RogerBW's Blog

2018 non-fiction, an informal look at the history, particularly in the twentieth and twenty-first centuries, of fraud.

I should say first that Davies is an economist who speaks my language. Quite often he introduces an idea and gives it a layman's explanation, but I know what he's talking about in a bit more detail, and this certainly helps my appreciation of the intricacies of what he's describing.

The theses are not particularly new, but are well assembled here. Davies divides financial fraud into four broad categories of increasing abstraction: borrowing money (or other value) and not paying it back, abuse of trust regarding ownership, control fraud (where the payment itself is legitimate, but the source is not, as for example dividends paid on the misrepresented value of a company) and market fraud (where the market as a whole is manipulated to extract value). But while this provides some structure to the book, it's a very loose categorisation, and mostly it's there to hang the anecdotes of frauds which provide the meat.

Of course all these frauds are ones that were found out… but they are not all ones for which people were successfully proscuted. In the case of PPI Davies goes into some detail on why not:

This is why nobody went to jail over PPI. Prosecuting the small fry and letting off the big bosses is unedifying and leaves a bad taste even in cases like the LIBOR fraud, where the conspirators are aesthetically horrible people who did make substantial personal profits. In the case of PPI, it would have crossed the line from 'unedifying' to 'actually repulsive'. But prosecuting the people at the top of the tree only works in situations when they meet you halfway by committing a crime. To the frustration of all, it is not a crime to set stupid targets for your sales force, nor is it a crime to fail to check up on them. At the time when the PPI scandal happened, it just wasn't a crime to run your bank really badly.

Another underlying thesis is the difference between high-trust and low-trust societies. In a low-trust society, you only do business with people you know, you don't extend trade credit… and there is very little fraud, but also very little business at all. In a high-trust society, where most of the time most of the people are expected to be acting honestly, you can do business with many more people; you can lend money or goods to relative strangers in reasonable expectation of getting them back… and there's much more economic activity, but also much more opportunity for the criminal. Is this an inevitable cost of openness? Probably; it's clear that the economically ideal level of fraud is not zero, because the cost of getting it there (both directly, and the opportunity cost of things that can't happen because the fraud prevention gets in the way) would exceed the value that would be lost to the last few prevented frauds.

There's some analysis of the common factors between different sorts of fraud: time differences are particularly important, and any sort of transaction that involves someone paying now in return for a future consideration can readily be used in a fraudulent way. But there's also the problem of the positive feedback effect: if you're paying people real profits on your notional money-making scheme, you have to get that real money from somewhere, which almost always means expanding the scheme. This in turn may explain why so many pyramid-scheme merchants seem to be relieved when they're finally caught.

Davies does have an admiration for some of the more artistic fraudsters:

The modern 'pyramid scheme' is a rough pile of rocks compared to the Venetian palazzo of Ponzi's original template. There is little of the design, hardly any of the flair and a virtual certainty of collapse in the most predictable way possible, rather than Ponzi's elegant dance of risks and intrigue.

though he concedes that most of them are in practice fairly horrible people, not just because of their criminality but personally too. He quotes from several autobiographies, but is at pains to point out where these stories differ from what everyone else thinks happened.

I found the lessons drawn from the anecdotes interesting in themselves: Gregor MacGregor and the notional country of Poyais may seem like an obvious scam now, but he laid his groundwork well, and in any case there's no reason to suppose that there aren't scams today which will seem obvious but that we haven't heard about yet. We just have different blind spots. And in a look at the Silk Road marketplace on Tor (the first one I've seen that doesn't just focus on its eventual destruction by law enforcement), there's a good point on why the reputation and review system for traders wasn't enough in the long run:

A key difference between the online drugs trade and the normal economy, though, is that not all that many people are interested in building a career in online drug dealing and passing the firm down to their children. People grow up, leave college, or have the kind of short interaction with the legal system which suggests to them that a lifestyle change is in order.

Davies also comes up with about the only good reason I've ever come across for trying to prevent insider dealing: it puts off the suckers who currently provide useful liquidity to the market.

But the retail orders would eventually dry up if the customers lost too much or felt that they weren't being given a fair chance. And without a steady flow of 'dumb money' lubricating the wheels, the professionals would find it a lot harder to trade, as they'd always suspect each other's motives for buying or selling.

My favourite footnote, though, was regarding prime bank fraud, a scam based entirely on a conspiracy theory (anti-Semitic as they usually are) which seems to be propagated largely by true believers who lose their profits in other scams of the same class:

A few references are in the bibliography but please, don't bother -- the further you go down this rabbit hole the more confusing and annoying it becomes, plus there is always the danger of convincing yourself there's something to it, which would be an expensive error to make. Even the books are overpriced.

The book is always amusing to read, though if you're inclined as I am to think that there are deep structural problems with capitalism as applied by humans it will do nothing to change your mind.