People have been getting ripped off lately.
Thousands of Enron employees reportedly have lost money on the Enron stock they held in their 401(k) plans or personally. Millions of Argentines who scrimped to build up dollar-denominated bank accounts now can’t get at their money.
These people have been victimized, in the first case by apparent fraud and in the second by decades of bad government. I feel sorry for them but would suggest that some of the loss claims need to be taken with a grain of salt.
The losses people feel frequently exceed the losses they actually experienced.
And I am not talking about Linda Lay’s claim earlier this week that she and her husband (former Enron CEO Kenneth Lay) had lost just everything, everything, in Enron’s collapse.
I refer, rather, to the differences between some true victims’ self-perceived losses and a more objective judgement.
One Enron employee testifying before Congress reported that his holdings of Enron stock had exceeded $1.2 million at one point and now were valued at less than $10,000. He feels he was cheated of $1.2 million.
This is true only in a very limited sense. Yes, if he had sold out all that stock on the day his holdings hit peak value and purchased other assets, his net worth might be $1.2 million higher today than it is.
Perhaps he was poised to do exactly that and was seduced into desisting at the last moment because of the siren songs of Mr. Lay and other company officials assuring shareholders that the future was bright. But I’m sure only a few employees in his situation considered doing that.
You might respond that if Enron had not issued fraudulent financial statements over the years, this man might have known to put his retirement funds in other alternatives.
That is true, but if he had, his retirement funds wouldn’t have soared, as did Enron’s stock. The employee might have had $400,000 or $500,000 in safer investments, but not $1.2 million, because safer alternatives didn’t experience the dizzying run-up that Enron did.
Thus, the true opportunity cost of this person’s fraudulent seduction was the $400,000 or so that he might have amassed in alternative investments, but not $1.2 million.
Middle class Argentines feel betrayed because their governments assured them that a peso and a dollar would forever be convertible at par and that they could opt to save in dollars or in pesos at their choice and convenience.
Those who chose to save in dollars now have dollar accounts that are effectively frozen. They can’t withdraw dollars perhaps not till 2004 or later, nor can they withdraw pesos.
These people similarly deserve sympathy. But the need to realize that the convertibility law, in which each peso they earned was deemed equal to an U.S. dollar, worked in their favor for nearly a decade.
If the peso had floated relative to the dollar during the 1990s, no one would have been able to amass the same dollar savings from peso earnings that they did under convertibility.
The true opportunity cost of their losses is the amount that they might have been able to save under an alternate exchange rate regime and not what was in their bankbook in mid-November of last year.
I have to admit that if I were in either of these situations, I would probably feel the same way. I would look at look at my 401(k) statement for the month in which it was at its highest value and say, “This is how much those blankety-blank cheats stole from me.” But I would be wrong.
I owned a farm in southwest Minnesota that in late 1982 probably was worth $500,000. Five years later, the economic policies of Ronald Reagan, Tip O’Neil and Paul Volcker had caused its value to drop to $200,000. Did I lose $300,000? Only in the sense that I lacked the foresight to sell out in 1982. Having decided to hang on to it, the subsequent drop in my net worth was my fault and not that of anyone in Washington.
“What is the true opportunity cost?” is the fundamental question in three fourths of all economic questions.
“I could’a been a contender,” Marlon Brando famously rasped in On the Waterfront.
That is a natural human impulse, but reality is usually somewhat more modest for most of us.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.