Fraud & Venture Capital
Christopher C. Goodfellow
March 1 1999

"If my memory serves me correctly, somewhere in the advertising of the National Bank, there is the phrase a "new way of banking". Indeed."

So whoever would have thought it would happen here? Our very own little Whitewater scandal with loans against non-existent assets guaranteed by the taxpayer!

Thanks to the Montreal Gazette's reporting this week on the federal government's small business loans guarantee program, what many of us have heard over the past year as rumours about what had been going on has been confirmed. The shenagans are in the open.

Your pocket has been picked once again! ...and this time by the banks themselves.

What's next?

I expect we have only seen the tip of the iceberg so far in this. I say this because I had a little personal experience with the U.S. Savings and Loan crisis in the mid 1980's. I had been asked to go to the southwest to look at some large "ranches" that had been re-possessed by the Federal Home Loan Administration. This was before the full scope of the problem became clear to the Federal Reserve and before the true cost of the bailout became apparent.

It was for me a lesson in how government guarantees administered by another party result in complete fiscal disaster. I saw firsthand how many local S&L's had extended loans using property as collateral with the full knowledge that it was highly unlikely the money could ever be repaid. The line between fraud and stupidity is very grey in many cases but land that was worth at most $20 an acre in terms of potential agricultural activity (I'm talking about mesquite, cactus and desert that would require 20 acres to support one cattle unit!) had been booked and collateralized at $5,000 an acre as prime potential real estate development land. This is essentially what Whitewater was all about. The simple fact a federal guarantee was available on the loan opened the door for complicity between real estate appraisers, bankers, lawyers and businessmen to fleece the government of billions of dollars and they did.

This is exactly the same door that was opened by our federal government guaranteeing these small business loans for hard assets, property and equipment here in Canada. What is so incredible is that the program was augmented in 1993 when anyone with any sense - and I include Mr. Martin - could see the possibilities for corruption entering the picture with the recent examples of S&L's in the U.S.

The responsibility clearly falls on Mr. Martin's doorstep because as Minister of Finance he should have been aware of the potential for fraud.

The Gazette articles point out (with the example of a once convicted drug dealer in complicity with another ex-convict and a bank manager, either dishonest or naive in the extreme) just how ill-conceived government loans, guarantees and grants are.

It is more of an incentive to criminal activity than to developing sound businesses.

What the Gazette articles do not suggest is a remedy which is far more important now that the problems are there for all to see.

The remedy is quite simple. It must all stop. Period. For thirty years we have had one department after another such as DREE and Investment Trade & Commerce come up with one scheme after another. From Bricklin to this latest example we have seen nothing but waste, theft, scandal and favouritism from most government intervention in private business through loans, grants and guarantees. Billions have been lost over the years. Big companies like GM, Bombardier and others have learned to use the threat of closure and job loss to extract what in the final analysis are concessions from governments which in another context might be considered blackmail.

I have written elsewhere on solutions and other more constructive objective tools that do not involve subjective input on the part of people, either politicians, bureaucrats or friends, that could result in defrauding the taxpayer. In order to get the economy moving, the prime tool that should be employed is a transparent, open and fair-to-all tax credit system and the incentive should only be paid out by the taxpayer ( yes, its our money! ) to the investor only AFTER the investment has actually produced the stated goals either of permanent job creation or taxable profits. Zip, Nada, Nothing upfront by the taxpayer...period.

After not Before.

The government has no business WHATSOEVER in acting as a venture capitalist in start up enterprises which is exactly what it has done with this small business loans program and in countless other scandalous failures in the past. However, even more to the point in this case, it has become a reckless venture capitalist once removed! If the government provides sufficient transparent, objective, open-to-all incentives through the tax system, there are plenty of private investors willing to put up the venture capital and shoulder the risk.

Moreover, the present system of subjectively managed incentives sets up potential situations similar to what has recently been disclosed in the operations of the International Olympic Committee. And let us not kid ouselves, favours do go to friends. The present approach also offends most honest businessmen who manage their businesses, conserve their assets and pay real taxes to see the government hand out largesse like this to fraud artists and friends.

True, the vast majority of borrowers from banks are legitimate and will pay back their debts and banks factor in for the bad apples. But it is wrong to transfer the credit risk to taxpayers. Leave the credit risk on the doorstep of the banks where it belongs for them to do adequate due diligence on the background of borrowers like Mr. Lallouz.

If the government felt that the banks were not making sufficient loans to small businesses then instead of taking the credit risk off the banks, there is another very simple solution. De-regulate banking immediately and allow many more lenders to come into being. The competition will be healthy and many more avenues of lending will be open for small business.

I wouldn't hesitate to employ both these suggestions tomorrow were I in a position to do so. I suspect when all is said and done the losses under this program will probably cost taxpayers in excess of half a billion dollars. Think about that the next time a friend or relative lies on a gurney in the ER for a few days. We shouldn't be bailing out the shareholders of the banks. We should be demanding the resignation of the Minister of Finance and the Minister of ITC for allowing this to happen. It isn't chump change. This is a major scandal. It is the price they would pay in any private enterprise boardroom.

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