Charles Schwab sent out an email this morning that contained this article. I don't understand -g-
Individual Investors' Worst Bloopers
by Zachary Karabell
September 11, 2000
Investing can seem like a cross between a roller-coaster ride and a train wreck: an absolutely exhilarating experience until disaster strikes. Long before this year's dot-com correction, investors have been persuaded to put money into schemes that seemed foolproof then and foolhardy now.
Take the Great Tulip Mania, which took hold in a country that would perfect many of the tools underlying capital systems, including the floating of stocks, bonds and credit. In the 1630s, the Netherlands was a prosperous region, a trading hub for the warring monarchies of western and central Europe. Tulips, valued by the wealthy for their decorative qualities, had become a popular commodity. The Semper Augustus, its petals streaked with purple, was the most valuable. One bulb of the purple-streaked variety could command 6,000 guilders, a small fortune which, according to Edward Chancellor, author of Devil Take the Hindmost, could have paid for a small furnished house and a few tons of grain to boot.
Many small-time investors, seeing the potential for huge profits, mortgaged their homes to obtain credit for the bulbs. When the tulip market collapsed in 1637, they were left penniless and flowerless.
Crazy trains
More than two centuries later and a continent away, railroads had become an American investment darling for thousands of investors. They seemed a sure thing in the years following the Civil War. Construction was booming as dozens of companies (most memorably the Union Pacific and Central Pacific racing to complete the transcontinental link) scrambled to build thousands of miles of track that would crisscross the continent. The lines were funded by bank loans and floating shares on various stock exchanges.
Toward the end of the 1860s and continuing for the next two decades, individual investors—many of them English speculators—who had hoped to profit from the booming economy watched their shares dwindle to almost nothing. How did this happen? While tracks continued to be laid and the freight business continued to grow, the cost of laying the track and buying locomotives simply exceeded revenues, according to Charles Morris' Money, Greed, and Risk. Too many lines competed for business, causing rate wars, which led to shrinking income, which in turn caused bankruptcy after bankruptcy. Multiple stock offerings to raise money further diluted the value of individual shares. The result: While bankers and steel magnates came out ahead, few individual investors did.
The so-called Chunnel represented another "sure bet" that wasn't. A century after the railroad boom, a joint British-French venture undertook one of the largest engineering projects ever: the construction of a tunnel underneath the English Channel. A consortium called Eurotunnel oversaw the building of what became known as the Chunnel.
No light at the end
In 1987, Eurotunnel offered shares to the public, and 700,000 investors took the leap. The stock soon climbed to nearly £6 per share ($10 U.S.) and investors were promised free trips through the tunnel. The Chunnel seemed like a no-brainer investment. After all, there was no doubt that the tunnel would be built, and that it would be used. Everyone assumed that if the cost overruns became too great and posed any danger to the company, either the French or British government would step in, rescue the company, complete the project and make sure that investors were compensated.
But as Drew Featherston grimly recounts in The Chunnel: The Amazing Story of the Undersea Crossing of the English Channel, the project went over budget every year. By the early 1990s the cost had doubled to nearly $15 billion. More shares were issued to raise the money, and the price began to drop. Then banks lent money in exchange for a larger stake in the company, further devaluing the shares. By the time the Chunnel opened in 1994, the shares were trading at a quarter of their peak value; neither government had stepped in to rescue the company, and no profits were forecast until at least 2005. The tunnel had been built, the contractors made a small fortune and the banks recouped. But the individual investors could have done much better elsewhere.
These investments in flowers, railroads and tunnels are just three examples of bad decisions that were made for what seemed like the right reasons. Investing always carries risk—and investors will always be susceptible to unpredictable and uncontrollable developments. Just as such debacles have happened throughout history, history indicates that they will happen again.
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