Fraud is a boom-time crime

[Crewleader]

Cheat, Pray, Love

by James Surowiecki




Along with slashed payrolls, rising foreclosures, and plummeting stock prices, 2008 brought another unwelcome development: a surge in bank robberies, which were up more than fifty per cent in New York. This wasn’t shocking: we typically expect property crimes to rise in hard economic times. There is, though, one crime against property which bucks this trend: defrauding investors. On Wall Street, fraudulent schemes tend to thrive during economic booms, and to blow up when times turn tough. While bank robbers are getting busier, the Bernard Madoffs are starting to get caught.

Madoff is just the latest in a long line of fraudsters who took advantage of investor euphoria. Time and again, as asset markets have become frothier, fraud has flourished. During England’s South Sea Bubble, in 1720, a host of bogus joint-stock companies arose, including one that described its enterprise as “nitvender,” or the selling of nothing. The boom of the nineteen-twenties featured men like Arthur Montgomery, who ran a Ponzi scheme promising investors four-hundred-per-cent returns in sixty days, and the Match King, Ivar Kreuger, who sustained match monopolies all over the world with forged bonds and doctored books. More recently, the stock-market bubble of the late nineties gave rise to enormous frauds at companies like Enron and WorldCom.

Fraud is a boom-time crime because it feeds on the faith of investors, and during bubbles that faith is overflowing. So while robbing a bank seems to be a demand-driven crime, robbing bank shareholders is all about supply. In the classic work on investor hysteria, “Manias, Panics, and Crashes,” the economist Charles Kindleberger wrote that during bubbles “the supply of corruption increases . . . much like the supply of credit.” This is more than a simple analogy: corruption and credit are stoked by the same forces. Cheap money engenders a surfeit of trust, and vice versa. (The word “credit” comes from the Latin for “believe.”) The same overconfidence that leads investors and lenders to underestimate the risks of legitimate investments also leads them to underestimate the likelihood of fraud. In Madoff’s case, for instance, his propensity for delivering inexplicably consistent returns month after month should have been a warning sign to his investors. But in the past few years besotted investors were willing to believe lots of foolish things—like the idea that housing prices would just keep going up.

http://www.newyorker.com/talk/financial/2009/01/12/090112ta_talk_surowiecki?

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1. There is a Hollywood type thought that won't leave my head about Madoff.

I was intrigued by the interview with him and his young genius employee who sat on the couch with him while they both explained how they ran their business - pre-'failure'. In the interview there were some words exchanged with the interviewer about how guiet their offices were. Then, I read the story of a wealthy philanthropist (I believe it was this person) who outlined how investors had to be approved by Madoff and not all were accepted.

What if he had two companies - one for getting himself and friends rich and the other for bringing others down (controlled by inclusion/exclusion) and only the latter is being exposed. Madoff is walking around, not in jail - I guess they are still trying to sort out all the damages and figure out what to charge him with. Meanwhile, I believe there are very few who expect him to be charged or found guilty. Something tells me that the Madoff scheme is not closed down.