The heatwave means that recently I haven’t been sitting in front of a computer much. Instead I’ve just finished reading Dan Davies delightful book “Lying for Money”.
Dan and I used to be competitors, so I know him to chat to over coffee and biscuits before (mostly dull) company presentations. I’ve been toying with the idea of publishing a book for a while, whereas Dan has actually done it. And he’s managed to get both Nassim Taleb and John Kay to review (and comment favourably on) his book: an impressive achievement which suggests his book is worth your time.
I really enjoyed it. From Gregor MacGregor, an early 19th century Scottish confidence trickster who invented a kingdom in Central America, to modern day financial crime like Libor rigging and Payment Protection Insurance.
This isn’t supposed to be a traditional book review. Instead a few thoughts on what I found interesting, such as the observation that:
“Part of a fraudster’s craft is the ability to tell a good story, and this is done both to banks and to trade victims.”
Analysts tend to look for evidence of fraud in numbers, for instance checking how cashflow converts into accounting profits. But I’ve always thought that understanding if stories make sense was a much more valuable skill.
And there a many good stories in the book, because famous frauds almost always make good stories. He also examines the trust mechanisms which underpin the modern world (with digressions into how some famous fraudsters exploited them). A fraud has to make sense, and not be recognisable as a fraud to the institutions that are there to protect us. Frauds must also fool our personal intuitions, so that we don’t “smell a rat”. It’s like a stage magician’s trick, the fraudster has to know where the audience is going to be looking, and then make sure the slight of hand is going on somewhere else.
As Dan points out: a public market provides the same service to liars that it also provides to honest businesses – it converts stories into cash.
Frauds of all shapes and sizes
The book covers a lot of ground, American Express Salad Oil Scandal, Bre-X, Bayou Capital, The Krays financial adviser Leslie Payne, Charles Ponzi, The Portuguese Banknote Affair, Nick Leeson and Barings to Charles Keating and the Savings and Loans disaster – faked suicides, gangsters, forging money, complex characters from naïve victims to sociopathic villains, it reads like a compendium of Sherlock Holmes stories, except true.
I was a little disappointed with some of the familiar stories that he left out, for instance BCCI (jokingly referred to among city wags as the Bank of Criminals and Conmen International) and Gerova, which tried to buy a former employer of mine.
Was PPI a fraud?
I also couldn’t help thinking that some of the most interesting fraud stories, were not really frauds at all. For instance Payment Protection Insurance (PPI) had been sold for over a decade to UK bank customers, with the full knowledge of the regulator. I even published a “sell” note on Lloyds about looking at PPI in October 2006, which no one took much notice of. It just didn’t make much sense to me that you could see on the banks website that they were offering unsecured loans of 6.2% APRs while making bad debt provisions of 6% and reporting a high level of profitablity of 24% post tax Return on Equity. The way to square this circle, was to realise that the unsecured loans were still hugely profitable despite the bad debts, because the insurance that was sold with the loan was such bad value for the customers. *
It was all legal…gouging your customers is legal, as long as you explain what you are doing in the small print that no one reads. Most companies don’t do this – we don’t bother reading the terms and conditions for tech companies, because if they abuse our trust we will move our custom elsewhere. Unlike tech firms, when bankers treat their customers fairly, they struggle to make a profit. It was only in 2011, when Antonio Horta Osario became Chief Executive of Lloyds Bank, and unilaterally decided to capitulate that tens of billions of pounds was repaid to customers. The profitability of banks will probably never recover to the 20% plus returns on equity we saw before 2008.
Dan points out that most of the people in the book got caught.
“The time, effort and commercial acumen that goes into almost any fraud would nearly always have been better spent on doing something productive.
Wherein lies another half truth. There are companies that have been terrible investments, but that are not frauds. Not just banks. Listed companies making supercapacitors or hydrogen fuel cells, which haven’t made a profit in more than a decade – but are still listed in on the stockmarket. Not to mention biotech research or oil and mining companies in remote parts of the world. The company management tell a good story, success seems just around the corner, upside seems huge. But nearly always you would be better off thinking about the story, if our intuitions are being fooled by someone who would be better off selling a product that was feasible to mass produce and customers wanted. Or put another way: perhaps those “mostly dull” company presentations really have the most interesting stories.
* My wordpress skills aren’t good enough to be able to embed the report into this post. But if you ask nicely I can send you a PDF version of the report.