| Tulipmania - this is the name coined for the | | | | human interactions. It distorts economic |
| first pyramid investment scheme in history.In | | | | decisions and it ends in misery on a national |
| 1634, tulip bulbs were traded in a special | | | | scale. It is the scourge of societies in |
| exchange in Amsterdam. People used these | | | | transition.The second type of financial |
| bulbs as means of exchange and value store. | | | | scandals is normally connected to the |
| They traded them and speculated in them. The | | | | laundering of capital generated in the "black |
| rare black tulip bulbs were as valuable as a | | | | economy", namely: the income not reported to |
| big mansion house. The craze lasted four | | | | the tax authorities. Such money passes |
| years and it seemed that it would last | | | | through banking channels, changes ownership a |
| forever. But this was not to be.The bubble | | | | few times, so that its track is covered and |
| burst in 1637. In a matter of a few days, the | | | | the identities of the owners of the money are |
| price of tulip bulbs was slashed by 96%!This | | | | concealed. Money generated by drug dealings, |
| specific pyramid investment scheme was | | | | illicit arm trade and the less exotic form of |
| somewhat different from the ones which were | | | | tax evasion is thus "laundered".The financial |
| to follow it in human financial history | | | | institutions which participate in laundering |
| elsewhere in the world. It had no "organizing | | | | operations, maintain double accounting books. |
| committee", no identifiable group of movers | | | | One book is for the purposes of the official |
| and shakers, which controlled and directed | | | | authorities. Those agencies and authorities |
| it. Also, no explicit promises were ever made | | | | that deal with taxation, bank supervision, |
| concerning the profits which the investors | | | | deposit insurance and financial liquidity are |
| could expect from participating in the scheme | | | | given access to this set of "engineered" |
| - or even that profits were forthcoming to | | | | books. The true record is kept hidden in |
| them.Since then, pyramid schemes have evolved | | | | another set of books. These accounts reflect |
| into intricate psychological ploys.Modern | | | | the real situation of the financial |
| ones have a few characteristics in | | | | institution: who deposited how much, when and |
| common:First, they involve ever growing | | | | under which conditions - and who borrowed |
| numbers of people. They mushroom | | | | what, when and under which conditions.This |
| exponentially into proportions that usually | | | | double standard blurs the true situation of |
| threaten the national economy and the very | | | | the institution to the point of no return. |
| fabric of society. All of them have grave | | | | Even the owners of the institution begin to |
| political and social implications.Hundreds of | | | | lose track of its activities and misapprehend |
| thousands of investors (in a population of | | | | its real standing.Is it stable? Is it liquid? |
| less than 3.5 million souls) were deeply | | | | Is the asset portfolio diversified enough? No |
| enmeshed in the 1983 banking crisis in | | | | one knows. The fog enshrouds even those who |
| Israel.This was a classic pyramid scheme: the | | | | created it in the first place. No proper |
| banks offered their own shares for sale, | | | | financial control and audit is possible under |
| promising investors that the price of the | | | | such circumstances.Less scrupulous members of |
| shares will only go up (sometimes by 2% | | | | the management and the staff of such |
| daily). The banks used depositors' money, | | | | financial bodies usually take advantage of |
| their capital, their profits and money that | | | | the situation. Embezzlements are very |
| they borrowed abroad to keep this impossible | | | | widespread, abuse of authority, misuse or |
| and unhealthy promise. Everyone knew what was | | | | misplacement of funds. Where no light shines, |
| going on and everyone was involved.The | | | | a lot of creepy creatures tend to develop.The |
| Ministers of Finance, the Governors of the | | | | most famous - and biggest - financial scandal |
| Central Bank assisted the banks in these | | | | of this type in human history was the |
| criminal pursuits. This specific pyramid | | | | collapse of the Bank for Credit and Commerce |
| scheme - arguably, the longest in history - | | | | International LTD. (BCCI) in London in 1991. |
| lasted 7 years.On one day in October 1983, | | | | For almost a decade, the management and |
| ALL the banks in Israel collapsed. The | | | | employees of this shady bank engaged in |
| government faced such civil unrest that it | | | | stealing and misappropriating 10 billion |
| was forced to compensate shareholders through | | | | (!!!) USD. The supervision department of the |
| an elaborate share buyback plan which lasted | | | | Bank of England, under whose scrutinizing |
| 9 years. The total indirect damage is hard to | | | | eyes this bank was supposed to have been - |
| evaluate, but the direct damage amounted to 6 | | | | was proven to be impotent and incompetent. |
| billion USD.This specific incident highlights | | | | The owners of the bank - some Arab Sheikhs - |
| another important attribute of pyramid | | | | had to invest billions of dollars in |
| schemes: investors are promised impossibly | | | | compensating its depositors.The combination |
| high yields, either by way of profits or by | | | | of black money, shoddy financial controls, |
| way of interest paid. Such yields cannot be | | | | shady bank accounts and shredded documents |
| derived from the proper investment of the | | | | proves to be quite elusive. It is impossible |
| funds - so, the organizers resort to dirty | | | | to evaluate the total damage in such |
| tricks.They use new money, invested by new | | | | cases.The third type is the most elusive, the |
| investors - to pay off the old investors.The | | | | hardest to discover. It is very common and |
| religion of Islam forbids lenders to charge | | | | scandal may erupt - or never occur, depending |
| interest on the credits that they provide. | | | | on chance, cash flows and the intellects of |
| This prohibition is problematic in modern day | | | | those involved.Financial institutions are |
| life and could bring modern finance to a | | | | subject to political pressures, forcing them |
| complete halt.It was against this backdrop, | | | | to give credits to the unworthy - or to forgo |
| that a few entrepreneurs and religious | | | | diversification (to give too much credit to a |
| figures in Egypt and in Pakistan established | | | | single borrower). Only lately in South Korea, |
| what they called: "Islamic banks". These | | | | such politically motivated loans were |
| banks refrained from either paying interest | | | | discovered to have been given to the failing |
| to depositors - or from charging their | | | | Hanbo conglomerate by virtually every bank in |
| clients interest on the loans that they doled | | | | the country. The same may safely be said |
| out. Instead, they have made their depositors | | | | about banks in Japan and almost everywhere |
| partners in fictitious profits - and have | | | | else. Very few banks would dare to refuse the |
| charged their clients for fictitious losses. | | | | Finance Minister's cronies, for instance.Some |
| All would have been well had the Islamic | | | | banks would subject the review of credit |
| banks stuck to healthier business | | | | applications to social considerations. They |
| practices.But they offer impossibly high | | | | would lend to certain sectors of the economy, |
| "profits" and ended the way every pyramid | | | | regardless of their financial viability. They |
| ends: they collapsed and dragged economies | | | | would lend to the needy, to the affluent, to |
| and political establishments with them.The | | | | urban renewal programs, to small businesses - |
| latest example of the price paid by whole | | | | and all in the name of social causes which, |
| nations due to failed pyramid schemes is, of | | | | however justified - cannot justify giving |
| course, Albania 1997. One third of the | | | | loans.This is a private case in a more |
| population was heavily involved in a series | | | | widespread phenomenon: the assets (=loan |
| of heavily leveraged investment plans which | | | | portfolios) of many a financial institution |
| collapsed almost simultaneously. Inept | | | | are not diversified enough. Their loans are |
| political and financial crisis management led | | | | concentrated in a single sector of the |
| Albania to the verge of disintegration into | | | | economy (agriculture, industry, |
| civil war.But why must pyramid schemes fail? | | | | construction), in a given country, or |
| Why can't they continue forever, riding on | | | | geographical region. Such exposure is |
| the back of new money and keeping every | | | | detrimental to the financial health of the |
| investor happy, new and old?The reason is | | | | lending institution. Economic trends tend to |
| that the number of new investors - and, | | | | develop in unison in the same sector, |
| therefore, the amount of new money available | | | | country, or region. When real estate in the |
| to the pyramid's organizers - is limited. | | | | West Coast of the USA plummets - it does so |
| There are just so many risk takers. The day | | | | indiscriminately. A bank whose total |
| of judgement is heralded by an ominous | | | | portfolio is composed of mortgages to West |
| mismatch between overblown obligations and | | | | Coast Realtors, would be demolished.In 1982, |
| the trickling down of new money. When there | | | | Mexico defaulted on the interest payments of |
| is no more money available to pay off the old | | | | its international debts. Its arrears grew |
| investors, panic ensues. Everyone wants to | | | | enormously and threatened the stability of |
| draw money at the same time. This, evidently, | | | | the entire Western financial system. USA |
| is never possible - some of the money is | | | | banks - which were the most exposed to the |
| usually invested in real estate or was | | | | Latin American debt crisis - had to foot the |
| provided as a loan. Even the most stable and | | | | bulk of the bill which amounted to tens of |
| healthiest financial institutions never put | | | | billions of USD. They had almost all their |
| aside more than 10% of the money deposited | | | | capital tied up in loans to Latin American |
| with them.Thus, pyramids are doomed to | | | | countries. Financial institutions bow to fads |
| collapse.But, then, most of the investors in | | | | and fashions. They are amenable to "lending |
| pyramids know that pyramids are scams, not | | | | trends" and display a herd-like mentality. |
| schemes. They stand warned by the collapse of | | | | They tend to concentrate their assets where |
| other pyramid schemes, sometimes in the same | | | | they believe that they could get the highest |
| place and at the same time. Still, they are | | | | yields in the shortest possible periods of |
| attracted again and again as butterflies are | | | | time. In this sense, they are not very |
| to the fire and with the same results.The | | | | different from investors in pyramid |
| reason is as old as human psychology: greed, | | | | investment schemes.Financial mismanagement |
| avarice. The organizers promise the investors | | | | can also be the result of lax or flawed |
| two things:that they could draw their money | | | | financial controls. The internal audit |
| anytime that they want to andthat in the | | | | department in every financing institution - |
| meantime, they will be able to continue to | | | | and the external audit exercised by the |
| receive high returns on their money.People | | | | appropriate supervision authorities are |
| know that this is highly improbable and that | | | | responsible to counter the natural human |
| the likelihood that they will lose all or | | | | propensity for gambling. The must help the |
| part of their money grows with time. But they | | | | financial organization re-orient itself in |
| convince themselves that the high profits or | | | | accordance with objective and objectively |
| interest payments that they will be able to | | | | analysed data. If they fail to do this - the |
| collect before the pyramid collapses - will | | | | financial institution would tend to behave |
| more than amply compensate them for the loss | | | | like a ship without navigation tools. |
| of their money. Some of them, hope to succeed | | | | Financial audit regulations (the most famous |
| in drawing the money before the imminent | | | | of which are the American FASBs) trail way |
| collapse, based on "warning signs". In other | | | | behind the development of the modern |
| words, the investors believe that they can | | | | financial marketplace. Still, their judicious |
| outwit the organizers of the pyramid. The | | | | and careful implementation could be of |
| investors collaborate with the organizers on | | | | invaluable assistance in steering away from |
| the psychological level: cheated and deceiver | | | | financial scandals.Taking human psychology |
| engage in a delicate ballet leading to their | | | | into account - coupled with the complexity of |
| mutual downfall.This is undeniably the most | | | | the modern world of finances - it is nothing |
| dangerous of all types of financial scandals. | | | | less than a miracle that financial scandals |
| It insidiously pervades the very fabric of | | | | are as few and far between as they are. |