"In a depression all.. is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise.."
“Readers of this site will recall that the now-defunct Celsius Network, a multi-billion dollar crypto lending firm (Ponzi scam) with very close ties to SBF [Sam Bankman-Fried], was destroyed in part by its token, CEL. Celsius Network was built around the CEL token, under the brilliant idea that it could be used to spin up billions of dollars in free assets. The structure of a flywheel scheme is quite simple:
“I think there is a real chance the FTX/Alameda collapse is the beginning of the end. The first-order effects are just starting to be felt, as firms like BlockFi shut their doors and others like Genesis get bailouts. More importantly, Sam Bankman-Fried had made himself and his firm perhaps the most public representatives of crypto through lobbying and advertising. Now that the massive fraud behind the scenes has come to light, the psychological devastation from this revelation will lead to more bank runs across the ‘industry.’ And regulators and lawmakers who shook SBF’s hand and took his money (aka stolen money) will need to bring the hammer down to save themselves.”
If you want to be soundly depressed about human nature, read No One Would Listen by Harry Markopolos. Remember Bernie Madoff’s $64 billion Ponzi scheme ? Grupo Santander probably does. As, presumably, do Fortis Bank, HSBC, Natixis, RBS, BNP Paribas, BBVA, Nomura, Tremont Capital, Axa, Dexia and Unicredit – just some of the entities who ended up with over $100 million exposure to Madoff’s, erm, creative accountancy. On five separate occasions, beginning in 2000, Harry Markopolos warned North America’s Securities and Exchange Commission, the SEC, about the Madoff fraud. In his 2005 submission alone, Markopolos highlighted 30 reasons to suspect Madoff of fraud. Reviewing the book, market commentator and author James Grant offered the following:
“How to improve financial regulation and reduce the federal budget deficit, all in one fell swoop ? Fire the SEC. Hire Harry Markopolos.”
Investors should feel rightly indebted to J.K. Galbraith for coining the term “the bezzle” in his fabulous account of The Great Crash [of 1929]:
“In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country’s business and banks. This inventory – it should perhaps be called the bezzle – amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.”
If you require an education in economics, don’t reach for your wallet and look to the LSE. Just bear in mind the following observation from Steven E. Landsburg:
“Most of economics can be summarized in four words: “People respond to incentives.” The rest is commentary.”
As ever, Berkshire Hathaway’s Charlie Munger deserves the last word on the topic: “Show me the incentive and I’ll show you the outcome”.
If people are determined to commit fraud, there is probably not much any of us can realistically do to stop them. We do recall what won us over to investing in Vietnam, however, some years ago – apart from the extraordinarily attractive valuations and growth prospects of this admittedly frontier market. We met with the chairman and chief executive officer of the country’s largest securities broker. We confessed that we had some questions about the standards of corporate governance in the country. She responded that they had indeed experienced a fraud perpetrated by the bank manager of a local bank. As a result he had been executed.
There are, however, certain steps one can take at least to minimise the risk of control fraud and the related risk of catastrophic capital loss. One is obviously to develop an acute judgment of other people’s character. One is not to invest in banks. One is to allow oneself to be naturally drawn to superior allocators of capital, running shareholder-friendly businesses in which they already have a meaningful equity stake. And one is to diversify anyway, because you simply never know.
Charlie Munger, outspoken as always, also has something to add to the risk debate, in this interview with the BBC’s Evan Davis. Asked how worried he is by the then current decline in the share price of Berkshire Hathaway, Munger replies as follows:
“Zero. This is the third time that Warren and I have seen our holdings in Berkshire go down top tick to bottom tick by 50 percent. I think that it’s in the nature of long term shareholding, with the normal vicissitudes and worldly outcomes and markets, that the long term holder has his quoted value of a stock go down by, say, 50 percent. In fact you can argue that if you’re not willing to act with equanimity to a market price decline of fifty percent two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get.”
Munger gets nought out of ten for investor empathy, but ten out of ten for insight and veracity. If you do not know who you are as an investor, the markets are an expensive way of finding out. The physicist Richard Feynman offers a variation on this theme:
“The first principle is that you must not fool yourself – and you are the easiest person to fool.”
Another example of what Munger calls the ‘institutional imperative’.. On July 10th, 2001, an Arizona-based FBI field agent called Ken Williams filed a warning with his bosses in Washington and New York. It was a six page document that began as follows:
“The purpose of this communication is to advise the Bureau and New York of the possibility of a coordinated effort by USAMA BIN LADEN (UBL) to send students to the United States to attend civil aviation universities and colleges.”
As Steven Johnson, author of ‘Where Good Ideas Come From’ points out, this was the infamous “Phoenix memo”, in which Williams had been compelled to draft his warning after detecting an unusually high number of people of “investigative interest” who had signed up at various flight schools in Arizona.
Among the people Williams had interviewed was Zakaria Mustapha Soubra, an aeronautical engineering student on an F-1 visa from the UK. Soubra had pictures of bin Laden at his home. But after sitting on Williams’ memo for three weeks, the agency assigned it to an analyst, who labelled it “routine”.
One month after Ken Williams filed his memo, Zacarias Moussaoui enrolled at Pan Am International Flight Academy at St Paul, Minnesota, where he started training to fly a Boeing 747-400 on a simulator. Onlookers grew suspicious after Moussaoui paid his entire $8,300 fee in cash, and claimed to have no interest in ever flying a real plane. Pan Am contacted the FBI. The FBI in Minnesota then tried frantically to obtain a search warrant to examine files on Moussaoui’s laptop. That search warrant would not be granted until the afternoon of September 11, 2001.
Our point is not to criticise the FBI or its role in US homeland security. But it is to highlight that in large organisations, things get missed. It wasn’t that the FBI was unaware of a possible plot involving foreign students and aircraft – to their very great credit, an agency staffer reported his concerns. But the agency was too big, or too bureaucratic, to act sufficiently quickly on that information.
The history of the financial crisis that erupted in 2007/8 and which continues to cast a dismal shadow over global monetary policy, austerity measures, ultra-low interest rates and quantitative easing, is a history of failing institutions. Central banks and government regulatory agencies conspicuously failed to understand, oversee or control commercial and investment banks during a historic property and credit bubble. And banking institutions, as we know only too well, by and large completely failed to manage their own balance sheets and risk exposures. So now we have an extraordinary crypto market blow up, and we seem well set on a journey back to J.K. Galbraith’s reformed, more chastened economy, in which money is watched with a narrow, suspicious eye. Ecclesiastes 1:9. There is nothing new under the sun.
As you may know, we also manage bespoke investment portfolios for private clients internationally. We would be delighted to help you, too. Because of the current heightened market volatility we are offering a completely free financial review, with no strings attached, to see if our value-oriented approach might benefit your portfolio -with no obligation at all:
Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’. You can access a full archive of these weekly investment commentaries here. You can listen to our regular ‘State of the Markets’ podcasts, with Paul Rodriguez of ThinkTrading.com, here. Email us: email@example.com
Price Value Partners manage investment portfolios for private clients. We also manage the VT Price Value Portfolio, an unconstrained global fund investing in Benjamin Graham-style value stocks and specialist managed funds.
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