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