With possible losses of $50 billion, one may exaggerate by describing Bernie Madoff’s scheme as the tip of an iceberg. If history is any guide, however, numerous other frauds will emerge before our ongoing debacle is over.
The basic problem stems from the same aspect of human nature that renders so many well-intentioned New Year’s resolutions void within weeks. Bad experiences scare us and we vow to change our ways. But, as memories of our fright fade away, so does our resolve to change.
A few weeks before his 1933 inauguration, Franklin Roosevelt wrote “we must build toward the time when a major depression cannot occur again, and if this means sacrificing the easy profits of inflationist booms, then let them go — and good riddance.”
In 1933, most Americans agreed wholeheartedly. But by the mid-1990s, the children and grandchildren of those Americans giddily celebrated another such boom.
The collapse of the dot-com bubble at the end of the decade seemed a temporary blip as post-9/11 recession fighting by the Fed sent asset values upward. Our 401(k) statements showed steady gains and our houses were worth more each time we got a real estate tax statement — or had them re-appraised for yet another mortgage refinance. Times were pretty good. And that set people up for scams.
In “Manias, Crashes and Panics,” his classic history of financial crises, MIT economist Charles Kindleberger devotes an entire chapter to “frauds, swindles and the credit cycle.” It begins, “The implosion of an asset price bubble always leads to the discovery of frauds and swindles.” He later describes how “fortunes are made in a boom, individuals become greedy for a share of the increase in wealth and swindlers come forward to exploit that greed.”
When media stories of windfall IPO profits or stellar mutual fund performance are common, it is much easier to suspend disbelief that someone like Madoff can outperform competing funds month after month, year after year.
When an entrepreneur like Tom Petters is able to acquire well-known companies like Polaroid and Sun Country Airlines, it is easier even for veteran financial managers to swallow the tale that he is making high margins holding inventories of consumer electronics for mass retailers.
In retrospect, that is as unbelievable as Charles Ponzi’s story that he could make millions by arbitraging international postage-paid reply coupons, but in the mass self-hypnosis of a bubble, it apparently seemed credible.
Watching flickering old newsreel footage on public television documentaries, we snicker at the gullibility of 1920s speculators in Miami house lots. But when our cousin got a great deal on a Boca Raton condo five years ago, few of us dared warn of a mistake.
Bubbles stem from human nature amplified by bad government policy. It is in the nature of some humans to break the law in acquiring wealth and in the nature of many others to fall into their traps. But this all compounds the social pain of an imploding bubble.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.