Ponzi Schemes, Auditors, Regulators, Credit Ratings, And Other Scams

There are honest people, and there are dishonest people, a whole spectrum. I like to think I’m near the honest end, I would have worn a white hat in the old cowboy movies. And I’ve had the misfortune to have met a few from right up close to the other extreme, with the black hats. Most people wear hats of various shades of grey. High finance is a business which encourages people to shift towards the dishonest end of the spectrum by putting temptation in their way, and the dishonest are drawn to this field by its quick and easy rewards.

Nothing that I have ever seen in investment banking and fund management has impressed me as a disincentive to crooked behaviour, absolutely nothing.

As a keen observer of human behaviour I have been fascinated watching people’s attitude towards money. In academia they struggle with their mixed feelings, on the one hand hating the filthy stuff since they are supposed to be above such worldly matters, but on the other hand rather liking what they can do with it. The really rich see it as nothing more than a measure of their success in life, a score. Some balanced people, few and far between, realise they need it, and that more is better than less, but it’s not the main focus in their lives. Then there is the common greed that we see in our business, nasty and unpleasant. And nasty, unpleasant greed is so easy to feed, it is encouraged in banking, but it has some unpleasant side effects.

The Madoff affair has highlighted several things, brought some corrupt practices to light, but we haven’t really learned anything new from all of this. The old lessons, the ones that should have been learned years ago, are just as valid. As I keep saying, there is little reason for regulators to do anything: People have short memories; People are easily distracted; The legal system is now much better at protecting the guilty than protecting the innocent.

Just like the Social Services in the UK, regulators do such a useless job that they are now permanently on the defensive. I bet you that few people working for regulators are doing their jobs right now, I bet most of their day is spent figuring out how to protect themselves against the growing backlash.

Quite frankly I don’t see much difference between Madoff’s Ponzi scheme and naive auditors, self-serving regulators and morally corrupt ratings agencies. They are all part of a financial system that encourages scams, scams that may then take years to sort out and years before the culprits are punished, meanwhile out on comfortable bail. The US legal system is particularly easy to ‘play’ so as to drag proceedings out so long that the accused dies of natural causes before justice is done.

There is no disincentive for dishonest behaviour in investment banking at the moment, in fact the opposite. If someone wants to invest with a manager they think might be dishonest but successful then they will ignore the dishonesty. If the investor loses their shirt then tough, serves them right. (Of course, it won’t be their money, so anyone found not having done their full due diligence ought to be arrested.) I know of several people who manage money who have broken serious laws, lawbreaking that would prevent them managing money. And I know of some investors who know that I know, but who, when considering investing with these people, deliberately do not ask for my opinion as part of their due diligence. Why not? Because once they hear what I have to say then they would no longer be able to invest with the crooked, but oh-so-smooth and convincing manager. If you’ve ever bought a dodgy DVD at the market, or a hi-fi from a man in the pub, then you are just as culpable. And you therefore might find some sympathy for a lot of people being blamed at the moment. I haven’t, and I don’t.

When I first realised, several years ago, that due diligence is deliberately not being done I proposed that formal psychometric testing be part of the process of setting up a hedge fund or managing money. I know this is easy to criticize or trivialize, especially by all the ‘left-brainers’ working in finance. But equally I’m not a great fan of having to pass multiple-choice exams to get letters after your name showing how many regulations you know, I don’t think this has much relevance today. But in this business trust is so important. In a world where we never get to know the people looking after our life savings, as we might have done in the old days, I can think of no other simple indicator of testing trustworthiness. Some people are dishonest, some can’t be trusted. Do you care? I do, and always have. Maybe other people don’t, that’s greed at work, but they will eventually, perhaps only after they’ve lost lots and lots of money.