On Friday, June 19, 2009, Texas billionaire Sir Allen Stanford, who was knighted by Antigua in 2006, was indicted by a federal grand jury in Houston for allegedly attempting to defraud investors through his Antiguan-based Stanford International Bank (SIB).

In what the SEC has called a "massive Ponzi scheme", Stanford is alleged to have "misused and misappropriated most of" the $8 billion entrusted to him by SIB's 5,000 to 6,000 investors, including more than $1.6 billion that went to Stanford himself in the form of personal loans, the indictment asserts. (For background reading, see The Biggest Stock Scams Of All Time.)

Not surprisingly, Stanford has denied any misconduct. In a tearful and sometimes defiant interview with Brian Ross of ABC News that aired April 6, the financier promised to fight what were then just allegations "with everything in me."

"I will die and go to Hell if it's a Ponzi scheme," Stanford told Ross. "It's no Ponzi scheme. If it's a Ponzi scheme, why are they finding billions and billions of dollars all over the place?"

Shut up; just shut up, Sir Allen. You had me at "I will die and go to Hell."

The Blame Game
Seriously, as egregious as Stanford's crimes are purported to be, how different was his organization from many of today's more, uh, "traditional" banks? According to that same ABC report, government officials claim they have "found only $500 million of the missing $8 billion in the alleged scheme." If I'm doing my math correctly (and if I'm not, I'm sure I could still find work as an SIB accountant), that amounts to a $7.5 billion shortfall - far less than the $33.9 billion that Bank of America (NYSE:BAC) was required to raise as part of the Fed's "stress test" back in early May.

The sad truth is, not since the blundering Uncle Billy nearly busted Bailey Savings & Loan in the classic 1946 film "It's A Wonderful Life" have financial institutions been so careless with their customers' money. If, in fact, a Ponzi scheme simply entails paying investors with other people's money, rather than profits, haven't some of our nation's largest banks been just as culpable as SIB?

After all, Washington Mutual (OTC:WAMUQ) was still cashing checks when it was losing money hand over fist, wasn't it? Yeah, the company was eventually shut down, but no one accused former CEOs Kerry Killinger and Alan Fishman of any wrongdoing. Yet, in 2007, while Killinger was taking home a $14 million salary, WAMU was taking a $67 million hit to its bottom line, thanks in large part to Killinger's aggressive - dare I say "irresponsible"? - lending strategies. Worse yet, according to The New York Times, Killinger and other WAMU executives "were excluding mortgage losses from the computation of their bonuses." (For related reading, see Executive Compensation: How Much Is Too Much?)

And how about Fishman? In less time than it would've taken WAMU shareholders to put their hands over their heads and lay face down on the bank's cold, tile floor, he was in and out as the company's chief executive officer. Nonetheless, for just 17 days of work, Fishman was paid approximately $20 million, according to FoxNews.com.

Someone Else's Money
Of course, WAMU wasn't the first bank to spend money it didn't have, and it probably won't be the last. For years, bank reserves, the amount of liquid assets some countries (like the U.S.) require financial institutions to keep on hand for withdrawals, have been dwindling. In an April 2008 blog entitled "Myths About The Monetary Base And Bank Reserves", Swedish economist Stefan Karlsson notes that "bank reserves in early 1990 were $60 billion as compared to $42 billion now."

At least in the United States, this practice of fractional-reserve banking continues to flourish, undoubtedly because the U.S. government continues to insure deposits - now for up to $250,000 - thanks to legislation signed by President Barack Obama on May 20. With such guarantees in place, is it any wonder that banks are lending depositors' money to practically anyone with a pulse? (For more on FDIC insurance, see Are Your Bank Deposits Insured?)

Heck, in Ohio, you don't even need a functioning ticker to get a loan. In March of 2007, Ohio mortgage brokers Mark S. Edwards and Mark D. Musselman were both convicted of 48 felony counts of mortgage fraud, which included using the "identities of recently deceased individuals to purchase properties," court documents revealed.

The Bank of the U.S. Government
Such abuses have led some to question the government's role in the banking industry.

"I believe the government needs to exit both the both banking and monetary arenas," said Douglas French, president of the Ludwig von Mises Institute, the self-described "world center" of Austrian economics. "Deposit insurance should be abolished."

In a June 11 post on the Mises Web site, French argues that "there is no incentive for bank depositors to go to the trouble of determining a bank's soundness if the government is going to guarantee deposits."

To bolster his point, the Mises Institute president cited a recent column by Forbes.com contributor Bernard Condon entitled "The Reverse Bank Run." In the piece, Condon notes that "in a curious twist to the traditional bank run, Americans seeking high yields on their money are causing deposits at struggling banks to mount in seeming lockstep with their troubles." (To read more about this debate, see The Government And Risk: A Love-Hate Relationship.)

"The problem is," Condon explains, "it's the banks in bad shape that often offer the highest rates on deposits."

Somewhere, Charles Ponzi has got to be smiling.

Related Articles
  1. Economics

    What is Fractional Reserve Banking?

    Fractional reserve banking is the banking system most countries use today.
  2. Investing Basics

    3 Alternative Investments the Ultra-Rich Usually Own

    Learn about the ultra rich and what normally comprises their net worth; understand the top three alternative investments usually owned by the ultra rich.
  3. Stock Analysis

    6 Hedge Funds With High Dividends

    Understand what value hedge funds can provide investors in the financial sector. Learn about seven hedge funds that pay consistent and high dividends.
  4. Professionals

    Top 5 Highest Paid Hedge Fund Managers

    Understand what a hedge fund is and why hedge fund managers make so much money. Learn about the top 5 highest paid hedge fund managers.
  5. Investing Basics

    6 Reasons Hedge Funds Underperform

    Understand the hedge fund industry and why it has grown exponentially since 1995. Learn about the top six reasons why the industry underperforms.
  6. Professionals

    10 Must Watch Documentaries For Finance Professionals

    Find out about some of the best documentaries that finance professionals can watch to gain a better understanding of their industry.
  7. Professionals

    How Brokers are Candy-Coating Alternatives

    Alternatives have become a sexy choice for many advisors. But they also come with additional risks that are not always clearly spelled out to clients.
  8. Investing

    What is Carried Interest?

    Carried interest is the percentage of a private equity or a hedge fund’s profits that its general partners receive as compensation.
  9. Investing

    A Look at 6 Leading Female Value Investors

    In an industry still largely predominated by men, we look at 6 leading female value investors working today.
  10. Stock Analysis

    This Is What George Soros' Portfolio Looks Like

    Learn about what George Soros is holding in his portfolio, including his large options position in the S&P 500 and what popular Internet stock he liquidated.
  1. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  2. Who do hedge funds lend money to?

    Many traditional lenders and banks are failing to provide loans. In their absence, hedge funds have begun to fill the gap. ... Read Full Answer >>
  3. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  4. What do hedge fund analysts do?

    A hedge fund analyst primarily provides support to a portfolio manager on how to best structure the hedge fund's investment ... Read Full Answer >>
  5. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  6. How does investment banking differ from commercial banking?

    Investment banking and commercial banking are two primary segments of the banking industry. Investment banks facilitate the ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!