Money is about accounting entries. Modern scams are all about stealing accounting entries, when the system has a ‘reconcilement’ problem.
Looking back on different financial sector scandals in different countries at different times, where one has had the outlandish privilege of a microscopic view, one is struck by a distraught sense of deja vu. Are all scams similar? Are they similar even when they are different?
It is much more efficient and easy to steal money directly, rather than steal widgets that then need to be converted to money. And it makes sense to steal from banks. And whatever Ocean’s Eleven might tell you, money is not about gold bars, not even about wads of currency notes. Money is about accounting entries. This means that a modern scam is about stealing accounting entries. And accounting entries are best stolen when the system has what is known as a “reconcilement” problem.
This arises when accounting entries in two different organisations tell two different stories.
The bank believes that it has given a loan to Company X; the accounting entry says so; the bank’s auditors think so. But lo and behold, Company X does not tell its auditors that any money is owed to the bank. Ay, there’s the rub. The accounting entries across the two organisations tell two different stories, because somewhere in the astral space, the accounting entry has been stolen or has been subject to a Houdini-style disappearance.
Modern money exists primarily in the form of accounting entries that all of us acknowledge. When such acknowledgement is not there, money is stolen; when it disappears, a scam has occurred. Sometimes a complete theft is not necessary. If you are a large investment bank, all you need to do is to convince a rating agency that a junk asset is a high quality Triple A asset. That can do the trick. When the “reconcilement” happens and the asset’s true quality is revealed, the scam surfaces.
Here are some recurring themes and patterns associated with scams:
The amount of money that is identified as lost/stolen/embezzled on Day 1 is always an understatement. Over the next few weeks and months, the amount is bound to grow.
Initially, it appears that a handful of folks were truant in a simple sort of way. Over time, a large, elaborate, complex spider’s web emerges.
ATMs don’t steal; even telex messages don’t steal. People steal. And sadly, banks make the same mistakes again and again about people. An employee that the Dublin branch of a bank hired was previously turned down by the London branch because of a poor background reference. Think of all the Trading Desk Heads who were considered wizards and magically produced profits every quarter. But the music stops after a reconcilement problem surfaces. And the losses are many times the profits of all the preceding great quarters. Think of all the Lending Officers who were promoted because they were able to lend to their customers just on the last day of the quarter and collect handsome upfront fees – and it never dawned on the big bosses that the borrowers may not intend or may not be able to repay the loans.
Think of the Branch Manager of the Year, who had a hundred percent growth in loans in a year when the nominal GDP grew by 12 per cent. And to think that the branch manager was rewarded for efficiency and productivity because instead of bothering with too many itsy-bitsy customers, the growth happened with just two customers.
And although it may appear to be some technical glitch or a fit of over-enthusiasm, the fact of the matter is that the people are almost always compromised. They are living beyond their means, socialising excessively with customers, trying to send their children to super-expensive playschools and so on.
Does ownership matter? Scams happen in the private sector and in the state sector. But ownership does matter to an extent. If taxpayers are also owners, they are invariably stuck with the losses. If others are owners, they bear the equity write-down; governments do lend to private banks to help them through scams, but the money is usually fully recovered along with a decent rate of return. Privately-owned banks tend to be quick to recognise losses, minimise them, recover as much as possible, sack a few persons, tweak a few systems and then move ahead. Government-owned banks tend to take forever to establish any momentum at all, and can remain internally derailed for years on end, sometimes eroding even more value than the scam losses entail.
In the social morality of the modern world, stealing from the government may be a crime, but it is not seen as a “sin”.
Coming back to reconcilements, here is a personal anecdote. In 1973, I was asked to do some research on a foreign exchange trader in Beirut who had walked away with a couple of million dollars. His modus operandi involved “making friends” with and “helping” the reconcilement clerk. Our friendly helpful trader managed to postpone reconcilement by 18 months and that was sufficient time to pull off the scam. Incidentally, the trader used to gamble heavily in the casino, something that the HR department was oblivious of.
If “reconcilement” is where scams finally tend to get caught, here is one practical suggestion. Let us go for a public block-chain type of reconcilement. If Bank A is disbursing a loan based on Bank B’s guarantee, perhaps this information, above a certain level of materiality, should be publicly disclosed, at least in the back pages of the voluminous annual report. This cannot and should not be withheld as “confidential”.
When this happens, a smart analyst, who is willing and able to delve into the back pages, will pick up on the discrepancies and the underlying risks. After all, if the market had known the extent of credit default swaps that Goldman and Lehman had outstanding with AIG in London, 2008 may never have happened.
This is a financial regulation that we could bring about as an unintended positive consequence of our present national agony.
Will we ever have a world without scams? Unlikely. Can we have a world where scams are fewer, are caught quickly and where ordinary tax-payers don’t subsidise the scamsters? Such a world is possible and worth working toward.
Jaithirth Rao lives in Mumbai. He is an entrepreneur and a writer.
Mr. Rao – only a devotee of the Chicago “Gharana” of economics would believe that money the government lends to private banks is “usually fully recovered along with a decent rate of return”. We non-Chicago Libertarians know this truth to be self-evident – the Government has nothing of its own that it did not steal from others. The money it lends to private banks to recover from reconcilement does not come back – it gets added to the money supply and what comes back is inflation (so much for that rate of return)
Oh – and please don’t let economists delude you into challenging the wisdom of Ocean’s Eleven. After all JP Morgan himself said it – Gold is money, everything else is credit !!