A Book Report: Zero Coupon by Paul Erdman
Published 26 Oct 2017
When Zero Coupon by Paul Erdman opens the main character, William (Willy) F. Saxton has just completed a three year plus one day sentence at the white-collar Federal Correctional Institution in Pleasanton, California for improprieties while selling junk bonds (Erdman). There is nothing illegal about selling junk bonds per se, but Erdman does not reveal the specific nature of Willy’s crime
While in prison, Willy redesigned the prison library with an emphasis toward finance and economics. Consequently he was able to keep current with the world economics as well as develop a multifaceted financial plan that would allow him to continue to work in finance even though the SEC banned him for life from the securities industry. Before going to prison Willy had stashed sixty million dollars in a numbered bank account Liechtenstein. By the time Willy got out of prison, the money had increased to nearly seventy-five million. Willy planned to use this money to provide capital for his plan (Erdman).
The first move Willy makes is to gain control of the investment-banking firm of Prescott & Quackenbush. This firm is ‘regarded as on of San Francisco’s finest’ investment banks (Erdman 14). The bank is owned by two of Willy’s friends, but is in trouble. They have been hit with a lawsuit that threatens the firm’s ability to remain solvent (Erdman).
Willy next buys forty-nine percent, with an option to buy the remaining fifty-one percent, of Western Credit Rating, a company that rates bonds before the bonds are issued for sell.
The company has a cash flow problem and is seeing its marketplace on the West Coast erode as two of the largest bond rating companies, Standard and Poors and Moody’s, have begun to move into the market in a large way. Willy also uses an implied threat of revealing the owner’s involvement in a fraudulent company to convince the owner of Western Credit Rating to sell. This threat will come to haunt Willy. In the process of setting up his business, Willy ingratiates himself to a famous San Francisco socialite named Denise van Bercham. She introduces him to a wide variety of people. When she introduces Willy to the Chief Administrative Officer of San Francisco. In a discussion about how difficult is to finance services for the poor. Willy suggests they ‘piggyback’ bonds to finance these services to a regular issue of San Francisco bonds. To ‘piggyback’ the bonds is to require that anyone who purchases any of San Francisco’s normally highly rated bonds must also buy some of the lesser-rated bonds to finance social services for the poor. This act helps Willy establish credibility within the San Francisco community and enhances his reputation (Erdman).
Willy’s next move is to start a company that uses advanced technology to predict market movement. He hires ‘geeks’ all of whom have been in trouble with the SEC and has them build a massive computer system and use a calculus that takes into account as many factors as possible to predict future movements in currency. To make this work he exhausts all of his funds and needs to provide additional capital. He issues zero coupon bonds to get the needed money and the company begins to operate. By thoroughly analyzing international currencies Willy hopes to make money by investing in derivatives. His plan works well and he quickly makes enough money to settle all of his debts and to make certain his company will continue to make money.
Willy’s financial scheme is to make money by buying and selling derivatives that are essentially money futures. His theory is that given sufficient information he will be able to predict movements in the value of currencies. He does this by selling short on derivatives or money futures. To provide short term capital, Willy makes use of information Willy has gained about a proposed recycling center in Ukiah and plans to build a town in Eastern Oregon to issues zero coupon bonds to finance two bogus recycling systems for two small cities in Northern California. He sells these bonds to an acquaintance on the East Coast. Since the bonds are not payable for forty years, Willy has in effect used bogus bonds to obtain capital to provided needed financing for his company with virtually no threat of being caught until the bonds become payable. Once Willy has made a sufficient profit he retires the bogus bonds he has issued by paying a premium of twenty-five percent to his friend on the East Coast. Although this process was illegal, Willy destroyed all the evidence when he burned the bonds and no one is the wiser and he is not exposed to threat of punishment (Erdman).
‘Junk bonds’ are bonds that are rated below investment grade. Investment grade is usually considered to be anything rating from BBB- or higher by Standard and Poor’s or Baa3 or higher by Moody’s. Typically these bonds pay a high rate of return but the risk is greater (Erdman).
‘Credit rating companies’ are companies that rate bonds prior to the time the bonds are issued. The two best-known companies are Poor’s and Moody’s.
The ‘SEC’ or Securities Exchange Commission is a federal agency charged with enforcing federal security laws and regulating the securities industry. The SEC has the authority to ban people found guilty of fraud and other crimes for life. According to Erdman the SEC does not have the authority to provide oversight of credit rating companies.
A ‘bond’ is a financial instrument used by both governments and private companies to get capital. Typically the bond is issued for a particular time and pays a specified interest rate. The purchaser of the bond ‘clips’ the bond coupons and turns them into the issuing organization. The ‘zero coupon bond’ mentioned in the title is a type of bond that has no coupons. Instead all the interest is paid when the bonds are retired at the end of the specified time (Erdman).
‘Derivatives’ are an instrument where an investor borrows funds at a specified rate and immediately sells the funds at the current rate. He takes the money this generates and, when the term of the contract expires uses this money to pay the amount he borrowed. If the currency has been devalued as the investor hopes, he is able to repay the loan and pocket the difference. If however the value of the currency goes up the investor will lose money. Derivatives are considered extremely risky because of the enormous amount of factors that can influence the value of a particular currency. This plan works well and the company soon begins to make money at a phenomenal rate, making approximately a half billion dollars in one week.
A ‘cash flow problem’ is a situation in which a company, although financially stable, has difficulty meeting its current obligations. Typically this is a short term problem do to a lack of liquidity, i.e., the ability to convert assets into cash to pay bills.
Erdman writes both fiction and nonfiction books dealing with the world of finance. His fiction is in the financial thriller genre and has been a bestseller. Some of them have been made into successful movies. He has publish finance books in both German and English. He has written columns for many newspapers and magazines. Erdman has extensive experience and education in this area. He earned a PhD from the University of Basel in Switzerland (Erdman flyleaf).
Zero Coupon is an exciting and informative book. Erdman writes in the third person. His prose is clear and easy to read. At times the financial details are complex and confusing, but Erdman does a good job of explaining what the terms mean. The plot twists in Zero Coupon are often surprising and as a result engage the reader fully. Like all of Erdman’s fictional works Zero Coupon is an excellent book and a thought-provoking read. It has been ten years since he has published a novel, hopefully Erdman will write a new financial thriller soon.
- Erdman, Paul. Zero Coupon. New York: Tom Doherty Associates, Inc., A Forge Book, 1993.