interesting about the 1980s is that even though charitable giving grew from $77.5 billion in 1980 to $121 billion in 1989,¹ some in the commentariat dismissed those years of robust economic growth as the “Decade of Greed.” Trump’s unapologetic advertisement of his great wealth helped fuel their misplaced disgust.

      Notable about Trump, and this shouldn’t be read as a pejorative, is that his accounting of his net worth was not necessarily how others perceived it. More to the point, Trump and those from whom he wanted to borrow did not share the perception of his creditworthiness.

      I can’t repeat enough that for every borrower there is a saver. Furthermore, when an individual borrows “money,” he is not seeking dollars so much as pursuing the economic resources (credit) that dollars can command in the marketplace. In Trump’s case, he sought credit in the late 1980s in order to fund the revival of the Ambassador Hotel in Los Angeles.

      A once grand hotel in the Wilshire District, a few miles from downtown Los Angeles, the Ambassador’s notoriety then had to do with something extremely tragic. On June 6, 1968, Democratic presidential candidate Senator Robert F. Kennedy was assassinated in the kitchen of the Ambassador.

      In the aftermath of the assassination both the hotel and the surrounding area fell into long-term decline. But an entrepreneur sees potential where others see failure. That’s what makes the entrepreneur so central to positive economic evolution. Trump saw potential in a hotel and an area of Los Angeles that others had given up on, and he needed credit to animate his vision.

      That’s where Security Pacific Bank came into the picture. The Los Angeles–based bank was the fifth largest in the United States at the time, and Trump sought a meeting with its newly appointed CEO, Robert H. Smith.

      Smith was no stranger to big names in the world of business. Given the size of Security Pacific, and its lending potential based on that size, major players from various business sectors regularly courted him and the bank he ran. A few years earlier, Peter Ueberroth had approached Security Pacific about loan financing for an airline idea he had. Smith and his colleagues probably should have ended the discussion right there, when we consider the historical correlation between airlines and bankruptcy.

      The fact that they didn’t speaks to a truism about credit that can never properly be explained by Fed officials playing around with interest rates. Ueberroth had an outstanding reputation. Having already built and sold a successful travel business, he perhaps had a sense of airlines that the average dreamer did not. His service as Commissioner of Major League Baseball increased his stature. He also oversaw the highly profitable 1984 Summer Olympics in Los Angeles.² Well connected, handsome, and in possession of a great track record, Ueberroth was the definition of good credit.

      Yet he wanted a large loan to purchase Hawaiian Airlines. Airlines were, and remain to this day, heavily regulated. Additionally, volatile fuel prices substantially impact their profits, because oil is priced in a floating dollar that lacks definition. Stated plainly, airlines are the definition of bad credit. Their history is in many ways a history of bankruptcy.

      Ueberroth planned to put a seasoned airline executive in charge of his purchase, partner up with a major airline, and eventually sell at a profit. It all seemed simple. And as Smith recalls, there was a strong desire among senior Security Pacific executives (including its then CEO, Richard Flamson) to do business with a prominent southern California personage like Ueberroth.

      Ueberroth’s argument in favor of the deal was a classic credit story. As he explained it to Smith, Flamson, and others, “I’m pretty sure that the name alone—Peter Ueberroth—can pull the deal through with one of the major airlines. That’s the key.”³

      So while the bank’s loan to Ueberroth didn’t measure up to its internal credit standards, it was made nonetheless. As Smith explained, “Security Pacific was paying a premium to be linked to the Ueberroth name, and there was a powerful windfall from such a prestigious involvement.”⁴

      Unfortunately for Ueberroth and Security Pacific, the seemingly foolproof plan never lived up to expectations from a profits standpoint. The airline’s planes remained rather empty, the partnership with a major airline never materialized, and the odds of Ueberroth paying back what Security Pacific had loaned him plummeted. Smith referred to the deal as Security Pacific’s Heaven’s Gate (referencing a famous Hollywood film bust),⁵ and the bank eventually sold its loans for a fraction of their initial worth. Security Pacific had, in the words of Smith, bought into “the