At the heart of every financial scandal is a loss of trust. We trust our banks to keep our money safe. We trust our investment advisors to keep our money reasonably safe. And we trust our leaders to oversee those that we trust with our money, so we don't have to rely totally on trust.
In 2008, we saw a collapse of trust. From the banks and brokerages, to mortgage companies and credit rating agencies, trust was destroyed as well as the economy.
Scandals Deflate Trust And Reduce Risk Taking
Without trust, risk taking becomes too perilous. And without risk taking, the economy slows down, sometimes significantly. Scandals deflate trust, reduce risk taking and impact our ability to move forward in the most productive way possible. (For related reading, see Measuring And Managing Investment Risk and Personalizing Risk Tolerance.)
In 2009, we continued the trend and found our trust misplaced in even more areas. When we find something isn't what we thought it was, the bubble pops and trust falls like the price of a mortgage-backed security. When it's simply sex, it's late-night TV fodder. When it's financial, its impact is far worse.
Here are the biggest scandals of the year:
- Bernie Madoff's Ponzi Scheme
The people who trusted Bernie Madoff are some of the smartest people in the world. He conned them into trusting him. His pedigree was beyond reproach, his results stellar. The trust built to bubble status, and then it popped.
Some people entrusted him to look out for their charitable funds, the money they have earmarked to help the poor and needy. So while it's hard to feel for those who are fortunate enough to be qualified to even invest in his fund, some of their money would have trickled down to those that need it most. Even if that's a small amount, it's certainly better than having him waste it on his own luxurious lifestyle.
The loss of money makes this clearly the biggest scandal in dollar terms. Billions of dollars that people counted on are simply gone. Not put at risk and lost; but instead, stolen and spent for his own personal gain.
- The Stanford Financial Fallout
Allen Stanford's ponzi scheme wasn't as big as Madoff's in dollar terms, but in trust terms it's at the top. Madoff didn't tell his clients they were invested in safe Certificates of Deposit. They knew they were in a hedge fund and could lose money. Stanford told his clients that his CDs were as safe as, or safer than, U.S. government-insured accounts. Who wouldn't trust that? So he gathered more than $8 billion using that story and funded a lifestyle that got him knighted. But that trust was misplaced, as many people will not get their money back. The bigger issue is that trust in safe investments like CDs is paramount to a sound financial system. Scandals like this one hurt that trust.
- The Galleon Greed Scandal
While the Galleon scandal was big and certainly part of any year-end list, this was an insider-trading scandal where greed got the better of a few people, and they found a way to profit in an illegal way.
Contrast this with Madoff and Stanford, who took people's trust in them and simply pocketed the money, leaving victims with massive unexpected losses. In the Galleon scandal people didn't lose their life savings, they lost a few points on a stock price they might have had if the inside information had not been used. While still a scandal and illegal, the impact on trust overall is minimal.
- Late Entry: Tiger Woods
No scandal list this year would be complete without the golfing great. This loss of trust may not be the biggest in financial terms, but there is a more subtle, and possibly more important, financial aspect.
Why Tiger? Most people expect there to be some financial crooks. The temptation of quick financial gain will win over the weak on occasion. But most people don't raise their kids to be hedge fund managers, nor do they expect stock traders to be role models.
However, they do buy products from phones, to cars, to razor blades to clothes, because they identify with the person selling them. Commercials with kids saying "I'm Tiger Woods" depicted an aspiration. His public demeanor and style confirmed that. A generation of parents wanted their kids to be like Tiger. They trusted him to be what they thought him to be.
When that bubble popped, there was some small direct economic impact, but even as companies start to distance themselves from Tiger, the greater impact may go beyond tabloid gossip and corporate sponsorship. Aspiration toward greatness through hard work needs all the role models it can get. The economic impact of that driving force makes Madoff's losses look like loose change in the couch, irreverent in the grand scheme of things.
If "Just Do It" turns into "Just Don't Bother," all the other scandals will pale in comparison.
For more on this topic, be sure to read The Biggest Stock Scams Of All Time.