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