This from Floyd Norris

Floyd Norris, the chief financial correspondent of The New York Times and The International Herald Tribune, covers the world of finance and economics.


February 27, 2009, 4:23 pm
Crime and Bubbles

Willie Sutton is supposed to have explained that he robbed banks because that was where the money was.

So it is with white collar crime. If you look where the bubble is, there too will be the crooks.

In the late 1990s, a company could be rewarded with a soaring stock price, and a valuation far beyond anything the company had actually accomplished — if it could show rapid growth. And stock options let executives monetize that gain almost immediately.

On the other hand, if your company was not hot, its share price could languish.

The result was a great temptation to fudge the numbers. At the extreme, we got Enron and WorldCom.

More recently, as soaring asset prices were pumped up by easy credit, it was money managers who could make zillions. Run a $500 million hedge fund and you get $10 million a year, plus 20 percent of the profits. Run a really big one that does very well, and you can take in a billion dollars.

And how do you attract enough money to manage? You show that you can produce outstanding investment results.

It turns out that the easiest way to do that was to lie about the results, and we are now seeing a succession of Ponzi schemes unveiled. The case involving Bernie Madoff may have been the largest, but others are multiplying.

It is no coincidence that we learn about the scandals after the bubbles burst. Enron had used its own high stock price to produce phony profits. When the stock price started to fall, it sparked a crisis and the facts eventually came out. So long as everyone believed assets were going up, money managers could siphon off new cash to pay those few investors who wanted to cash out. But when losses in other investments caused investors to flee, the game was up.

My suspicion is that there are more such schemes to be revealed.