Wednesday, May 12, 2010

Bernie Madoff Was An Amateur

Let's stay on the topic of stupidity today. It's such a rich vein to tap, stupidity. There's just so much of it to marvel at.

When's the last time you thought about Albania? Such an architectural marvel, that nation. But if you think America has been taken in by Enron and Goldman Sachs and the like, you haven't seen anything yet.

Tirana is not New York. Albania knows a lot less about how to play the financial markets than Wall Street. They weren't helped by being a Communist regime under Enver Hoxha until 1991. So when the Iron Curtain came down, one of the things Albania had to do was get itself a financial system.

Their first attempt was good old fashioned banks. Three state-run banks had 90% of the money. They also had some bad loans. Not being total lunkheads like we were, Albania's government started to regulate credit ceilings.

Unfortunately, the Albanian people WERE total lunkheads, and responded by pulling their money out of the banks. But where would the money go? There weren't enough private banks to serve the purpose.

Ponzi schemes. Gigantic Ponzi schemes.

As you might be aware from the Bernie Madoff scandal, a Ponzi scheme needs a steady influx of new investors in order to keep going. The continual addition of money by new investors helps to keep the old investors involved. The earliest ones even get paid some of that money.

Albania managed to break a Ponzi scheme. Not because they busted it. No, no. The government was fooled too, even calling the so-called private deposit-taking institutions good for the economy. In fact, when a bill was passed in February 1996 giving the Bank of Albania the power to close just such things, the Bank couldn't get the government on board. The scheme runners bought enough of them to make sure they were.

So the government didn't break the Ponzi scheme. Albania broke the Ponzi scheme because two-thirds of the country got in on the ground floor. In this paragraph from the IMF's story on it, you can see some of the competing schemes (oh yes, they were competing with each other) showing one of the warning signs- raising interest rates- as well as the fervor of the investing:
The proliferation of schemes had baleful effects. First, more depositors were drawn in. Although VEFA had the largest liabilities, it had only 85,000 depositors. Xhafferi and Populli between them attracted nearly 2 million depositors—in a country with a population of 3.5 million—within a few months. Second, the investment funds felt pressured to compete and began to offer higher interest rates on deposits. In July, Kamberi raised its monthly interest rate to 10 percent. In September, Populli began offering more than 30 percent a month. In November, Xhafferi offered to treble depositors' money in three months; Sude responded with an offer to double principal in two months. By November, the face value of the schemes' liabilities totaled $1.2 billion. Albanians sold their houses to invest in the schemes; farmers sold their livestock. The mood is vividly captured by a resident who said that, in the fall of 1996, Tirana smelled and sounded like a slaughterhouse, as farmers drove their animals to market to invest the proceeds in the pyramid schemes.

When the IMF stepped in to try and put a stop to it, they were smacked around by both bought politicians and lunkhead voters. Eventually, though, the situation became too dangerous for even the politicians, and they set up a committee to try and deal with the schemes.

It was too late. The first scheme, Sude, collapsed before the committee could even meet. (Who was Sude run by? A 32-year-old gypsy fortuneteller. With a crystal ball and everything. She was ultimately entrusted with $100 million.) The government finally acted, but only after other schemes, confidence shaken by Sude's failure, were collapsing left and right and there was no more money for the government to make from them. A law banning pyramid schemes was passed, but there was no definition of what a pyramid scheme actually was. Even some of the actual pyramid schemes were waved off as "bilateral loans".

It was too late for the government to even save itself; a full-scale uprising was underway by March 1997 that would soon see a new interim government seated that would actually do something. Some 2,000 people would die, the south was in anarchy, people would flee the country, those weapons taken out of the armory that weren't used in the uprising would end up largely migrating to Kosovo. The soldiers and cops weren't about to stop it; they'd already deserted and in fact had done some of the weapon looting.

And through it all, four of the ten major schemes were still alive. They obviously weren't getting any new money, but they stayed in the game by slowly- very, very slowly- paying back investors, just barely enough to get people convinced that everybody would eventually, on some distant day, get their money back. Regulators wouldn't gain control of the last of them until March 1998.

All could have been avoided had the Albanian people just gone along with the regulation of credit ceilings.

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