The dog in the night time

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The Devil’s Advocate

In which the curmudgeonly old sod puts the world to rights.

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Thene 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?



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

The disaster cafe



  • 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:
  • 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 ThielTemplate:Be
  • 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
  • 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

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

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.
  • Lavish lifestyle, private jets, fast cars.
  • Spends a lot of time at conferences, Davos, wef
  • 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.
  • 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.


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

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)
  • 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)

Correlation risks

  • Interconnectedness of red-flags

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