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Author: tjscott0 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 62032  
Subject: "We're Incentivized to Cheat" Date: 4/7/2013 8:48 AM
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Jim Chanos, an early detector of Enron's fraudulent practices, explains our dysfunctional banking system.

The articles like to one below really drive home the fact that the stock market is a crap shoot. Though with zero % interest its the only game to play. I concentrate on dividend stocks so that at least I know some money will be coming my way. And to reduce volatility tilt somewhat in consumer staple & utility stock etfs.

http://www.salon.com/2013/04/03/wall_street_power_player_wer...

LP: Good deeds can be a sign of fraud?

JC: One of the more interesting observations in the world of fraud is that some of the most egregious frauds were some of the most philanthropic companies in their communities.

LP: You’re known for your early detection of Enron’s problems. How does a company like Enron stay in business for years? How is the fraud sustained over time?

JC: It’s one of the great questions, Lynn, and I think that in the case of Enron, there were a lot of people getting rich aiding and abetting what turned out to be to be a fraud. They may not have known it was go-to-jail fraud, as it turned out to be (and most fraud certainly does not end up in jail sentences for the perpetrators, as we know).

LP: What do we know about the timing of frauds? When are they most likely to happen?

JC: One of our models is the Kindleberger-Minsky model, named after Hyman Minsky and Charles Kindleberger. It’s a macro model, and basically it takes a look at various market cycles. What we find is that the greatest clustering of fraud in the financial markets occurs, as you might imagine, during and immediately after the biggest bull markets. As I like to tell my students, it’s basically a period in which people suspend their disbelief. Everybody’s getting rich and it becomes increasingly easy to sell more questionable schemes and investments to investors.

LP: One look at your Yale syllabus shows that fraud has been rife through business history. Yet for the last 20 years, many people have insisted with near-religious conviction that markets are efficient and therefore resistant to fraud. Where is this belief coming from, and why is it a problem?

JC: It rests upon an assumption that is deeply flawed, and that is that the people who are stewarding your capital in the marketplace — the boards of directors and the people that the boards hire – management — are acting not only in your best interest, but are playing by the rules all the time, so that, for example, the accounts that the company puts together for the accountants (and keep in mind, management prepares financial statement, not accountants, not the auditors) are accurate.

I point out to my class that in 1998 there was a survey– Business Week (which is owned by McGraw-Hill) and McGraw-Hill (which also owns Standard and Poor’s) had a conference for the S&P’s 500 chief financial officers. They asked these chief financial officers if they’ve ever been asked to falsify their financial statements by their superior. Now, the chief financial officer’s superior is the chief executive officer, or the chief operating officer—basically the boss. It was a stunning—of course anonymous – survey. 55 percent of the CFOs indicated they’d been asked, but did not do so. 12 percent admitted that they’d been asked and did so. And then 33 percent said they’d never been pressured to do that. In effect, only one third of the companies in the S&P’s 500 at that time did not have a CEO or COO try to pressure their financial officer to falsify financial results.

If we look at the recent global financial crisis, a lot of people say: why were there no prosecutions? One of the first sort of default defenses you heard over and over again is well, stupidity is not a crime, and making bad decisions is not a crime. It may certainly lead to grievous losses, but that’s the marketplace. And I agree with that 100 percent. The problem is that financial crimes, unlike crimes of passion and crimes of opportunity, come with their alibis already built in. You build a veneer of legitimacy about what you’re doing. You get accountants to sign off on what you’ve done. You don’t look at any emails or get sent any emails –- at Enron Jeff Skilling never saw any emails (so how do you run a global trading powerhouse and never use email, right?). We teach this legal concept called “willful blindness,” and that is, in some cases senior executives are cut out intentionally from controversial things because they don’t want to be able to say, well, I approved that or I saw that. Someone below them is compensated quite handsomely for taking the fall, if you will.
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