The dog in the night time

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Theme tune: born under a bad sign/crawling kingsnake - dangerboy Podcast idea - look at unusual anomalies in the markets and ask why they persist. What are the red-flags that an out and out fraud, pyramid, ponzi scheme is going on? are there some consistent themes? The idea is not to look at the progenitors of these crashes, so much as the rest of us. Why did gatekeepers, investors, regulators miss it? Why did our control mechanisms fail?

Examples

Miscarriages of justice, positive and negative

• Lindy Chamberlain
• Peter Ellis
• David Bain
• Post Office Horizon IT scandal
• Lucy Letby

Crashes

What caused the crashes and how were these risks managed and viewed before the crash?

• Dotcom bust
• Russia crash of 1998
• October 1987
• Credit crunch of 2007

Theories

Disbelief-suspenders

• Reliance on agents and intermediaries: Reliance on trusted intermediaries as experts to place your funds so hold themselves out as experts and imply that they are taking responsibility for your interests but

(a) expressly (but discreetly) disclaim that responsibility and

(b) are incentivised in conflict to your interests (by retrocession commission from end investment and upfront commission from client)

• Compliance with ad hoc control mechanisms: presence of ad hoc proxy measures with which the plan was formally compliant: credit ratings, certifications, audit reports Sharpe ratios, "official" measurements which substitute for and *represent* actual intractable data with a simplified measurement or derivative, often provided by a third party not itself in possession of the intractable data.
• The velvet rope: the hoi polloi not welcome here. Celebrities only. See also “I don't want your business oh go on then”
• Affinity fraud: He's one of us.
• I don’t want your business: ... Oh go on then, really, if you must, just as a favour to you, you understand.
• Credibility: Connection top political figures or well-regarded community pillars. If George Schultz is on the board the company must be legit, right? We imagine community pillars have done their due diligence on our behalf?
• Cult of personality: A single Svengali, genius, Nobel prize-winners, NASDAQ chairmen
• The noble believer: The credible person who is duped and who unwittingly enables the fraud, The prison of belief.
• The big lie: The lie so big it couldn't possibly be a lie. Could it?

Oh come on, Ref

• Over-reliance on “other adults”: We imagine regulators/rating agencies are better resourced, more watchful, more powerful, more talented and less human than they are. Examples:
  • SEC on Madoff.
  • FDA on Theranos.
  • Moody’s on the GFC
  • Auditors for Enron - see also the agency problem.
  • BaFin on WireCard
• oversized management committee: a top heavy management structure with multiple board members whose function is effectively to to diffuse away responsibility rather than accept it, thereby giving cover 2 to micro dictator behaviour. See: Peter Thiel — Zero to One
• Referees with personal skin in the game: where referees have (wittingly or otherwise) committed personally to the enterprise, and are thus incentivised to find another explanation that doesn’t make them look bad

• Regulators on the Savings and Loan scandal
• BaFin on Wirecard

• Patchwork of politicised regulators: Operating a business at the intersection of regulatory regimes where:

• arbitrage is possible even for honest players;
• complexity makes compliance difficult, encourages opaque behaviour;
• sophisticated forensic analysis of the rules pays further dividends;
• competing regulators have a turf war and are thus otherwise occupied,
• competing regulators are incentivised to keep businesses they regulate “onside”;
• business finance political campaigns and indirectly influence the leadership of regulators - S&L scandal

• Who is going to say no?: where is the person inside the organisation who can stand up to the visionary? Who is Lear’s Fool?

In bed with the lawyers and accountants/my special friend

A very cosy relationship with a single law firm, accounting firm or management consultancy firm. Especially if there is a history of parachuting senior personnel of one organisation into the other — senior partner becomes general counsel, etc. Especially if the law firm is otherwise not a significant player. Points for style: cosy relations with single firms in all of the above (top marks, Enron!)

• Enron and McKinsey; Vinson & Elkins; Arthur Andersen
• Big eight accounting firms and S&L firms
• Greensill - The Greensill Capital’s Australian parent was audited by Nexia Sydney. Its London-based operating entity was audited by Saffery Champness, a UK partner of the Nexia Group.

This time it’s different

A paradigm shift as part of the narrative. We’ve banished risk. The internet has changed economics forever.

• Enron: mark-to-market accounting
• Dotcom bust: traditional valuation models
• LTCM: option tail risk
• They're techno trousers. They’re ex NASA.
• Debatable product quality/differentiators — low barriers to entry/inability to create monopoly conditions in which to seek rent

Hiding in plain sight

• Publicity courting, egotistical CEO: Adam Neumann, Jeff Skilling, Lex Greensill
• Lavish lifestyle, private jets, fast cars: Greensill’s suits and fleet of private jets.
• Spends a lot of time at conferences, Davos, wef: Greensill again!
• Inspiring public speakers - hokey aspirational hogwash mixed with virtue signalling as a BS detector bypass. “we don’t discriminate on age, sex, race and together we are unstoppable”.

Money, money, money

• No, or little, like actual profit. You know, yet.
• Management compensation package out of line with ;actual (not aspirational) peers
• Compensation based on stock-price or top-line growth, incentivising short term behaviour
• Suggestions of cashflow trouble: especially if masked as “just in time financing” — delays in paying usual outgoings.
• Just-in-time financing
• High debt-to-equity ratio
• Duration mismatch — long-term assets funded by short-term liabilities — subprime mortgages; WeWork.
• Low quality earnings — enthusiasm for sophisticated or state-of-the-art accounting.

Nothing to see here folks

• Narrative failures: Control oversights brought about by overzealous application of the theory of the game.
  • LTCM: reliance on Black Scholes notwithstanding it's failure to manage tail events
  • WireCard: BaFin not able to believe that this could be corporate fraud when "mendacious short-selling" by "locust" hedge funds - aided and abetted by, ahh, investigative FT journalists - fit the BaFin's regulatory world view and seemed a better story.
  • Enron: mtm up front realisation of lifetime deal pnl
• Sleepy backwater: It’s a boring and unglamorous part of the operational network. No one’s taking any risks there: Barclays Programme Limit, Excess margin return in Archegos, Libor, Kerviel, Abodolo.

Cassandras

• Weirdo whistleblowers: The people who called it out were unglamorous, outsiders, easy to categorise as cranks.

• Harry Markopolos on Madoff
• Daniel Sheard
• Shorts on the Big Short
• Twitter groups, bloggers

• Short-sellers are the enemy: narratising the short-sellers as venal and self-interested (as if any investors aren’t!)
• SoftBank: SoftBank is an investor! Greensill, Wirecard, WeWork

Porkie Indicators

• No errors: no screw ups, no bad launches: everything is fine. Real companies have setbacks. Especially if defended with hostility - e.g., you threaten to ruin EVERYTHING with your questions.
• Also implausibly steady rate of return over a period of time. Sea Madoff, Enron, AIG, WireCard
• The dog ate my homework: Promised answers to your questions are delayed, derailed, lost or excused. There's an excuse for everything. The excuses are implausible/out of proportion with the question. (what's the most plausible explanation: The dog really did eat your homework or ---?

Cloaking devices

• Micromanagement: Single person unusually able to influence/control the narrative.
• Reality distortion field: Charismatic leader can do no wrong, unusually able to divert attention from potential issues
• Secrecy: Insistence on confidentiality not just of unannounced plans but of entire operation. Black box operations. Masking the size of the operation (Madoff) or suggesting it is so secretive that you cannot know it (Theranos)
• It’s the law: I can’t possibly tell you because of GPDR, Health & Safety, potential market abuse, anti-trust and so on.
• Hostility: combative/aggressive demeanour to criticism
• This is different how?: To what extent is “fake it till you make it” bravura, and how much is it confidence in your ability to sort it out later, or big opportunities. Is there a difference?
• Performative, virtue signalling behaviour: making it difficult to quibble/criticise without seeming politically incorrect.

All is not well

• High turnover: Especially when combined with confidentiality. Especially risk/control personnel. Workplace bullying etc.
• Who’s that guy?: A position of unusual influence with a flaky backstory
• A big problem is a small one that you didn’t fix when you could have: Often big problems start out as small problems, where a well-intended patch didn't play out. How disciplined is your organisation with sweating the little stuff. and what of the trade off between “bureaucracy” and “discipline with sweating the small stuff”?
• Internal checks defeaters: cultural/organisational factors undermining internal control mechanisms

Internal competition/eat what you kill/personal ambition/territoriality

Risk control defeat devices

• Juniorisation: Specialisation/siloisation/jujniorisation of key risk personnel: miss emergent risks between functions, not understand bigger picture; not understand risks at all. Emphasis of form over substance: Playbook as a substitute for comprehension.
• Misaligned incentives: financial reporting as a profit centre (Enron)

Well fancy seeing you here

• McKinsey and McKinsey alumni
• Ayn Rand fanboys

Correlation risks

• Interconnectedness of red-flags

With all the checks and balances in financial regulation, how did:

The disaster cafe

Roll of Honour, financial disasters edition

Scandal	Date	Where	Loss	Reason	Firings	Jail-Time?
Post Office Horizon IT scandal	UK	Unjustified prosecution and conviction of hundreds of subpostmasters across the UK	Unaccountability, groupthink, astonishing collective amnesia, widespread incompetence, stupidity.	Conviction, imprisonment, suicide and bankruptcy of hundreds of perfectly innocent and quite nice people.	Loss of public honours (CBE). No firings yet: many candidates for defenestration jumped before they could be fired.	Excoriating public humiliation in front of public enquiry. Increasingly likely some criminal prosecutions may follow.
Credit Suisse	Switzerland	Gradual decline into entropy with a 92% decline in share price since 2015.	Hubris, widespread incompetence, stupidity, spying, uselessness.	Billions and billions over a series of avoidable cockups.	Like the old man in Monty Python and the Holy Grail, “I’m not dead. I think I’m going for a walk. I feel happy.” Market (to SNB): “Isn’t there anything you can do?”	It is not, yet, a crime to make a series of howling cockups over a credulity-defying period any more than it is a crime to not read an AT1 prospectus. Reputations damaged for ever, but alas no porridge, however richly deserved it may seem.
Silicon Valley Bank memeplex	2023	US	$80bn or more	Dopey bank management, regulator asleep at switch, Peter Thiel panicking	Bank insolvent. Bondholders and shareholders wiped out. Other banks levied. Triggered other moral panics such as First National, Signature bank and others (poor old lucky Credit Suisse)	None yet. Lots of arguments about the presence or absence of moral hazard. Moral panic more like.
Frank	2023	US	$175m	Fraud, unfeasible gullibility	Javice got fired. Surely more to come	Not yet clear
FTX/Sam Bankman-Fried	2022	US, Bahamas	$32bn (so far) so some claims that everything has now been recovered and returned to its rightful owner	Hubris, stupidity, fraud	Fired: Gary Wang, Caroline Ellison, SBF. Bankruptcies: Alameda, Genesis, Blockfi. Suspensions of trading: Gemini Reported Losses: Crypto.com, Tiger Global Management, the Ontario Teachers' Pension Plan, SoftBank Group, BlackRock, Lightspeed Venture Partners, Temasek, and Sequoia Capital reported losses of $1bn	Charged with wire fraud, conspiracy to commit securities fraud, money laundering, conspiracy to defraud the U.S., violation of campaign finance laws.
Barclays MTN Programme Limit	2022	US	£1.3bn	Internal Operations	None reported but you have to fear for those poor folk in ops. I beg your pardon? What poor folk in ops? Oh, Right.	No-one goes to jail for forgetting to monitor a programme limit.
LME Nickel short squeeze	2022	London	“Billions”	LME	None reported ... yet	No
Evergrande	2021	China	$300bn		Who knows?	No
Archegos	2021	US	$10bn+	UMR Internal operations	100+ across brokers plus several senior executives and one CEO	Eyes peeled, Mr Huang
Greensill	2021	UK	$4.6bn
Melvin Capital Management LP	2021	US	$7bn	Hubris detector failed	Everyone! The fund shut down shortlay after	Talk of regulators, outrageously, going after the outsider traders, but nothing as yet.
Citigroup v Brigade	2021	US	$500m	Outsourcing, Operations, IT	Not reported but wouldn’t fancy being head of the team in Bangalore	No
Nikola	2020	US	About 80% share drop	CEO misrep	Must have been plenty	CEO indicted on charges of securities fraud
Wirecard	2020	Germany	$4bn	CEO misrep	All of them	Three charged with fraud including CEO
WeWork	2019	US	$11bn over three years	CEO yogababble	Nothing to see here folks! Got a new venture to start up	Jail? Dude hasn’t even been kicked off Marc Andreesen’s Xmas Card list.
Carillion	2018	UK	£7bn	Auditors	3,000 jobs	No but litigation a-plenty
Patisserie Valerie	2018	UK	£94m	Auditors	900 jobs	No but PWC fined 2.3m
Abraaj	2017	Saudi	$1bn	Fraud, Virtue signalling	Some, not clear how many.	Naqvi extradited and charged in US, many many gatekeepers fined
Fyre festival	2017	US
Mozambique tuna bonds	2012-2016	Mozambique, Russia and Switzerland	£1.5-2bn Credit Suisse fined £350m and required to forgive its loans ouch	Fraud, corruption, money laundering	Plenty, including three Credit Suisse bankers and the minister in Mozambique	Three Credit Suisse bankers done on money laundering charges
1MDB	2016	Malaysia, but tentacles stretching all over the world: USA, Saudi Arabia, Singapore, Switzerland, China	Somewhere between $4.5bn and $8bn	Colossal fraud, corruption, money laundering and hip-hop	Hell yeah. Prime Ministers, Goldman Sachs Partners, and one dude — Jho Low — on the lam in rural china	You betcha: Australia, Hong Kong, Indonesia, Luxembourg, Seychelles, Singapore, Switzerland, UAE, UK and US are all actively pursuing action. The two Goldman partners pled or were found guilty; one sentenced to 10 years, one awaiting sentencing. Malaysian PM and wife convicted and sentenced to 10+ years with money laundering. If anyone catches Jho Low he’s for the high jump too.
Mossack Fonseca	2016	Panama
Theranos	2016	US	peak valuation 10bn	Fraud, delusion	everyone at the firm	Founders in jail for hundreds of years.
Wells Fargo accounts fraud	2016	US	$2.7bn in fines and civil suits	fraud, out-of-control rampant bad appledom	Plenty	SEC civil suits vs two senior executives
Volkswagen emissions	2015	Germany and US
AIG	2008	US	US$61bn	Misunderstanding mortgages	Not reported	Some irritation that bonuses were still paid
Olympus	2012	Asia	US$4.9	Accounting shenanigans, fraud	2700 jobs	Kikugawa and Mori sentenced to 3 years in prison, 5 years suspended. Auditor sentenced to 2.5 years in prison, 4 years suspended. Olympus was fined 700 million yen ($7 million USD). In April 2014, six banks filed a civil suit against Olympus over the fraud, seeking an additional 28 billion yen in damages.
LIBOR rigging	2009	Worldwide	“If your mortgage or car-loan was pinned to Libor then perhaps you were disadvantaged by the manipulation of the rate. But it is also possible that you benefited from it.” To date, no one has been able to prove any loss.	Bad apples	Lots of firings of mid-level traders and rate submitters. Strange absence of exits from the Executive Suite, though you could say it contributed to Bob Diamond’s defenestration	Tom Hayes and Carlo Palombo were among 37 City traders prosecuted for manipulating benchmarks Libor and Euribor. Both men spent time in prison before being released in 2021. Matt Connolly and Gavin Black were convicted in the US then their convictions were overturned in 2023.
London Whale	2012	UK	£6.2b	Rogue trader	Bruno Iskill was fired; an external lawfirm did a deep dive but unclear anyone else was directly whacked	No
Kweku Abodoli	2011	UK	$4.5bn	Rogue trader	Abodoli and his line management	Abodoli
Jérôme Kerviel	2008	UK	$6.7bn	Rogue trader	Kerviel and his line management	Kerviel
Bernie Madoff	2008	US	US$65bn	Fraud/Ponzi	Whole firm, many subsidiaries and feeders	Madoff imprisoned. Several implicated enablers topped themselves.
Amaranth	2007	US	US$9.2	Hubris, Markets misbehaving	Whole firm	Charges settled on payment of 750,000 fine.
Tyco	2002	US	US$3bn	Accounting shenanigans	Unclear	Kozlowski did a stretch.
Parmalat	2003	Italy	EUR14bn	Accounting shenanigans		Lots of settlements, fines and red faces
Freddie Mac and Fannie Mae	2008	US	US$14.9bn	Failure to understand the concentrated risk of subprime home loans	No it was everyone else’s fault	No it was everyone else’s fault
Global Crossing	2002	US	US$47bn if you believed the company0146s valuations	accounting shenanigans	Whole firm	Gary Winnick and other ex-executives settled lawsuits filed by investors and former employees accusing the executives of committing securities fraud by using improper accounting to inflate the company's revenue
WorldCom	2002	US	US$11bn	Accounting shenanigans	Whole firm	Ebbers convicted of fraud, conspiracy, and filing false documents with regulators and sentenced to 25 years.
Enron	2001	US	US$63.4bn	Accounting shenanigans, hubris, mismanagement	Whole firm, plus Arthur Anderson collapsed, which was nice, oh and the Sarbanes Oxley Act	Skilling, Lay and Fastow jailed, for fraud, money laundering, insider trading, and conspiracy among other things.
LTCM	1998	US	$3.6 bn bailout orchestrated by the Fed	Black-Scholes option pricing model attacked them from nowhere	Everyone out of a job, Master of the Universe-sized reputations (John Meriwether, Myron Scholes, Robert C. Merton) cut to ribbons	No, though fourteen bank CEOs were locked in a room by the Federal Reserve for a weekend so that is something.
Yasuo Hamanaka	1996	Asia	US$1.8bn	Rogue Trader	Fired	Hamanaka convicted on four counts of forgery and fraud and sentenced to eight years in jail. Sumitomo paid fines of US$150 million to CFTC and US$8 million to the SIB to settle charges of copper price manipulations.
Nick Leeson	1992	UK Singapore	US$1.4	Rogue trader	Whole firm	Leeson jailed.
Lehman	2008	Worldwide	US$613bn	Bankruptcy	Hundreds of thousands	Noone.