Great frauds in history: Charles Keating
Charles Keating's junk bond scam let the American taxpayer on the hook for $3.4bn.
Charles Keating was born in Cincinnati, Ohio, in 1923 and went on to serve in the US Navy before getting a law degree from the University of Cincinnati in 1948. He set up the law firm Keating, Muething & Keating in 1952, before co-founding American Financial Corporation with Carl Lindner Jr. in 1960. American Financial was initially very successful, but Keating was forced to leave amid accusations of fraud and misleading investors. In return for resigning, Keating was given control of American Continental Homes (later American Continental Corporation).
What was the scam?
In 1984 American Continental Corporation bought Lincoln Savings and Loan Association for $50m. Keating took advantage of a prior relaxation of the rules to expand Lincoln’s asset base by buying large numbers of junk bonds and speculating in various real-estate schemes. When American Continental ran into trouble in the weak property market of the late 1980s, Keating began diverting money from Lincoln to prop up the parent firm. At the same time, he pressured Lincoln’s customers to exchange their federally protected deposits for American Continental bonds, falsely claiming they were risk-free.
What happened next?
Government regulators became increasingly concerned at Lincoln’s lending practices and the flow of money between the two companies. Although he was initially able to exploit his political connections to keep them at bay, the regulators eventually cracked down, banning any further money transfers. Facing huge losses from property speculation, American Continental went bankrupt in April 1989, and regulators immediately shut down Lincoln as well. After a long legal battle, Keating spent nearly five years in prison.
Thanks to federal protection, Lincoln’s depositors emerged unscathed, although the US taxpayer was left with a $3.4bn bill. By contrast, the American Continental bonds were not only unprotected, but also subordinated to other creditors. The 23,000 bondholders lost a total of $250m.
Lessons for investors
Always check whether a supposedly “risk-free” investment is fully protected before you invest. Deposits in banks covered by the Financial Services Compensation Scheme are protected, but those in corporate bonds generally are not (which is why the latter usually offer a much higher interest rate).