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