Bad Blood

On the one side, we hear that America is secretly being run by a very clever set of nefarious financiers. These evil masterminds control large sums of wealth which thy use to create large businesses, bringing them ever more profits while destroying the small businesses and jobs of regular Americans. Wall Street dominates Main Street in every way possible, both financially and politically.

On the other side we hear about the American miracle of growth driven by a free and open economy which allows funds to flow to businesses which will make the best use of those funds. The noble financier makes this all possible. Through the purchase of stock, a hard-working laborer in Nebraska can easily become an owner of Apple. America has grown because the system works so well, rewarding the industrious and clever and eliminating the outdated and failures. The financier makes this all possible.

These narratives are everywhere. It is likely you subscribe to one of the other.

Here is the funny thing. Pick your favorite narrative. Then try to explain Theranos.

John Carryrou’s Bad Blood is a rollicking tale about a fledgling startup company which rocketed to the top and then crashed and burned in the most spectacular manner possible. I learned about the book when I was the moderator on a panel of alums at Mount Holyoke who had come back to give tips to the students on how to get started in business. One of the questions I asked was what book each panelist would recommend. Two of the five panelists suggested Bad Blood; both clearly loved the book. So, I assigned in in my Introductory Economics class this semester. It was indeed a riveting story.

Elizabeth Holmes dropped out of Stanford to pursue her dream of founding the next Great Tech Company. The company was Theranos. The idea: build a small, easily portable device which could take a mere few drops of human blood and run just about every blood test in existence.

The possibilities of such a device are endless. If you need to do regular blood tests, you could have one in your home. Drugstores and supermarkets could have blood testing stations in the corner of the market. The military could put them in the back of a Humvee. Instant analysis of your blood, any time, any place. No needles necessary; just prick your finger and this marvelous little machine will do the rest.

It is certainly an attractive idea. Everyone agreed about that.

Now to build something like that, you need money. And Elizabeth Holmes was very good at convincing people to give her company money. Lots of money. Staggering amounts of money. She was young, perky, dressed like Steve Jobs, and had an intense gaze and boundless self-confidence. People were lining up to fund her company.

There was just one problem. The machine didn’t actually exist. Not only that, but nobody in the company could figure out how to actually create the machine. Not only that, it didn’t take long for everyone who showed up to work for the company to figure out that there really wasn’t any way to get a machine to do all these tests with so little blood. Not only that, but every prototype of the machine was an absolute disaster. The results generated by the machines were all over the place; there was absolutely no reason to trust the results of these machines.

So, how was Holmes able to convince so many people that Theranos was on the verge of rolling out this marvelous product? The prototypes she used for her presentations were fakes. They pretended to analyze the blood, but they weren’t actually do it.

Eventually, Theranos started rolling out their product into Walgreens stores. The whole thing was a sham. For many of the tests, instead of taking a drop of blood, they would get the blood the old fashioned way—with a needle. They would then send the blood to a regular lab with regular equipment. You were lucky if they did that, by the way. If they used their machines, then you might well find out you had some terrible disease which you didn’t actually have.

Yet, the company kept growing. At one point, the Theranos Board of Directors had the following people on it: Henry Kissinger, James Mattis, Sam Nunn, William Perry, Gary Roughead, and George Schultz. Two former Secretaries of State, a former Secretary of Defense, two former high ranking military commanders, and a former Senator. If a company with that Board of Directors tells you they have this neat new product, why wouldn’t you believe them?

And wow, did people believe it. Tim Draper, for example, invested a million dollars in the early years. Rupert Murdoch invested $125 million in the later years. Over all, the company raised $700 million. And remember, there was never a functioning prototype or even a realistic schematic of a prototype that might actually work. There was nothing at all.

Eventually, Carreyrou, a Wall Street Journal reporter, got wind of what was going on at Theranos, and exposed the whole company for the fraud it was. The house of cards crumbled. Bad Blood is the story.

The amazing thing about the book is that by the end of chapter 2, you know the end is about to come. The rise of Theranos goes on for another chapter, and you know this has to be the end. Then, chapter by chapter, Theranos just keeps getting bigger and bigger. All the signs of the problems were there right at the outset. But, that did not stop Elizabeth Holmes.

How did this happen? And here is where those conflicting narratives about American finance get stuck. If financiers are such evil or clever geniuses, why did they fall for the spiel of a young Stanford dropout? People lost a lot of money here. Why?

The reality is that far from being omnipotent forces for good or evil in the world, the modern American financier is just a person with large ambitions and the same range of insight and intelligence as the rest of the population. The reason they seem so much more brilliant is selection bias.

Imagine average people each picking an individual company as the wave of the future. Some of those companies will fail and we will never hear about those investors again. But some will succeed and we will hear about those investors. They will naturally attribute their success to their cleverness and brilliance. But, was it?

That is an answerable question, by the way. All we have to do is look to see how the investors who made successful choices in the past do on their subsequent investments. It turns out they look very average. In other words, having had one success has no predictive value on whether they will have future success. We just hear about the ones with the lucky streak. The unlucky ones vanish.

Elizabeth Holmes was perfect for this world. She was the type of person every 60 year old successful man wanted to believe in. So, they believed in her. And they lost.

Elizabeth Holmes’ trial on charges of conspiracy and wire fraud is slated to begin next year.