He “also paid out to earlier investors money he took in from later investors,” the prosecutor said.

TO BE NOTED: From Bloomberg:

"Regensberg, Investment Adviser, Sentenced to 9 Years (Update1)

By David Glovin

June 19 (Bloomberg) -- Hayim Regensberg, the former president of Arbco Capital Management LLP and Mid West Trading LLC, was sentenced to more than nine years in prison for defrauding investors in an $13 million Ponzi scheme, prosecutors said.

Regensberg, 44, was found guilty in April of two counts of securities fraud and seven counts of wire fraud. He was sentenced to 100 months in prison by U.S. District Judge Victor Marrero in New York.

The money-manager was arrested in 2007. He told investors he had access to foreign initial public offerings before the general public did and that his investors could receive returns of 5 percent to 15 percent within weeks, prosecutors said.

“He invested and lost large portions of investor money in highly speculative and risky trading,” Acting U.S. Attorney Lev Dassin in New York said today in a statement. He “also paid out to earlier investors money he took in from later investors,” the prosecutor said.

Robert Baum, a federal public defender for Regensberg, said he will appeal and declined to comment further.

The case is U.S. v. Regensberg, 07-cr- 1865, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporters on this story: David Glovin in Manhattan federal court at dglovin@bloomberg.net."

And I’m perfectly happy to be one of the people alleging that Stanford was a Ponzi, even if Matt isn’t quite there yet.

From Reuters:

"Felix Salmon

nonrival, nonexcludable

« Previous Post

June 4th, 2009

Does Kroll run a regulator-quashing operation?

Post a comment (1)

Posted by: Felix Salmon

Tags: fraud, regulation

My new colleague Matt Goldstein wonders today why it took so long to nail Allen Stanford:

Bryan Burroughs, in the most recent issue of Vanity Fair, does a good job detailing how just about every US investigative agency was on Stanford’s tail for more than 15 years…

I’m told Houston and New Orleans agents from DEA and IRS even considered running an ABSCAM-style sting on Stanford in 1998… The agencies planned to invite Stanford and some of his cronies to the party to see if he’d be willing to do business with the drug dealers… The sting never happened. It’s not entirely clear why.

Sure, a lot of the difficulty in going after Stanford stemmed from the simple fact that he kept the core of his operation in a tiny country, whose political leaders were all too cozy with the native Texan and dependent on his largess to fuel the nation’s economy. But there probably also was a simple lack of will on the part of the SEC, FBI, DEA and IRS to follow things through, in part because so many of Stanford’s banking customers were Latin Americans.

Or, as Burroughs describes, may be it was the aggressive lobbying by the investigative firm Kroll that tamed the authorities looking into Stanford.

The Kroll connection is fascinating. Here’s Burroughs:

Behind the scenes, Stanford was even more aggressive. as the company grew, he became renowned within law-enforcement circles for aggressive counter-intelligence. Stanford’s security chief was a former head of the FBI’s Miami office. But his greatest asset may have been a top security firm, Kroll associates, whose Miami office worked with Stanford for years. “Stanford was spending millions of dollars a year trying to figure out who was looking at him, and aggressively combating whoever it was,” recalls the former FBI agent. “Kroll was essentially running a propaganda campaign in defense of Stanford’s good name.

Kroll’s role in defending Stanford’s reputation, in both law-enforcement circles and the wider banking community, was an example of a controversial practice known within the private-security world as “reputational self-due diligence,” that is, vouching for a client’s good name… “It is, by all accounts, an exceedingly lucrative business… It is controversial, even inside the firm. Kroll is considered—how to say this nicely—well, they’re willing to take more controversial clients for this type of service.”

Kroll worked for Stanford for over a decade, and if it does turn out that they were running a regulator-quashing operation, this could turn out to be extremely bad for their reputation.

Incidentally, Matt’s still adjusting gingerly to the world of blog: like the careful reporter that he is, he’s still describing Stanford as “the man who allegedly ran an $8 billion Ponzi scheme”. My response to the ritual insertion of the word “allegedly” in such sentences is to say that you can’t be running an alleged Ponzi scheme if there’s no one doing the alleging. And I’m perfectly happy to be one of the people alleging that Stanford was a Ponzi, even if Matt isn’t quite there yet."

Me:

I still believe that the best lobbyists for a Ponzi Scheme are the clients, many, if not all, of whom, are wealthy and well connected, with easy access to lawyers. After all, you have to go to these clients and say:

“We’d like to look into your investment, since you’re getting unnaturally high returns.”

The answer might well be:

“You don’t say. Fancy that. That’s what I’m paying this person for!”

Perhaps someone could look into what, if anything, clients said or did, during these years.

- Posted by Don the libertarian Democrat

There are 100 good reasons why Mr. Dreier should be” jailed, Judge Rakoff said.

TO BE NOTED: From the NY Times:

"Lawyer Pleads Guilty to Running Ponzi Scheme

By BENJAMIN WEISER

Published: May 11, 2009

A prominent New York lawyer whom prosecutors have called a “Houdini of impersonation and false documents” pleaded guilty on Monday to leading what the authorities have called a Ponzi scheme that bilked hedge funds and other investors out of at least $400 million.

Skip to next paragraph

Multimedia

Interactive

Documents in the Case of Marc Dreier

The lawyer, Marc S. Dreier, a graduate of Yale University and Harvard Law School, sold $700 million worth of bogus promissory notes to investors, a federal indictment charged.

He then used the proceeds to maintain a lavish lifestyle, according to the authorities, which included owning a $10 million apartment on the Upper East Side, beachfront properties in the Hamptons, a valuable art collection, expensive cars and an $18.5 million yacht, documents show.

“He has disgraced the honorable profession of law,” the judge, Jed S. Rakoff of Federal District Court in Manhattan, said after Mr. Dreier entered his plea.

His decision to admit guilt was not a surprise, as his lawyer, Gerald L. Shargel, had been saying for months that his client intended to plead guilty. Last month, Mr. Shargel told Judge Rakoff that Mr. Dreier felt “profound remorse,” accepted full responsibility for his crimes and had been cooperating with the authorities as they attempted to untangle his scheme and track down assets that might be returned to victims.

But Mr. Shargel and a federal prosecutor, Jonathan R. Streeter, clashed over whether Mr. Dreier, who turns 59 on Tuesday and could face up to life in prison, should be allowed to remain in his Manhattan apartment under highly restrictive conditions of home detention until he is sentenced on July 13.

“There are 100 good reasons why Mr. Dreier should be” jailed, Judge Rakoff said. “By his own admission here today, he has shown that he is to be ranked with those who have committed some of the most egregious frauds in history.”

But Judge Rakoff ultimately ruled that Mr. Shargel had met the legal standard for his client to remain out of jail, by demonstrating that Mr. Dreier, who no longer controls the millions of dollars he obtained, had neither the ability nor the resources to flee."

People like to feel special and there's something seductive about profiting from being an insider

From Free Exchange:

"Insider seduction

Posted by:

Economist.com | NEW YORK

Categories:

Crime and punishment

LAST week on "Gossip Girl", a soap opera about rich New York City high-school students, I caught an interesting bit of dialogue between Rufus (the impoverished middle-class Brooklyn arty type) and Serena's new boyfriend Gabriel (the prodigal son of a wealthy, tobacco family who had some elaborate, yet noble-sounding scheme to make lots of money and help the African poor).

Rufus: I’d like to invest as well.

Gabriel: And as much as I appreciate your support, there are other investments better suited for someone in your situation: municipal bonds, mutual funds. I’d be happy to show you how to set something up.

Rufus: I know how to open a mutual fund... I don’t appreciate being patronised

Gabriel: No, No, No. That wasn’t my intention, I apologise

Rufus: My money is just as good as anyone else's. That's how the game works, isn't it? Opportunity arises in the private rooms of restaurants and on exclusive golf courses, and the rich get richer and the guys in the middle are never there. Well, I am right here and I want in.

The investment turned out to be a Ponzi scheme (and yes, I occasionally watch "Gossip Girl"). But this highlights the popular view that long-term investors holding mutual funds have become suckers, missing out on the backroom dealings that make the rich richer. The truth, of course, is that even the balance sheets of the wealthy have taken a large hit—they often have even more equity exposure. And, as in the show, many of those insider deals turn out to be frauds.

Why do seemingly smart investors hand over their money to shady characters? I once interviewed a "reformed" con artist who claimed that the surest way to rope in your target was to convince him he was in on a scheme that no one else knew about. People like to feel special and there's something seductive about profiting from being an insider. The exclusivity of investing with Bernie Madoff probably explains some of the lack of diligence."

Me:
Don the libertarian Democrat wrote:

May 6, 2009 16:14

"to convince him he was in on a scheme that no one else knew about"

I'm not sure about this, but, in the case of Madoff, it's more like you don't want to be at a party where someone asks you if you invest with X ( Excellent returns, exclusive, etc. ), as they do, and you say "no", as they then look at you with a knowing and pitying smile.

If you look at "Ponzi Schemes of the Caribbean" on The Baseline Scenario, you'll read this:

http://baselinescenario.com/2009/05/02/ponzi-schemes-of-the-caribbean-a-...

“validation, when
large and easy rewards earned by initial members generate strong word of mouth publicity”

Again, this sounds very public, like gaining admittance to an exclusive, but well known, club. I don't see keeping it a secret as being capable of generating the number of clients ( suckers ) needed for a Ponzi Scheme.

more detail than you likely ever wanted to know about how Ponzi schemes work - particularly in and around the Caribbean

From The Baseline Scenario:

"Ponzi Schemes Of The Caribbean (A Weekend Comment Competition)

with 8 comments

The IMF has just released a new working paper, with more detail than you likely ever wanted to know about how Ponzi schemes work - particularly in and around the Caribbean.

Ponzi schemes are everywhere and, at least in some environments, new versions arrive frequently. But why are they so hard to prevent and shut down once they appear? The paper contains some strong hints, albeit couched in very diplomatic language.

The comment competition is: what, if anything, does the failure of governments to shut down blatant Ponzi schemes imply about the prospects for a potential “macro-prudential” system/market-stability regulator implementing cycle-proof rules in the United States? Is there a better way to prevent the kind of behavior that led to our current financial crisis?

Written by Simon Johnson

May 2, 2009 at 7:34 am"

Me:

I said the following on one of James’ posts on March 12th:

“Have you ever heard of a Ponzi Scheme being stopped as soon as it began? I doubt it. That’s because it mirrors a particularly lucrative investment for quite a long time. How many people are going to let you close down there investor because you suspect that his returns are too high? They’re more likely to respond that you’re high.

There’s no stopping a Ponzi Scheme until it runs its course. It’s a perfect crime for a fairly long time. Also, notice, Madoff admitted his guilt. Stanford isn’t so stupid it seems. He doesn’t believe that the government can even figure out how a Ponzi Scheme works, let alone convict him of running one. He might turn out to be right.”

Now I can refine my view, based on that superb paper. First, this post for reference, from The Trader’s Narrative:

“The Madoff Red Flags, Let’s Count Them”

http://www.tradersnarrative.com/the-madoff-red-flags-lets-count-them-2154.html

From the essay:

“Red flags. Experience shows that there are certain hallmarks that point towards the
existence of investment fraud. Thus, the development of such red flags creates a basic
tool for the identification and investigation of fraudulent schemes. The Caribbean UIS
had a number of features considered to be red flags by the Securities and Exchange
Commission (SEC) and the Commodity Futures Trading Commission (CFTC).”

I don’t think it’s an ignorance of Red Flags that’s the problem. The problem occurs here:

“validation, when
large and easy rewards earned by initial members generate strong word of mouth publicity”

If you look at the recommendations, they depend upon giving the power to a regulator to confront people who are making big money. Depending upon who these people are and their resources, that is a herculean task. In other words, depending upon who is being defrauded, the regulator might not be able to stop the scheme until the major investors in the scheme begin to get hurt. I’m simply dubious that Red Flags are enough to stop a Ponzi Scheme, nor are Regulators enough.

What regulators could do is develop a case and attempt to get the actual investors in the scheme to call for an accounting. Again, if you simply go to investors and say, “We’d like to shut down your investment because your returns are too high”, they will probably respond,”Are you high?”.

And:

I should have said that the conclusion of my reading of Ponzi’s Schemes is that Counter-Cyclical policies, if this means restraining investment during an upturn, are not likely to work well. The idea of the Fed, for example, slowing the entire economy in order to stop a possible bubble in one area of investment, just seems unrealistic, especially when it could add to unemployment. Maybe I’m wrong. My thought experiment is to consider how hard value investing is to do well. It’s hard to invest in a downturn and to cut back in an upturn.

My reason for going to Narrow/Limited Banking is that it would place our free market system on sounder footing. There are certainly trade-offs, but allowing ourselves to be dealing with Debt-Deflation is really awful.

To the extent that we’ve dodged a Debt-Deflationary Spiral, we ought to thank God. For those of us who are terribly afraid of this possibility, we cannot allow ourselves to let this happen again. Many other people don’t seem to fear this beast. I am certainly critical of Geithner, Paulson, and Bernanke, but, to the extent that their actions have been directed at stopping Debt-deflation, I’m glad that they understood the problem, and have attacked it, if not as effectively as I would have liked.

Other cases that resulted in big settlements involved allegations of conflicts of interest and suspicions of a Ponzi scheme

TO BE NOTED: From the NY Times:

"Last year, the Securities and Exchange Commission faced criticism that it had been lax in its duties as a financial enforcer. This year, under its new chairwoman, Mary L. Schapiro, it appears to be working to change that impression. It is picking up the pace of financial settlements.

Skip to next paragraph

The New York Times

In the first quarter of 2009, the S.E.C. reached 182 new financial settlements, according to NERA Economic Consulting. That compares with 157 in the year-ago period and 123 in the previous quarter.

The largest S.E.C. settlement, for $200 million, involved UBS, accused of facilitating tax evasion. The second largest, for $177 million, involved Halliburton and a former unit, KBR, which were accused of bribing foreign officials. (The companies also settled with the Justice Department in these cases.)

Other cases that resulted in big settlements involved allegations of conflicts of interest and suspicions of a Ponzi scheme. PHYLLIS KORKKI

Next Article in Business (16 of 24) » A version of this article appeared in print on April 26, 2009, on page BU2 of the New York edition."

the bank will experience a run. To deal with this problem, we have deposit insurance

TO BE NOTED: From Derivative Dribble:

"The Unbearable Lightness of Nassim Taleb In Uncategorized on April 13, 2009 at 7:30 am

Also published on the Atlantic Monthly’s Business Channel.

As Conor notes, Nassim Taleb offered up some less than sage advice in a recent “article” in the Financial Times. The article, which takes the form of a talismanic list, was crafted in order to the deliver humanity from its suffering by pointing our mind’s eye towards the failures of our regulatory dogma. Wielding powerful metaphors such as “Make an omelette with the broken eggs,” Taleb fails to meet even the lowest of standard for a statement on regulatory policy. “Counter-balance complexity with simplicity” might be an acceptable policy position for Deepak Chopra. But it is certainly unacceptable for an economist.

Looking beyond Taleb’s absurd delivery, the substance of his policies is, in large part, absent, and where present, addresses the real issues at play in a superficial and borderline whimsical fashion. It is unclear whether this is the product of haste, or the product of a complete lack of command over the issues and concepts. For example, Taleb states that:

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

To say that only Ponzi schemes depend on confidence — they don’t, since they’re the product of fraud and misrepresentation — is factually incorrect and suggests intellectual laziness. The extension of credit and contracting depend on confidence in the ability of a counterparty to perform. In a broader sense, the organizational structure of society depends on people being able to rely on the predictability of certain events around them (e.g., bus, train, and plane arrivals, banks maintaining deposits, etc.).

This organizational structure is itself a product of confidence. I am confident that the train will arrive shortly after I get to the train station in the morning, and as a result, I plan on taking the train to work each day. I am confident that my bank will maintain my deposit level, and so I don’t have a mattress full of cash. When confidence is eroded, the incentives of individuals become misaligned.

Take, for example, the case of a bank run. Each depositor has an incentive to withdraw its deposits based solely upon the assumption that all other depositors are doing so, since we have a fractional reserve banking system. Yet each would be better off if none of them withdrew their deposits. When the assumption rings true in the minds of enough depositors, that is, when confidence breaks down, the bank will experience a run. To deal with this problem, we have deposit insurance, which the Government provides to create and maintain confidence in the banking system."

These numbers as large as they are, vastly understate the problem of fraud.

TO BE NOTED: From Bill Moyers Journal:

"April 3, 2009

BILL MOYERS: Welcome to the Journal.

For months now, revelations of the wholesale greed and blatant transgressions of Wall Street have reminded us that "The Best Way to Rob a Bank Is to Own One." In fact, the man you're about to meet wrote a book with just that title. It was based upon his experience as a tough regulator during one of the darkest chapters in our financial history: the savings and loan scandal in the late 1980s.

WILLIAM K. BLACK: These numbers as large as they are, vastly understate the problem of fraud.

BILL MOYERS: Bill Black was in New York this week for a conference at the John Jay College of Criminal Justice where scholars and journalists gathered to ask the question, "How do they get away with it?" Well, no one has asked that question more often than Bill Black.

The former Director of the Institute for Fraud Prevention now teaches Economics and Law at the University of Missouri, Kansas City. During the savings and loan crisis, it was Black who accused then-house speaker Jim Wright and five US Senators, including John Glenn and John McCain, of doing favors for the S&L's in exchange for contributions and other perks. The senators got off with a slap on the wrist, but so enraged was one of those bankers, Charles Keating — after whom the senate's so-called "Keating Five" were named — he sent a memo that read, in part, "get Black — kill him dead." Metaphorically, of course. Of course.

Now Black is focused on an even greater scandal, and he spares no one — not even the President he worked hard to elect, Barack Obama. But his main targets are the Wall Street barons, heirs of an earlier generation whose scandalous rip-offs of wealth back in the 1930s earned them comparison to Al Capone and the mob, and the nickname "banksters."

Bill Black, welcome to the Journal.

WILLIAM K. BLACK: Thank you.

BILL MOYERS: I was taken with your candor at the conference here in New York to hear you say that this crisis we're going through, this economic and financial meltdown is driven by fraud. What's your definition of fraud?

WILLIAM K. BLACK: Fraud is deceit. And the essence of fraud is, "I create trust in you, and then I betray that trust, and get you to give me something of value." And as a result, there's no more effective acid against trust than fraud, especially fraud by top elites, and that's what we have.

BILL MOYERS: In your book, you make it clear that calculated dishonesty by people in charge is at the heart of most large corporate failures and scandals, including, of course, the S&L, but is that true? Is that what you're saying here, that it was in the boardrooms and the CEO offices where this fraud began?

WILLIAM K. BLACK: Absolutely.

BILL MOYERS: How did they do it? What do you mean?

WILLIAM K. BLACK: Well, the way that you do it is to make really bad loans, because they pay better. Then you grow extremely rapidly, in other words, you're a Ponzi-like scheme. And the third thing you do is we call it leverage. That just means borrowing a lot of money, and the combination creates a situation where you have guaranteed record profits in the early years. That makes you rich, through the bonuses that modern executive compensation has produced. It also makes it inevitable that there's going to be a disaster down the road.

BILL MOYERS: So you're suggesting, saying that CEOs of some of these banks and mortgage firms in order to increase their own personal income, deliberately set out to make bad loans?

WILLIAM K. BLACK: Yes.

BILL MOYERS: How do they get away with it? I mean, what about their own checks and balances in the company? What about their accounting divisions?

WILLIAM K. BLACK: All of those checks and balances report to the CEO, so if the CEO goes bad, all of the checks and balances are easily overcome. And the art form is not simply to defeat those internal controls, but to suborn them, to turn them into your greatest allies. And the bonus programs are exactly how you do that.

BILL MOYERS: If I wanted to go looking for the parties to this, with a good bird dog, where would you send me?

WILLIAM K. BLACK: Well, that's exactly what hasn't happened. We haven't looked, all right? The Bush Administration essentially got rid of regulation, so if nobody was looking, you were able to do this with impunity and that's exactly what happened. Where would you look? You'd look at the specialty lenders. The lenders that did almost all of their work in the sub-prime and what's called Alt-A, liars' loans.

BILL MOYERS: Yeah. Liars' loans--

WILLIAM K. BLACK: Liars' loans.

BILL MOYERS: Why did they call them liars' loans?

WILLIAM K. BLACK: Because they were liars' loans.

BILL MOYERS: And they knew it?

WILLIAM K. BLACK: They knew it. They knew that they were frauds.

WILLIAM K. BLACK: Liars' loans mean that we don't check. You tell us what your income is. You tell us what your job is. You tell us what your assets are, and we agree to believe you. We won't check on any of those things. And by the way, you get a better deal if you inflate your income and your job history and your assets.

BILL MOYERS: You think they really said that to borrowers?

WILLIAM K. BLACK: We know that they said that to borrowers. In fact, they were also called, in the trade, ninja loans.

BILL MOYERS: Ninja?

WILLIAM K. BLACK: Yeah, because no income verification, no job verification, no asset verification.

BILL MOYERS: You're talking about significant American companies.

WILLIAM K. BLACK: Huge! One company produced as many losses as the entire Savings and Loan debacle.

BILL MOYERS: Which company?

WILLIAM K. BLACK: IndyMac specialized in making liars' loans. In 2006 alone, it sold $80 billion dollars of liars' loans to other companies. $80 billion.

BILL MOYERS: And was this happening exclusively in this sub-prime mortgage business?

WILLIAM K. BLACK: No, and that's a big part of the story as well. Even prime loans began to have non-verification. Even Ronald Reagan, you know, said, "Trust, but verify." They just gutted the verification process. We know that will produce enormous fraud, under economic theory, criminology theory, and two thousand years of life experience.

BILL MOYERS: Is it possible that these complex instruments were deliberately created so swindlers could exploit them?

WILLIAM K. BLACK: Oh, absolutely. This stuff, the exotic stuff that you're talking about was created out of things like liars' loans, that were known to be extraordinarily bad. And now it was getting triple-A ratings. Now a triple-A rating is supposed to mean there is zero credit risk. So you take something that not only has significant, it has crushing risk. That's why it's toxic. And you create this fiction that it has zero risk. That itself, of course, is a fraudulent exercise. And again, there was nobody looking, during the Bush years. So finally, only a year ago, we started to have a Congressional investigation of some of these rating agencies, and it's scandalous what came out. What we know now is that the rating agencies never looked at a single loan file. When they finally did look, after the markets had completely collapsed, they found, and I'm quoting Fitch, the smallest of the rating agencies, "the results were disconcerting, in that there was the appearance of fraud in nearly every file we examined."

BILL MOYERS: So if your assumption is correct, your evidence is sound, the bank, the lending company, created a fraud. And the ratings agency that is supposed to test the value of these assets knowingly entered into the fraud. Both parties are committing fraud by intention.

WILLIAM K. BLACK: Right, and the investment banker that — we call it pooling — puts together these bad mortgages, these liars' loans, and creates the toxic waste of these derivatives. All of them do that. And then they sell it to the world and the world just thinks because it has a triple-A rating it must actually be safe. Well, instead, there are 60 and 80 percent losses on these things, because of course they, in reality, are toxic waste.

BILL MOYERS: You're describing what Bernie Madoff did to a limited number of people. But you're saying it's systemic, a systemic Ponzi scheme.

WILLIAM K. BLACK: Oh, Bernie was a piker. He doesn't even get into the front ranks of a Ponzi scheme...

BILL MOYERS: But you're saying our system became a Ponzi scheme.

WILLIAM K. BLACK: Our system...

BILL MOYERS: Our financial system...

WILLIAM K. BLACK: Became a Ponzi scheme. Everybody was buying a pig in the poke. But they were buying a pig in the poke with a pretty pink ribbon, and the pink ribbon said, "Triple-A."

BILL MOYERS: Is there a law against liars' loans?

WILLIAM K. BLACK: Not directly, but there, of course, many laws against fraud, and liars' loans are fraudulent.

BILL MOYERS: Because...

WILLIAM K. BLACK: Because they're not going to be repaid and because they had false representations. They involve deceit, which is the essence of fraud.

BILL MOYERS: Why is it so hard to prosecute? Why hasn't anyone been brought to justice over this?

WILLIAM K. BLACK: Because they didn't even begin to investigate the major lenders until the market had actually collapsed, which is completely contrary to what we did successfully in the Savings and Loan crisis, right? Even while the institutions were reporting they were the most profitable savings and loan in America, we knew they were frauds. And we were moving to close them down. Here, the Justice Department, even though it very appropriately warned, in 2004, that there was an epidemic...

BILL MOYERS: Who did?

WILLIAM K. BLACK: The FBI publicly warned, in September 2004 that there was an epidemic of mortgage fraud, that if it was allowed to continue it would produce a crisis at least as large as the Savings and Loan debacle. And that they were going to make sure that they didn't let that happen. So what goes wrong? After 9/11, the attacks, the Justice Department transfers 500 white-collar specialists in the FBI to national terrorism. Well, we can all understand that. But then, the Bush administration refused to replace the missing 500 agents. So even today, again, as you say, this crisis is 1000 times worse, perhaps, certainly 100 times worse, than the Savings and Loan crisis. There are one-fifth as many FBI agents as worked the Savings and Loan crisis.

BILL MOYERS: You talk about the Bush administration. Of course, there's that famous photograph of some of the regulators in 2003, who come to a press conference with a chainsaw suggesting that they're going to slash, cut business loose from regulation, right?

WILLIAM K. BLACK: Well, they succeeded. And in that picture, by the way, the other — three of the other guys with pruning shears are the...

BILL MOYERS: That's right.

WILLIAM K. BLACK: They're the trade representatives. They're the lobbyists for the bankers. And everybody's grinning. The government's working together with the industry to destroy regulation. Well, we now know what happens when you destroy regulation. You get the biggest financial calamity of anybody under the age of 80.

BILL MOYERS: But I can point you to statements by Larry Summers, who was then Bill Clinton's Secretary of the Treasury, or the other Clinton Secretary of the Treasury, Rubin. I can point you to suspects in both parties, right?

WILLIAM K. BLACK: There were two really big things, under the Clinton administration. One, they got rid of the law that came out of the real-world disasters of the Great Depression. We learned a lot of things in the Great Depression. And one is we had to separate what's called commercial banking from investment banking. That's the Glass-Steagall law. But we thought we were much smarter, supposedly. So we got rid of that law, and that was bipartisan. And the other thing is we passed a law, because there was a very good regulator, Brooksley Born, that everybody should know about and probably doesn't. She tried to do the right thing to regulate one of these exotic derivatives that you're talking about. We call them C.D.F.S. And Summers, Rubin, and Phil Gramm came together to say not only will we block this particular regulation. We will pass a law that says you can't regulate. And it's this type of derivative that is most involved in the AIG scandal. AIG all by itself, cost the same as the entire Savings and Loan debacle.

BILL MOYERS: What did AIG contribute? What did they do wrong?

WILLIAM K. BLACK: They made bad loans. Their type of loan was to sell a guarantee, right? And they charged a lot of fees up front. So, they booked a lot of income. Paid enormous bonuses. The bonuses we're thinking about now, they're much smaller than these bonuses that were also the product of accounting fraud. And they got very, very rich. But, of course, then they had guaranteed this toxic waste. These liars' loans. Well, we've just gone through why those toxic waste, those liars' loans, are going to have enormous losses. And so, you have to pay the guarantee on those enormous losses. And you go bankrupt. Except that you don't in the modern world, because you've come to the United States, and the taxpayers play the fool. Under Secretary Geithner and under Secretary Paulson before him... we took $5 billion dollars, for example, in U.S. taxpayer money. And sent it to a huge Swiss Bank called UBS. At the same time that that bank was defrauding the taxpayers of America. And we were bringing a criminal case against them. We eventually get them to pay a $780 million fine, but wait, we gave them $5 billion. So, the taxpayers of America paid the fine of a Swiss Bank. And why are we bailing out somebody who that is defrauding us?

BILL MOYERS: And why...

WILLIAM K. BLACK: How mad is this?

BILL MOYERS: What is your explanation for why the bankers who created this mess are still calling the shots?

WILLIAM K. BLACK: Well, that, especially after what's just happened at G.M., that's... it's scandalous.

BILL MOYERS: Why are they firing the president of G.M. and not firing the head of all these banks that are involved?

WILLIAM K. BLACK: There are two reasons. One, they're much closer to the bankers. These are people from the banking industry. And they have a lot more sympathy. In fact, they're outright hostile to autoworkers, as you can see. They want to bash all of their contracts. But when they get to banking, they say, ‘contracts, sacred.' But the other element of your question is we don't want to change the bankers, because if we do, if we put honest people in, who didn't cause the problem, their first job would be to find the scope of the problem. And that would destroy the cover up.

BILL MOYERS: The cover up?

WILLIAM K. BLACK: Sure. The cover up.

BILL MOYERS: That's a serious charge.

WILLIAM K. BLACK: Of course.

BILL MOYERS: Who's covering up?

WILLIAM K. BLACK: Geithner is charging, is covering up. Just like Paulson did before him. Geithner is publicly saying that it's going to take $2 trillion — a trillion is a thousand billion — $2 trillion taxpayer dollars to deal with this problem. But they're allowing all the banks to report that they're not only solvent, but fully capitalized. Both statements can't be true. It can't be that they need $2 trillion, because they have masses losses, and that they're fine.

These are all people who have failed. Paulson failed, Geithner failed. They were all promoted because they failed, not because...

BILL MOYERS: What do you mean?

WILLIAM K. BLACK: Well, Geithner has, was one of our nation's top regulators, during the entire subprime scandal, that I just described. He took absolutely no effective action. He gave no warning. He did nothing in response to the FBI warning that there was an epidemic of fraud. All this pig in the poke stuff happened under him. So, in his phrase about legacy assets. Well he's a failed legacy regulator.

BILL MOYERS: But he denies that he was a regulator. Let me show you some of his testimony before Congress. Take a look at this.

TIMOTHY GEITHNER:I've never been a regulator, for better or worse. And I think you're right to say that we have to be very skeptical that regulation can solve all of these problems. We have parts of our system that are overwhelmed by regulation.

Overwhelmed by regulation! It wasn't the absence of regulation that was the problem, it was despite the presence of regulation you've got huge risks that build up.

WILLIAM K. BLACK: Well, he may be right that he never regulated, but his job was to regulate. That was his mission statement.

BILL MOYERS: As?

WILLIAM K. BLACK: As president of the Federal Reserve Bank of New York, which is responsible for regulating most of the largest bank holding companies in America. And he's completely wrong that we had too much regulation in some of these areas. I mean, he gives no details, obviously. But that's just plain wrong.

BILL MOYERS: How is this happening? I mean why is it happening?

WILLIAM K. BLACK: Until you get the facts, it's harder to blow all this up. And, of course, the entire strategy is to keep people from getting the facts.

BILL MOYERS: What facts?

WILLIAM K. BLACK: The facts about how bad the condition of the banks is. So, as long as I keep the old CEO who caused the problems, is he going to go vigorously around finding the problems? Finding the frauds?

BILL MOYERS: You--

WILLIAM K. BLACK: Taking away people's bonuses?

BILL MOYERS: To hear you say this is unusual because you supported Barack Obama, during the campaign. But you're seeming disillusioned now.

WILLIAM K. BLACK: Well, certainly in the financial sphere, I am. I think, first, the policies are substantively bad. Second, I think they completely lack integrity. Third, they violate the rule of law. This is being done just like Secretary Paulson did it. In violation of the law. We adopted a law after the Savings and Loan crisis, called the Prompt Corrective Action Law. And it requires them to close these institutions. And they're refusing to obey the law.

BILL MOYERS: In other words, they could have closed these banks without nationalizing them?

WILLIAM K. BLACK: Well, you do a receivership. No one -- Ronald Reagan did receiverships. Nobody called it nationalization.

BILL MOYERS: And that's a law?

WILLIAM K. BLACK: That's the law.

BILL MOYERS: So, Paulson could have done this? Geithner could do this?

WILLIAM K. BLACK: Not could. Was mandated--

BILL MOYERS: By the law.

WILLIAM K. BLACK: By the law.

BILL MOYERS: This law, you're talking about.

WILLIAM K. BLACK: Yes.

BILL MOYERS: What the reason they give for not doing it?

WILLIAM K. BLACK: They ignore it. And nobody calls them on it.

BILL MOYERS: Well, where's Congress? Where's the press? Where--

WILLIAM K. BLACK: Well, where's the Pecora investigation?

BILL MOYERS: The what?

WILLIAM K. BLACK: The Pecora investigation. The Great Depression, we said, "Hey, we have to learn the facts. What caused this disaster, so that we can take steps, like pass the Glass-Steagall law, that will prevent future disasters?" Where's our investigation?

What would happen if after a plane crashes, we said, "Oh, we don't want to look in the past. We want to be forward looking. Many people might have been, you know, we don't want to pass blame. No. We have a nonpartisan, skilled inquiry. We spend lots of money on, get really bright people. And we find out, to the best of our ability, what caused every single major plane crash in America. And because of that, aviation has an extraordinarily good safety record. We ought to follow the same policies in the financial sphere. We have to find out what caused the disasters, or we will keep reliving them. And here, we've got a double tragedy. It isn't just that we are failing to learn from the mistakes of the past. We're failing to learn from the successes of the past.

BILL MOYERS: What do you mean?

WILLIAM K. BLACK: In the Savings and Loan debacle, we developed excellent ways for dealing with the frauds, and for dealing with the failed institutions. And for 15 years after the Savings and Loan crisis, didn't matter which party was in power, the U.S. Treasury Secretary would fly over to Tokyo and tell the Japanese, "You ought to do things the way we did in the Savings and Loan crisis, because it worked really well. Instead you're covering up the bank losses, because you know, you say you need confidence. And so, we have to lie to the people to create confidence. And it doesn't work. You will cause your recession to continue and continue." And the Japanese call it the lost decade. That was the result. So, now we get in trouble, and what do we do? We adopt the Japanese approach of lying about the assets. And you know what? It's working just as well as it did in Japan.

BILL MOYERS: Yeah. Are you saying that Timothy Geithner, the Secretary of the Treasury, and others in the administration, with the banks, are engaged in a cover up to keep us from knowing what went wrong?

WILLIAM K. BLACK: Absolutely.

BILL MOYERS: You are.

WILLIAM K. BLACK: Absolutely, because they are scared to death. All right? They're scared to death of a collapse. They're afraid that if they admit the truth, that many of the large banks are insolvent. They think Americans are a bunch of cowards, and that we'll run screaming to the exits. And we won't rely on deposit insurance. And, by the way, you can rely on deposit insurance. And it's foolishness. All right? Now, it may be worse than that. You can impute more cynical motives. But I think they are sincerely just panicked about, "We just can't let the big banks fail." That's wrong.

BILL MOYERS: But what might happen, at this point, if in fact they keep from us the true health of the banks?

WILLIAM K. BLACK: Well, then the banks will, as they did in Japan, either stay enormously weak, or Treasury will be forced to increasingly absurd giveaways of taxpayer money. We've seen how horrific AIG -- and remember, they kept secrets from everyone.

BILL MOYERS: A.I.G. did?

WILLIAM K. BLACK: What we're doing with -- no, Treasury and both administrations. The Bush administration and now the Obama administration kept secret from us what was being done with AIG. AIG was being used secretly to bail out favored banks like UBS and like Goldman Sachs. Secretary Paulson's firm, that he had come from being CEO. It got the largest amount of money. $12.9 billion. And they didn't want us to know that. And it was only Congressional pressure, and not Congressional pressure, by the way, on Geithner, but Congressional pressure on AIG.

Where Congress said, "We will not give you a single penny more unless we know who received the money." And, you know, when he was Treasury Secretary, Paulson created a recommendation group to tell Treasury what they ought to do with AIG. And he put Goldman Sachs on it.

BILL MOYERS: Even though Goldman Sachs had a big vested stake.

WILLIAM K. BLACK: Massive stake. And even though he had just been CEO of Goldman Sachs before becoming Treasury Secretary. Now, in most stages in American history, that would be a scandal of such proportions that he wouldn't be allowed in civilized society.

BILL MOYERS: Yeah, like a conflict of interest, it seems.

WILLIAM K. BLACK: Massive conflict of interests.

BILL MOYERS: So, how did he get away with it?

WILLIAM K. BLACK: I don't know whether we've lost our capability of outrage. Or whether the cover up has been so successful that people just don't have the facts to react to it.

BILL MOYERS: Who's going to get the facts?

WILLIAM K. BLACK: We need some chairmen or chairwomen--

BILL MOYERS: In Congress.

WILLIAM K. BLACK: --in Congress, to hold the necessary hearings. And we can blast this out. But if you leave the failed CEOs in place, it isn't just that they're terrible business people, though they are. It isn't just that they lack integrity, though they do. Because they were engaged in these frauds. But they're not going to disclose the truth about the assets.

BILL MOYERS: And we have to know that, in order to know what?

WILLIAM K. BLACK: To know everything. To know who committed the frauds. Whose bonuses we should recover. How much the assets are worth. How much they should be sold for. Is the bank insolvent, such that we should resolve it in this way? It's the predicate, right? You need to know the facts to make intelligent decisions. And they're deliberately leaving in place the people that caused the problem, because they don't want the facts. And this is not new. The Reagan Administration's central priority, at all times, during the Savings and Loan crisis, was covering up the losses.

BILL MOYERS: So, you're saying that people in power, political power, and financial power, act in concert when their own behinds are in the ringer, right?

WILLIAM K. BLACK: That's right. And it's particularly a crisis that brings this out, because then the class of the banker says, "You've got to keep the information away from the public or everything will collapse. If they understand how bad it is, they'll run for the exits."

BILL MOYERS: Yeah, and this week in New York, at this conference, you described this as more than a financial crisis. You called it a moral crisis.

WILLIAM K. BLACK: Yes.

BILL MOYERS: Why?

WILLIAM K. BLACK: Because it is a fundamental lack of integrity. But also because, if you look back at crises, an economist who is also a presidential appointee, as a regulator in the Savings and Loan industry, right here in New York, Larry White, wrote a book about the Savings and Loan crisis. And he said, you know, one of the most interesting questions is why so few people engaged in fraud? Because objectively, you could have gotten away with it. But only about ten percent of the CEOs, engaged in fraud. So, 90 percent of them were restrained by ethics and integrity. So, far more than law or by F.B.I. agents, it's our integrity that often prevents the greatest abuses. And what we had in this crisis, instead of the Savings and Loan, is the most elite institutions in America engaging or facilitating fraud.

BILL MOYERS: This wound that you say has been inflicted on American life. The loss of worker's income. And security and pensions and future happened, because of the misconduct of a relatively few, very well-heeled people, in very well-decorated corporate suites, right?

WILLIAM K. BLACK: Right.

BILL MOYERS: It was relatively a handful of people.

WILLIAM K. BLACK: And their ideologies, which swept away regulation. So, in the example, regulation means that cheaters don't prosper. So, instead of being bad for capitalism, it's what saves capitalism. "Honest purveyors prosper" is what we want. And you need regulation and law enforcement to be able to do this. The tragedy of this crisis is it didn't need to happen at all.

BILL MOYERS: When you wake in the middle of the night, thinking about your work, what do you make of that? What do you tell yourself?

WILLIAM K. BLACK: There's a saying that we took great comfort in. It's actually by the Dutch, who were fighting this impossible war for independence against what was then the most powerful nation in the world, Spain. And their motto was, "It is not necessary to hope in order to persevere."

Now, going forward, get rid of the people that have caused the problems. That's a pretty straightforward thing, as well. Why would we keep CEOs and CFOs and other senior officers, that caused the problems? That's facially nuts. That's our current system.

So stop that current system. We're hiding the losses, instead of trying to find out the real losses. Stop that, because you need good information to make good decisions, right? Follow what works instead of what's failed. Start appointing people who have records of success, instead of records of failure. That would be another nice place to start. There are lots of things we can do. Even today, as late as it is. Even though they've had a terrible start to the administration. They could change, and they could change within weeks. And by the way, the folks who are the better regulators, they paid their taxes. So, you can get them through the vetting process a lot quicker.

BILL MOYERS: William Black, thank you very much for being with me on the Journal.

WILLIAM K. BLACK: Thank you so much."

No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis

TO BE NOTED: From The Big Picture:

"AIG: Before CDS, There Was Reinsurance

Posted By Chris Whalen On April 2, 2009 @ 5:38 am In Markets | 51 Comments

Updated!!

Below is the latest issue of [1] The Institutional Risk Analyst. We did a lot of work on this one. Look forward to your comments.

Also, check out the earlier writings of Lucy Komisar on offshore shenanigans of AIG and the offshore transaction set:

[2] http://www.ritholtz.com/blog/2009/04/aig-before-cds-there-was-reinsurance-part-2/

– Chris

“What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?”

Infinite Risk?

CFO Magazine

June 1, 2005

“In the regulatory world, a ’side letter’ is perhaps the most insidious and destructive weapon in the white-collar criminal’s arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless.”
Fraud Magazine

July/August 2006

PRMIA Event: Market & Liquidity Risk Management for Financial Institutions

First, a housekeeping item. On Monday, May 4, 2009, in partnership with the Federal Deposit Insurance Corporation (FDIC) & the Office of Thrift Supervision (OTS), the Washington DC chapter of Professional Risk Managers’ International Association (PRMIA) is presenting an important day-long conference on managing liquidity and market risk for financial institutions. Speakers include some of the leading risk practitioners, investors, researchers, bank executives and regulators in the US financial community. [3] PRMIA free and sustaining members may register on the PRMIA web site. Members of the regulatory community may register via the FDIC University. IRA co-founder Christopher Whalen will participate in the conference and serve as MC. See the PRMIA web site for more information on the program and speakers.

And yes, our favorite bank regulator is making the opening remarks.

For some time now, we have been trying to reconcile the apparent paradox of American International Group (NYSE:AIG) walking away from the highly profitable, double-digit RAROC business of underwriting property and casualty (P&C) risk and diving into the rancid cesspool of credit default swaps (”CDS”) contracts and other types of “high beta” risks, business lines that are highly correlated with the financial markets.

In our interview with Robert Arvanitis last year, [4] “‘Bailout: It’s About Capital, Not Liquidity; Seeking Beta: Interview with Robert Arvanitis’, September 29, 2008,” we discussed the difference between high and low beta. We also learned from Arvanitis, who worked for AIG during much of the relevant period, that the decision by Hank Greenberg and the AIG board to enter the CDS market was, at best, chasing revenue. No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis, could have resulted in a favorable decision to pursue CDS and other “high beta” risks, at least from our perspective. ( NB DON )

In an effort to resolve this conundrum, over the past several months The IRA has interviewed a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem. Below we present our preliminary findings and invite your comments.

One of the first things we learned about the insurance world is that the concept of “shifting risk” for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm’s entry into the CDS market.

In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG’s foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.

pleaded guilty to running a $14 million Ponzi scheme that promised investors 24 percent annual returns

TO BE NOTED: From Bloomberg:

"Ex-Bank of America Employee Pleads Guilty in Scheme (Update1)

Share | Email | Print | A A A

By Edvard Pettersson

March 30 (Bloomberg) -- A former Bank of America Corp. customer service representative pleaded guilty to running a $14 million Ponzi scheme that promised investors 24 percent annual returns, the third criminal case he has admitted to.

Antoine David Haroutunian, 47, of Glendale, California, pleaded guilty to mail fraud at a hearing today in federal court in Los Angeles, U.S. Attorney Thomas O’Brien said in a statement. Haroutunian, who is scheduled to be sentenced Aug. 3, faces as long as 20 years in prison, according to the statement.

Haroutunian earlier this month pleaded guilty to a separate case of bank fraud for obtaining customer account information he used to make unauthorized withdrawals in 2003, according to the statement. The theft caused Bank of America $450,000 in losses, O’Brien said.

In a third case, Haroutunian pleaded guilty to tax fraud for obtaining a $183,345 tax refund based on fictitious gambling winnings and losses, according to the statement. He faces as long as 120 years in prison in the bank-fraud case and five years in the tax-fraud case. Sentencing for those cases will be on Aug. 10, O’Brien said.

Michael Proctor, a lawyer for Haroutunian, didn’t immediately return a call seeking comment.

The cases are U.S. v. Haroutunian, 08-01037, 08-01038, and 09-00186, U.S. District Court, Central District of California (Los Angeles.)"

US federal regulators have warned of a “rampant Ponzimonium”

TO BE NOTED: From the FT:

"Watchdog fears market ‘Ponzimonium’

By Javier Blas, Commodities Correspondent

Published: March 20 2009 19:35 | Last updated: March 20 2009 19:35

US federal regulators have warned of a “rampant Ponzimonium” as they disclosed they are investigating “hundreds” of possible scams in the aftermath of the $50bn fraud allegedly perpetrated by Bernard Madoff.

Bart Chilton, a commissioner at the Commodities Futures Trading Commission, the US regulator, said the watchdog was “seeing more of these scams than ever before” in commodities and other futures markets.

Mr Chilton said the CFTC, which patrol commodities and financial futures markets such as derivatives on stocks and foreign exchange, was investigating “hundreds of individuals and entities, many of which were related to Ponzi scams”.

The CFTC has filed charges against 15 alleged Ponzi schemes so far this year, compared with 13 during the whole of 2008. If the rate were sustained, the regulator could end the year filling more than 60 cases, officials said.

US regulators have said they are detecting more scams than before as the publicity surrounding Mr Madoff‘s case prompts some investors to question the credibility of returns.

But this is the first time a senior regulator has publicly put the number of investigation in the “hundreds”.

“The floundering economy has unearthed many of these house-of-card scams,” said Mr Chilton. “In the last month alone we’ve gone after crooks in Pennsylvania, New York, North Carolina, Iowa, Idaho, Texas and Hawaii.”

Mr Chilton did not provide details of the investigations but it is likely the majority of the cases relate to small investments, in the range of a few million dollars to $50m (€37m, £35m). In the latest case, the CFTC this week charged a North Carolina investment company over an alleged $40m Ponzi scheme in foreign exchange trading.

“These frauds combined harmed tens of thousands of hard-working Americans, many of whom thought they were investing properly to save for retirement or even their first home,” said Mr Chilton.

“It is a good thing that folks are double-checking to ensure they aren’t being ripped off by fraudsters,” he said, referring to the increasing number of investors who are tipping off US federal regulators after they have become suspicious.

Copyright The Financial Times Limited 2009"

the implicit prediction that we would see a blossoming of enforcement energy in a market bust - after most of the damage has been done

From The Baseline Scenario:

"Bernie Madoff Day

with one comment

As Bernie Madoff goes to his reward today, we should be asking how this could have happened. Not only Madoff and Allen Stanford, but also dozens of “mini-Madoffs” have been unearthed since the market collapse in September and October, which seems to have reminded the SEC that it has an law enforcement function. Not surprisingly, regulators are ramping up their enforcement divisions, and Congressmen are planning legislation to increase enforcement budgets.

A little late to close the barn door.

While Christopher Cox, SEC chairman from 2005 until this January, makes an obvious target, there is a deeper phenomenon at work than just the Bush administration’s hands-off attitude toward corporate fraud (an attitude largely shared by the Clinton administration). That is the general tendency of people - investors and officials alike - to underestimate the risk of fraud during a boom and overestimate the risk of fraud during a bust.

This issue is discussed in a paper by Amitai Aviram published in my own school’s Yale Journal on Regulation (but since you can’t get it from their website, get it from SSRN).

Aviram’s first point is that people tend to ignore fraud risk in good times and worry about it in bad times. There are many reasons for this. Falling asset values and credit crunches make it harder to perpetuate certain types of fraud, such as Ponzi schemes, but there are other factors. In one form of cognitive bias, people ascribe good outcomes to their own investing “skill,” and bad outcomes to exogenous factors they cannot be blamed for, such as fraud. The discovery of a few well-publicized instances of fraud creates an availability bias, where people miscalculate the incidence of fraud.

Typical enforcement patterns only exacerbate this cycle. According to Aviram, the traditional academic model of enforcement is that you set a budget such that, at the margin, the marginal cost of enforcement equals the marginal benefit of enforcement. In practice, however, this model is affected by political pressures. In a boom, when the public underestimates the risk of fraud, there is no percentage in presenting yourself as a crusader against big corporations or Wall Street - especially when they are being portrayed in the media as heroes, as Enron was prior to 2001. But in a bust, the way to score political points is to go after the “crooks and robbers,” which is especially convenient after they have been pointed out to you by the markets (Enron, Madoff). This leads to underenforcement during the boom and overenforcement during the bust. (Or, I might say, severe underenforcement during the boom and maybe sufficient enforcement during the bust.)

Here’s what this looks like:

That’s the annual percent change in the S&P 500 plotted against the annual percent change in the number of SEC enforcement actions. I would have liked to see a regression, or at least a correlation, but this is a law paper, after all.

So, yes, it’s the fault of regulators who are too soft on industry, but they also share the misperceptions of the public at large, which wants to believe that everything is just fine when the market is going up. Of course, regulators are supposed to know more than the public at large.

Aviram has a discussion of the role of conspicuous law enforcement itself in reinforcing or counteracting these misperceptions. This discussion is wishy-washy, because he leaves open the question of whether conspicuous law enforcement increases or decreases risk perceptions. (Again, this is a law paper - no equations and few numbers, just concepts.) But I think it’s pretty clear that it decreases risk perceptions. Let’s put it this way: On the day that you learned about Bernie Madoff, did you feel more secure because you felt like the SEC was doing a good job protecting you? Or did you feel less secure because if Madoff could get away with it for so long, who else could? Let’s assume I’m right and then follow Aviram’s reasoning. In that case, this cyclical enforcement pattern makes things even worse, because the lack of enforcement during good times makes people feel even more secure, and the “over” enforcement in bad times makes them even more paranoid. Therefore, he concludes, enforcement should be expressly counter-cyclical, which requires insulating the regulators from public pressure to be lax during a boom.

Thus, when conspicuous law enforcement increases risk perception [my assumption], implementing the correct long-term policy will cause fear and anger among the public in the short term. Nonetheless, if the goal of anti-fraud laws is to maximize long term efficiency, the public’s immediate sentiments should not be a consideration for abandoning the optimal (long-term) policy. In fact, the law enforcer should be shielded from precisely these short-term pressures.

Aviram cites central banks as an example of an institution that is appropriately counter-cyclical. But let’s not fault him for that. The paper was first written in early 2007, and few people could have foreseen what happened since. Indeed, the implicit prediction that we would see a blossoming of enforcement energy in a market bust - after most of the damage has been done - turns out to have been dead-on.

Written by James Kwak

March 12, 2009 at 2:05 pm"

Me:
Have you ever heard of a Ponzi Scheme being stopped as soon as it began? I doubt it. That’s because it mirrors a particularly lucrative investment for quite a long time. How many people are going to let you close down there investor because you suspect that his returns are too high? They’re more likely to respond that you’re high.

There’s no stopping a Ponzi Scheme until it runs its course. It’s a perfect crime for a fairly long time. Also, notice, Madoff admitted his guilt. Stanford isn’t so stupid it seems. He doesn’t believe that the government can even figure out how a Ponzi Scheme works, let alone convict him of running one. He might turn out to be right.

I suggest reading this post from Scientific American:

http://www.sciam.com/article.cfm?id=limits-on-human-comprehension&print=true

“David H. Wolpert, a physics-trained computer scientist at the NASA Ames Research Center, has chimed in with his version of a knowledge limit. Because of it, he concludes, the universe lies beyond the grasp of any intellect, no matter how powerful, that could exist within the universe. Specifically, during the past two years, he has been refining a proof that no matter what laws of physics govern a universe, there are inevitably facts about the universe that its inhabitants cannot learn by experiment or predict with a computation. Philippe M. Binder, a physicist at the University of Hawaii at Hilo, suggests that the theory implies researchers seeking unified laws cannot hope for anything better than a “theory of almost everything.”

Perhaps with Ponzi Schemes, we’ve simply run up against the limits of human knowledge.

If you look where the bubble is, there too will be the crooks.

From Floyd Norris:

"Crime and Bubbles

Willie Sutton is supposed to have explained that he robbed banks because that was where the money was.

So it is with white collar crime. If you look where the bubble is, there too will be the crooks.

In the late 1990s, a company could be rewarded with a soaring stock price, and a valuation far beyond anything the company had actually accomplished — if it could show rapid growth. And stock options let executives monetize that gain almost immediately.

On the other hand, if your company was not hot, its share price could languish.

The result was a great temptation to fudge the numbers. At the extreme, we got Enron and WorldCom.

More recently, as soaring asset prices were pumped up by easy credit, it was money managers who could make zillions. Run a $500 million hedge fund and you get $10 million a year, plus 20 percent of the profits. Run a really big one that does very well, and you can take in a billion dollars.

And how do you attract enough money to manage? You show that you can produce outstanding investment results.

It turns out that the easiest way to do that was to lie about the results, and we are now seeing a succession of Ponzi schemes unveiled. The case involving Bernie Madoff may have been the largest, but others are multiplying.

It is no coincidence that we learn about the scandals after the bubbles burst. Enron had used its own high stock price to produce phony profits. When the stock price started to fall, it sparked a crisis and the facts eventually came out. So long as everyone believed assets were going up, money managers could siphon off new cash to pay those few investors who wanted to cash out. But when losses in other investments caused investors to flee, the game was up.

My suspicion is that there are more such schemes to be revealed."

Me:

I keep asking: When was the last time that you heard of a Ponzi Scheme being stopped as soon as it began?

Apparently, they cannot be distinguished from a very good investment for years and years. This means, for anyone looking for a way to live like a king for many years, a Ponzi Scheme just might be the ticket. It’s really a matter of anticipating and avoiding arrest when you’re finally discovered. That seems to be the only flaw.

Not only do I suspect many more to be revealed, I suspect that they will be a growing concern going forward. Fraud was a huge part of this crisis, but it will never be investigated or prosecuted as it should be. That will be the lesson that many remember.

— Don the libertarian Democrat

I know that this is silly in a serious time, but I keep hearing Don Ho singing that title.

— Don the libertarian Democrat

That is the Ponzi definition of solvency. So long as there is an unclaimed dollar in the till, the financial institution is solvent.

From the Aleph Blog:

"When is a Financial Company Insolvent?

Every now and then, I see a stupid post saying that a financial company is solvent if it is still making timely payments on its liabilities. That is the Ponzi definition of solvency. So long as there is an unclaimed dollar in the till, the financial institution is solvent.

To this I say “hooey.” Financial institutions don’t have all that much to them. They are just a bundle of promises. “Parties I have lent to will pay me more than parties I have borrowed from.” They are a bundle of longer-dated accruals. The value of assets and liabilities can’t be firmly fixed in the same way that those of an industrial company can. In that same sense, the current value of assets versus liabilities in a financial firm correlates highly with the trading value of its equity.

So when a financial company has a negative net worth on a fair market value basis, the odds of the common stock being wiped out is high. Could the market come back? Yes, but the odds are less than even.

This is my way of saying that regulators should take control of operating financial companies when the fair value of their net worth goes negative. Like a good technical trader, honor the stop-loss."

Me:

1. Don the libertarian Democrat Says:
   February 21st, 200911:21 am at

   “Every now and then, I see a stupid post saying that a financial company is solvent if it is still making timely payments on its liabilities. That is the Ponzi definition of solvency. So long as there is an unclaimed dollar in the till, the financial institution is solvent.”

   A very good point.This view might explain why Ponzi Schemes seem like an unsolvable puzzle. They mimic working investments for quite a long time, in the sense that they are making payments, which is what many investors mainly care about, not looking under the hood. My only question about Ponzi Schemes is: Where is the hood?

I'm beginning to think that this thing is going to run and run.

From Felix Salmon:

"Stanford Ponzi Investigations: 22 Years Old

The WSJ says that "federal prosecutors are investigating whether Texas businessman R. Allen Stanford was operating a Ponzi scheme", even as Matt Goldstein reports that they've been doing that for 22 years:

One person who has known Stanford for nearly two decades, but declined to be identified, says as far back as 1987 FBI agents from Houston were looking into Stanford and his bank. This person says the FBI was looking into allegations of money laundering and that the CD business was a Ponzi scheme.

I'm beginning to think that this thing is going to run and run. The fact that the Feds still haven't managed to cobble together some basic wire-fraud charges is borderline incomprehensible."

Me:

Perhaps we should have a Manhattan Project to figure out how to determine when we're in the presence of a Ponzi Scheme. I suggest that we start by gathering together the people who've been working on Goldbach's Conjecture. Perhaps we could also have a contest: What is the earliest point in a Ponzi Scheme that it can be definitely determined to be a Ponzi Scheme? You can round off to the nearest decade.

By DonthelibertarianDemocrat Posted: Feb 20 2009 01:07am ET

This is another illustration of the fact that technical regulatory fixes will not suffice

From The Kaufmann Governance Post:

"From Madoff to Stanford Ponzi, from SEC to Congress: in dire need of political reforms

By Kaufmann | February 18, 2009

Another Ponzi scheme has allegedly been uncovered now, led by the Texas Financier R. A. Stanford, who may have swindled about 50,000 investors out of US $8 billion, or so. The Feds have raided his house of cards but were having a hard time finding him.

At US $50 billion, Madoff may have stood out because of the sheer magnitude of his scam. But obviously he is not alone in large Ponzi schemes, not even within the US. As global financial conditions have continued to deteriorate, the nakedness of those emperors without clothes is starkly exposed.

Sir R. Allen Stanford gets out of his helicopter (AP Photo/Lefteris Pitarakis)

But like the case of Madoff, this case also raises questions about whether ‘the SEC was asleep at the switch’ in this case as well. Evidently allegations of fraud (and possible drug money laundering) have been made against Stanford over the past decade. Yet the SEC took belated action very recently only after two former employees filed a lawsuit in civil court.

And again, like Madoff and other instances of ‘capture,’ this case raises questions about the links between financiers and Washington politicians. Did money in politics play a role in this case as well? It is alleged that Stanford and his companies (based in the Caribbean island of Antigua…) spent over US $7 million on campaign contributions and lobbying efforts to loosen regulation of offshore banks. In Congress, the main political recipients of such largesse cut across party lines, and at least one of them may have taken a paid trip to Antigua to be entertained by Stanford.

Sheila Krumholz of the Center for Responsive Politics argues that the investigation of Stanford should include his links with members of Congress: “Surely there has to be a part of the investigation to look at what was done in Congress and whether the money that was spent to lobby and make political contributions played any role in all of this”.

This is another illustration of the fact that technical regulatory fixes will not suffice, because it begs the role of ‘money in politics’ and of ‘legal corruption.’ A serious reform agenda ought to transcend narrow technical aspects and also encompass political dimensions, particularly regarding political finance, lobbying, conflict of interest and capture."

Me:

1. Don the libertarian Democrat Says: Your comment is awaiting moderation.
   February 18th, 2009 at 5:06 pm

   I’m predicting a Ponzi Bubble. It seems that you can run one of these schemes for years without anyone being able to figure out if it’s a Ponzi Scheme or genius investing. All you need to worry about is how to evade eventual capture. In the meantime, you can live the High Life.

   Let me ask you: Has anyone ever been caught right after starting a Ponzi Scheme?

The game was up last week already: "A client whose $250,000 CD matured on Feb. 9 could not get the money out."

From Felix Salmon:

"Extra Credit, Tuesday Edition

Automakers Seek $14 Billion More in Aid: And will surely seek more still, in a couple more months, if they get this now.

Bill Moyers interviews Simon Johnson: Video here.

Investors caught as regulators swoop on Stanford: The game was up last week already: "A client whose $250,000 CD matured on Feb. 9 could not get the money out."

College crush: "90 percent of high-school students are told by their high-school counselors that they ought to go to college." For a huge number of them, this is a lie.

What I learned listening to Larry Kudlow: Krugman becomes a fully-paid-up member of the CNBC-haters-on-CNBC club.

Recovery.gov: Is live.

On moving Valentine’s Day to stimulate the economy: If it were on the second Wednesday of every February, then restaurant revenues would rise. Even at PF Chang's, the least romantic restaurant in the world.

Opinion Laundering: A phrase which should enter the general demotic, and a phenomenon for which everybody should be on the lookout.

The Case for Free Transit: From Yglesias. Avent glosses.

NY Times article skimmer: A great way to rediscover the serendipity of the newspaper."

Me:

I hate to say this, but I expect a growth industry in Ponzi Schemes. Apparently, you can run them for years living like a king, and nobody can determine whether you're running a Ponzi Scheme or not. It's like solving Fermat's Theorem for a time. I've never been able to live like a king for a second, let alone years. At some point, years down the line, you'll be found out for certain, and then it's just a matter of seeing the signs and being prepared. Hell, I might do it if my last name wasn't Ponzi.

In other words, I'm positing a theory, that Ponzi Schemes need years to detect. Has anybody ever been arrested for one the week it started? As long as you pay out for a while, the end result is not clear, and you can wine and dine, surf and turf. I can't eat the surf though. Am I wrong about this?

By DonthelibertarianDemocrat Posted: Feb 18 2009 01:00am ET

"for those who invest with prudence and an eye toward long-term values, the market need not be a Ponzi scheme. "

From the NY Times, a Value Investing View:

"By ROGER LOWENSTEIN

Published: January 6, 2009

In October, Columbia University’s business school honored its most famous investing guru, Benjamin Graham, with a series of panel discussions loosely connected to the market crash, which was then accelerating. The panelists, of which I was one, had contributed to an updated version of Graham’s 1930s textbook, whose signature themes are caution, avoidance of speculation and — at all costs — the preservation of capital( HE'S THE MAN BEHIND THE MAN BEHIND THE MAN ). The day we met, the Dow Jones industrial average fell 350 points en route to one of its worst months ever.

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J. Ezra Merkin, a Wall Street sage, noted philanthropist and professional money manager, seemed to embody more than any of the other panelists the fear that was gripping traders. When it was suggested that the government should stop intervening in markets and bailing out banks, Merkin rejoined that the system had cracked and desperately needed help( I AGREE ). As the world now knows, Merkin had entrusted close to $2 billion of his investors’ money to someone even less dependable than the Dow — that is, the accused Ponzi artist Bernard Madoff. I have no reason to think that Merkin, at the time, had any knowledge of the fraud that was soon to secure his 15 minutes of fame, but that afternoon at Columbia now seems pregnant with latent connections. Perhaps Madoff’s investors lost a greater percentage of their money, and lost it more suddenly, than the rest of us. But beyond these mere matters of degree, is there really any difference?

At least for investors of attenuated time horizons, there is not. Public-securities markets are a wondrous artifice precisely because they offer permanent capital to industry and short-term liquidity to investors. Think about it: a General Electric or a Google sells stock to the public and then retains the proceeds — the capital — indefinitely. Even if the companies earn a profit, by selling more light bulbs or Internet ads, they are under no obligation to pay out the gains in dividends. How, then, do the shareholders claim their reward? Why, by selling their stock to other investors, of course. This means that, in the short term at least, each investor is dependent on the willingness of other investors to hop on board. If other investors go away, prices (even of solvent companies) plummet, to devastating effect on those who sell( I AGREE ).

In a Ponzi scheme, there is no G.E. or Google underneath the pyramid( TRUE. THE PHRASE IS NOW BEING MISUSED FOR RHETORICAL EFFECT. ): only air. Outgoing investors are paid from the money put up by new ones. And the game for Madoff ended, as Ponzi schemes always do, when he ran out of suckers.

In theory, stocks and bonds are more valuable than air. But when investors get hooked on trading securities (as distinct from owning them)( ALSO INVESTMENT VS SPECULATION ), especially ones that are overvalued, they are courting disaster. In retrospect, this was true of the legions that invested in mortgage-backed securities and in the banks that owned them, not to mention the many other companies affected indirectly. Nobody was thinking about what these companies were worth, only about the next quotation on the screen.

This was doubly true for the banks that held those wearily complex and difficult-to-value mortgage bonds. Look at the post-mortem issued by UBS, one of the world’s largest banks, which has suffered mortgage-related losses of some $50 billion (enough to bail out the auto industry several times over). Discussing one particular write down, the bank admitted, “The super senior notes were always treated as trading book (i.e., the book for assets intended for resale in the short term), notwithstanding the fact that there does not appear to have been a liquid secondary market( NEGLIGENCE AND FIDUCIARY MISMANAGEMENT ).” Legally, UBS was a bank; conceptually, it was investing with Bernie Madoff( TRUE ).

There is, of course, an alternative to this madness. Which is to invest for the long term, independent of the market action on any given day or year. This is what most small investors pretended, and maybe believed, they were actually doing.

Robert Barbera, the chief economist at ITG, an investment firm, says there are really three schools of investing. There are people who think they can identify superior stocks and bonds over the long term and selectively invest in those that they deem to be undervalued. Second, there are people who recognize that they don’t have this ability and resolve to salt away a fixed portion of their savings, month after month, in a generic and diversified portfolio. Though the first approach requires considerably more talent and is not recommended for novices, both should work.

What does not work is believing you are following either strategy No. 1 or 2 when you are actually engaging in the third approach — which is, essentially, following the crowd, day by day and hour by hour. At the top of the market, investors told themselves they were disciplined and in for the long haul. Now they are selling or refraining from investing. Some misjudged their liquidity needs and have come under pressure to raise cash; others have simply lost heart. Either way, they are dependent on new money to come in for them to get out.

Benjamin Graham’s premise (which he did not abandon, even in the depths of the Great Depression) was that, sooner or later, markets will reflect underlying corporate values( TRUE. ). Thus, he wrote, long-term investors had a “basic advantage” over others, because they could ride out bubbles and crashes rather than be gulled during such highs and lows into, respectively, buying or selling. In other words, for those who invest with prudence and an eye toward long-term values, the market need not be a Ponzi scheme( TRUE ). While stocks periodically go for roller-coaster rides, the earning power of the U.S. economy, albeit with serious fluctuations, endures( TRUE ). The people who chased unrealistic returns at the top, like those who are selling now, have simply cashiered their “advantage” to play a game that more nearly resembles Bernie Madoff’s.( I AGREE, ALTHOUGH SOME SPECULATION IS FINE, IF DONE CORRECTLY. IN OTHER WORDS, WITH FUNDS THAT YOU CAN AFFORD TO LOSE.)

Roger Lowenstein, an outside director of the Sequoia Fund, is a contributing writer for the magazine. His most recent book is “While America Aged.”