Scandals in the Financial Industry

Scandals in the Financial Industry

The first such pyramid investment scam was called Tulipmania.

Tulip bulbs were exchanged in Amsterdam in 1634 at a special exchange. These bulbs served both as a medium of trade and a store of value for the people who utilized them. In order to make a profit, they traded them and invested in them. Black tulip bulbs, which are very uncommon, were worth as much as a large home. In the four years that the frenzy lasted, many people thought that it would never end. Sadly, this was not to be the case, though.

In 1637, the bubble finally burst. The price of tulip bulbs was reduced by 96% in only a few days!

This particular pyramid investment plan differed from the others that followed in human financial history elsewhere in the globe. There was no "organizing committee," no clear-cut set of decision-makers in charge of it. The investors never received any assurances that they would benefit from their investment in the program, or even that they would

When pyramid schemes first appeared, they were simple moneymaking operations.

There are a few things that all modern ones have in common:

There are an increasing number of people involved. As they grow in size, they pose a serious danger to national economies and society as a whole. Political and social consequences are inherent in all of them.

The financial crisis in Israel in 1983 affected hundreds of thousands of investors in a country with a population of fewer than 3.5 million.

The banks offered their own shares for sale, telling investors that the price of the shares would only rise. This was a typical pyramid scam (sometimes by 2 percent). Depositor money, bank capital, profit money, and money borrowed from overseas were all utilized to uphold this unhealthy and unattainable promise. Everyone was aware of the situation and actively participated.

Criminal activities were supported by Ministers of Finance and Central Bank Governors. This particular pyramid scam lasted seven years and is considered to be the longest in history.

All of Israel's banks failed on the same day in October of 1983. Government civil unrest was so severe that an extensive nine-year share purchase program was implemented to compensate owners. The entire indirect loss is impossible to calculate, but the direct harm amounts to 6 billion USD.

One of the most essential characteristics of pyramid schemes is that investors are promised returns that are impossible to achieve, either in terms of earnings or interest. The organizers resort to dishonest techniques since they can't get such high returns from genuine investing.

They pay off the old investors by using fresh money invested by new investors.

According to the faith, interest-bearing loans are strictly prohibited by Islam. If this limitation is not abolished, contemporary finance will grind to a standstill.

A few Egyptian and Pakistani businessmen and religious leaders saw an opportunity to build what they dubbed "Islamic banks" against this background. These banks did not pay interest to their depositors, nor did they charge interest on the loans they gave out to their customers. Instead, they have made their depositors participants in phony gains and have taxed their customers for fictitious losses. All would have been good had the Islamic banks kept to better business methods.

These "earnings" were absurdly large, and like all pyramid schemes, they eventually fell and brought economies and political institutions down with them.

Albania, 1997, is the most recent example of a country paying the price for a failed pyramid scam. Over a third of the population was significantly invested in a series of highly leveraged investment schemes that all crashed at the same time. Albania was on the brink of civil war due to ineffective crisis management on the political and financial fronts.

However, why do pyramid schemes always fail? If fresh money keeps flowing in, why can't these companies continue to thrive for the rest of their lives?

As a result, the quantity of fresh money accessible to the pyramid's organizers is constrained due to the restricted number of new investors. The number of people willing to take risks is staggering. By contrast, an alarming mismatch between exaggerated liabilities and the steady flow of fresh money foreshadows the day of reckoning. Panic sets in when there is not enough money to pay off the old investors. Each and every one of us hopes to win a sum of money simultaneously. A loan or investment in real estate is almost always involved, so this is obviously not an option. It's impossible for even the strongest and healthiest banks to save more than 10% of the money deposited in their accounts.

As a result, the pyramids will eventually come down.

However, the majority of those that participate in pyramid schemes are well aware that they are frauds. The collapse of earlier pyramid scams has served as a cautionary tale for them. Even still, they're drawn to it again and again, like butterflies to a flame.

There is nothing new here: selfishness and avarice. The organizers promised investors two things: they would be able to withdraw their money whenever they wanted, and they would earn significant returns while they waited.

People are well aware that such an event is exceedingly unlikely, and that as time passes, the probability that they may lose some or all of their funds increases. These people believe that the enormous earnings or interest payments they would have gotten prior to the collapse of the pyramid will more than make up for the loss of their original investment. Some of them, relying on "warning indications," seek to withdraw the money before the impending collapse. To put it another way, the investors are certain that they can outsmart the pyramid's creators. The organizers and investors work together psychologically to bring about their own demise: cheated and deceived engage in a sophisticated tango.

This is unquestionably the most serious financial scandal of all time. Every aspect of human connection is infiltrated by it. In the long run, it leads to national unhappiness since it affects economic choices. When a society is in transition, it is the enemy.

Scams involving the "black economy," i.e., revenue that has not been declared to tax authorities, are the most common source of financial mismanagement. As a result, it is possible to hide the identity of the money's owners by passing through financial systems and changing hands many times. Drug money, illegal arms trade, and tax evasion are all "laundered" in this way.

The financial institutions that engage in money laundering activities have two sets of books. One of the books is for the use of the government. For taxes, bank regulation and deposit insurance, and financial liquidity, these "manufactured" books are available. However, the real record is stored in a different collection of documents. In these records, you can see who has deposited how much, when, and under what terms, and who has borrowed how much, when, and under what conditions.

It's impossible to discern the institution's genuine state with such a skewed set of criteria. They begin to lose sight of what is going on and misunderstand the institution's true position.

Is it stable? The answer is yes. Is the company's investment portfolio sufficiently diversified? Nobody is aware of this. Even those who produced the fog are enshrouded in it. Under these conditions, it is impossible to conduct a proper financial audit or control.

Members of these financial institutions' management and personnel who are less conscientious often take advantage of the situation. Abuse of power and misappropriation of money are all too common occurrences, as is embezzlement. Creatures of all shapes and sizes thrive in dimly lit environments.

To date, no other financial scandal of this magnitude has been as well-known or as large as BCCI's fall in London in 1991. A total of 10 billion (!) dollars was stolen and misappropriated by the bank's executives and workers over the course of almost a decade. The Bank of England's supervisory department, which was intended to keep a check on this bank, was shown to be powerless and ineffective. Depositors of the bank, owned by Arab Sheikhs, had to fork up billions of dollars to the bank's owners to cover the losses.

Shredded papers and shadowy bank accounts are hard to track down when they're all mixed together. Damage in these situations is hard to estimate.

Among the three, the most difficult to locate is the third. Scandal may erupt-or not-depending on the chance, financial flow, and intelligence of the people concerned. It's a typical occurrence.

If they don't hand out loans to those who don't deserve them, financial institutions are forced by political demands to sacrifice diversity (to give too much credit to a single borrower). Almost all of South Korea's banks have recently been forced to reveal politically driven loans they made to Hanbo, a now-bankrupt corporation. It is fair to say the same about banks in Japan and almost every other country as well. Few banks, for example, would be willing to turn down loans from the Finance Minister's friends.

Social factors are taken into account by several banks when evaluating loan applications. They would lend regardless of the financial viability of specific areas of the economy. For social purposes, they'd hand out money to the poor and the rich, as well as to urban regeneration projects and small enterprises, all in the name of social objectives that can't be justified by lending money.

This is a unique instance of a more common problem: financial institutions' assets (i.e., loan portfolios) are too thinly spread out. In a particular nation or area, their loans are concentrated in a single industry (agricultural, manufacturing, or construction). The lending institution's financial health suffers as a result of this vulnerability. Sectoral, national, and region-specific economic trends often follow one another. When property values on the West Coast of the United States fall, it affects everyone equally. As long as the majority of its loans go to West Coast real estate agents, the bank will be dismantled.

Mexico went into default on its foreign debt interest payments in 1982. In the end, it jeopardized the stability of the whole Western financial system because of its large debts. The US banks, which were the most vulnerable to the Latin American debt crisis, had to pay the majority of the cost, which totaled tens of billions of dollars. Almost all of their resources were earmarked for loans to governments in Latin America. Fads and trends are accepted by financial institutions. "Lending trends" appeal to them, and they behave like sheep. Wherever they can obtain the most returns in the quickest amount of time is where they put most of their investments. Investors in pyramid scams aren't much different in this regard.

Lax or defective financial controls may also lead to financial mismanagement. To offset the inherent human predisposition for gambling, financial institutions must have an internal audit department and an external audit performed by the proper supervising agencies. With the support of objective and objectively evaluated facts, the financial institution must reorient itself. If they don't accomplish this, the financial institution will act like a ship without a map. Financial audit laws (the most notable of which are the American FASBs) are lagging far behind the current financial sector in terms of technological advancements. However, if implemented with care and discretion, they might be useful in preventing financial scandals.

A financial scandal is nothing short of a miracle when one considers human psychology and the intricacy of the current world of money.