Tuesday, December 3, 2013

Book review: The Great Salad Oil Swindle

The Great Salad Oil Swindle, by Norman C Miller, Published by Coward McCann New York, 1965, Library of Congress Catalogue Number 65-20407




Tina De Angelis and The Great Salad Oil Swindle are remembered today as an important milestone in the career of Warren Buffett. American Express was the biggest (dollar) victim of the swindle and their stock cratered. A then unknown small-town hedge fund manager called Warren Buffett purchased five percent of American express for twenty million dollars - and scored a ten bagger.

However, this is not a book about Warren Buffett. The unknown Buffett doesn't even rate a mention. It's a book about fraud and fraudsters and the dupes that allow them to thrive.

And that is a story that is plenty relevant today.

===

1963 was a different world. Agricultural commodities were king. Twenty thousand tonnes of tallow (hard fat from meat often used in making soap) cost an amount sufficient to bankrupt many Wall Street firms - now it costs an amount equal to a half dozen good bonuses. Selling food to Spain involved negotiating with the Opus Dei (a conservative Catholic sect controversial in part for backing authoritarian right-wing governments). And where American Express insisted that all divisions make at least $500,000 in profit.

But it was surprisingly similar in various ways as well. People worked within their narrow domain and when it didn't make sense they didn't rock the boat. People could be bought-off by surprisingly small profit streams. And when it all went wrong they went back to business as usual without much introspection as to their stuff-ups.

Moreover the really large stuff-ups and frauds could then (as now) be avoided with common sense (something that is surprisingly uncommon).

Background

Tino De Angelis was a Bronx boy, son of Italian immigrants, who found a job in the meat and fish market and rapidly found success. Mostly that came through circumventing government regulation or ripping off government programs. His first fortune was black-market meat with war-time rationing - though he was never prosecuted. The vegetable oil business for which he later became famous (and which is the subject of this book) arose from quirks in the Food for Peace program, a program which was ostensibly about aiding the beaten up economies of Europe but was just as much about subsidizing farmers.

Tino's first company was Gobel, a meat-packing concern which had frequent enough clashes with the government, the first major one being over the sale of 18,900,000 pounds of smoked meat to a school lunch program. [The weights were wrong...]

Later Gobel was prosecuted by the SEC for overstated profits - then understated losses and for borrowing money against inventory that didn't exist. The book doesn't spell it out so clearly but Gobel either overstated revenue or understated its expenses producing fake profits. Fake profits would normally be held in the balance sheet as fake cash however that was too easy for auditors to find so the fake cash was converted into fake inventory. Just to add insult Gobel borrowed money against non-existent inventory.

Nobody went to prison for that but the Justice Department later prosecuted Tino for perjury and destroying evidence, however the prosecution case fell apart at trial when the key witness recanted.

Tino then entered the business of exporting vegetable oil from the US. Most of the "oil crushers" were in the Midwest and exported via the Great Lakes or Mississippi, but Tino established the Allied Crude Vegetable Oil Refining Corporation (Allied) at Bayonne New Jersey in a port facility with some reconditioned petroleum refining tanks. He had to be there - it was closer to Manhattan and the money and status of Wall Street.

The (privately held) Allied seemed to be profitable and accrued large tax bills, however like at Gobel the profit was an illusion - it was spent on endless inventory and some overstated plant - and like at Gobel the inventory was illusory.

Like at Gobel there was an undertone of ripping off the government, some of which was done through "Food For Peace" program. An early example was the (subsidized) shipping of a million tonnes of feed grain to Austria for feeding pigs. The population of Austria was seven million so this is 140 kg (over 300 lbs) per man, woman and child. As an official investigating later observed everyone in Austria would have been truly sated on pork chops. [The grain was then sold at very low prices on the black market to East Germany - the then cold-war enemy. This is an extension of the war-time rationing cheats De Angelis grew rich on.]

Also like Gobel there was extensive borrowing against phantom inventory.

Most of the book is about how the borrowing took place. The key however was that American Express had a warehousing business which issued receipts confirming that commodities (oil, grain, vegetable oil and other commodities) had been delivered to warehouses and were stored safely. Finance was offered by at least fifty banks against these receipts. [This sort of finance, including finance for cargoes on ships, is common enough and usually goes under the rubric of "trade finance".]

In this case the warehouses were on the Hudson river, used to contain petrochemicals and were now filled with sea-water topped with a thin layer of vegetable oil. In each tank there was a tube built over the testing hole - and that tube which went to the bottom of the tank was also filled with vegetable oil. Depth-tests of the vegetable oil showed the tanks were full.

Over $100 million worth of these receipts were issued. Allied also stole an American Express receipt book and forged additional receipts. Many of the forged receipts were held by brokers (especially Ira Haupt & Co) as collateral for futures contracts buying still more vegetable oil.

A lesson of the book: corrupting people is inexpensive especially when they are only a small cog in a big wheel. It is very difficult for say a warehouseman to take an honest job if it involves a sixty percent drop in his salary. [Corollary - you have to cut Wall Street bonuses a long way before you make corruption unattractive...]

The collapse of Ira Haupt & Co

The forgotten part of the scandal is the collapse of a small Wall Street broker - Ira Haupt & Co. Ira Haupt paid $18 million in margin calls on behalf of Allied (secured by fraudulent warehouse receipts) and thus the futures exchange had no loss. Ira Haupt however was bust.

Because the Chicago commodity exchanges had no loss they behaved holier-than-thou taking no responsibility for their (moderate) duplicity. But the New York Stock Exchange was terrified. The text has resonance even today:
[T]he stock exchange officials feared with good reason that if they did not help Haupt, there might be a widespread loss of confidence by investors in the integrity of brokerage firms. Haupt's 20,700 customers had left stocks worth more than $450 million in the safekeeping of the firm. Almost $90 million of these stocks had been purchased partially on credit and, as was entirely proper, Haupt had pledged these stocks to banks for loans. Customers also had left $5.5 million in cash on deposit with Haupt.
Haupt was bailed out, a bail-out largely forgotten because it happened the weekend President Kennedy was assassinated.

The collapse of Haupt however led to the establishment of the first Wall Street fidelity fund. It was settled with the quaint sum of $25 million.

This book is refreshingly jargon-free. And the human foibles that make great scandals possible haven't changed much. Nor has their vulnerability to common sense.

When Allied collapsed the stocks of vegetable oil at Bayonne and in futures contracts were more than a year's supply. To avoid this one you only needed to ask the right questions.






John

PS. Several prices amuse me. Soya oil was typically about 7.5-8c per pound (say about $180 per tonne). A Cadillac cost $6000 - about 33 tonnes of oil. A New York apartment suitable for a mistress [the measure in the book] cost about $15000 (or 83 tonnes of oil).

Soya Oil is now about 40c per pound.  The Cadillac costs $75000 or about 85 tonnes of oil. The New York apartment costs maybe $1.5-2 million or over 1700 tonnes of oil. New York apartments measured in vegetable oil have been twenty baggers.

This accords with other observations. Australian farmers have gone from being the richest people in the world to having difficulty sending their children to city schools. Warren Buffett (befitting someone his age) tends to compare businesses to the yield on farm land whereas nobody else on Wall Street would have any idea what the yield on farm land is.

--

PPS. The book - purchased on Amazon - came with two bookmarks. The first was a computer punch card (the first I have seen in more than a decade). The second a business card.



J. Victor Herd was an important person in New York insurance in the 1950s to 1970s. He warranted a long obit in the New York Times. The Continental Insurance Companies may have once been headquartered downtown but are now firmly in Chicago (as part of CNA). This is just another example of the decline of "Downtown".

The business card is old school. There is an address but no phone number (his secretary would have worked out whether you were worth his time) but only after you looked up the phone number in the white pages and were directed through the switchboard. (Correction, there is a phone number with an area code being LL...)

I am not sure when they retired the musket-soldier image. These are now collectables on Ebay.




J





4 comments:

JD said...

Isn't that a phone number in the top-right corner of the card? Or does it mean something else?

Anonymous said...

That's definitely a phone number in the upper right. Prefix codes were given in letters and used to refer to neighborhoods.

Scott Garren and Heather Shay said...

Yup, a phone number. When I was a kid in Manhattan my phone number was GR7-5502 where GR was for Gramercy, a neighborhood near us.

John Connor said...

I have wondered if part of the problem with farming is democracy and urbanisation. The country vote doesnt matter and high food prices are deeply unpopular not just for voters but also central bankers (see UK / US et al inflation pre 1900 or India today). I own a farming business in Australia (family owns the land and a brother and I own the business which runs), it does OK as we sell water (best margin business I know) but the buyer of the water is companies given contracts by the govt. Our core farming business of livestock faces the duopolistic nature of super markets in many countries plus spreads and comms in livestock sales which are an equity brokers dream. We however view the farming business as a hedge and prefer to play the game (working in finance etc) where the government take x% of peoples pay and force it into markets based on a tick of a box even if they have no need for the capital, the sickness of indexation. However at some point the game will be up. Do you have a real world hedge? Or do you believe the financial system is sound? I do not understand in a low growth world how brokers and asset managers overall can skim conservatively 100bps from the real worlds retirement assets each year plus corporate executives pay largess in addition to dilutive option plans, this amounts to no real return for most. For now I play the game (working with the system) because farming doesnt make as much money, I somehow feel immoral for not fighting against this but I have children for whom I want the best education. Perhaps worse, I sadly suspect most of my contemporises are simply amoral which is worse than not knowing what yield in farming terms means.

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The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.