Under pressure following the Saradha scam, West Bengal chief minister Mamata Banerjee promptly announced a special relief fund based on additional tax on tobacco, to partially compensate stricken investors. One more time the political executive was stepping forward to bail out those who should have known better than to invest their money in a dubious firm promising extraordinary returns. It’s a pattern. A farmer sells his land at what he believes is a great deal and when prices go up a few years later, claims he’s been gypped. Nor is it unique to India. Home buyers in the US who took out second and third mortgages on their homes were the first to seek a bailout when the market collapsed.
By constituting a special fund, Banerjee is trying to protect her government from culpability in the matter. But this bailout will also mean absolving investors of any responsibility for investing in such schemes. Does the onus of checking the credentials of such schemes lie only with the government and the regulator? The case is further complicated by the fact that most investors would have believed that the money was safe since it was in some way backstopped by the Trinamool Congress (TMC). Yet, does that make the moral hazard any the less?
Fraud, wrote Jonathan Gash in his 1991 potboiler The Great California Game, “is the daughter of greed.” Since the 1920s, when Charles Ponzi defrauded investors out of millions by promising them a 400% return on redeemed postal reply coupons, swindling gullible investors has become the great game in which greed goes hand in glove with the desire for more. It’s like having unprotected sex to enhance pleasure and then asking the government for childcare expenses when the copulation leads to creation.
Even regulation is not enough so long as there are gullible investors queuing up for the abnormal profits promised. Tamal Bandyopadhyay wrote in Mint about how the Securities and Exchange Board of India (Sebi) has been fighting a protracted legal battle against at least two other companies—MPS Greenery Developers Ltd and Rose Valley Real Estates and Constructions Ltd—in West Bengal, to stop them from collecting public deposits under so-called collective investment schemes (CIS). Yet Sebi’s cease-and-desist orders haven’t stopped depositors—MPS has 1.6 million depositors—from flocking to them.
Sure, there are times when “asymmetrical information” leads to investors being duped despite due diligence. There is a difference between those who invested with Bernard Madoff and lost most of their $65 billion and between those who invested in American International Group Inc. (AIG) on the belief that their money was relatively safe in an insurance company that had the highest rating given by the credit rating agencies.
Following such blowouts, Indiana in 2010 became the first state in the US to adopt legislation establishing a “Securities Restitution Fund”. The law gave the Indiana securities commissioner the ability to award victims a portion of their losses up to $15,000, or 25% of unrecovered awards, whichever is less. One vital clause in the law was the consideration of “whether a victim contributed to the infliction of the victim’s monetary injury.” Additionally, “no restitution assistance shall be awarded if the victim…were overly greedy or wilfully blind to the fraud when deciding to invest.”
It’s a funny situation. The more guarantees investors have that if the investee company collapses their funds will be protected by a fiat of the state, the more reckless they are likely to be. But the courts in the US haven’t been too kind to victims of Ponzi schemes who have sought to sue regulators for missing warning signs. Recently, the federal Ninth Circuit Court upheld a lower court ruling denying victims of Ponzi schemer Madoff the right to sue the Securities and Exchange Commission for failing for more than two decades to stop the scheme.
What complicates redressal in any such scheme is that in most cases the investors are not all alike. Some will have got back all or some part of their original investment. Some may be labelled as “winners” because they have withdrawn more than they invested.
In his 1999 book You Can’t Cheat an Honest Man: How Ponzi Schemes and Pyramid Frauds Work, James Walsh writes “What’s remarkable about Ponzi’s legacy is that, no matter how many times investors lose money, new schemes keep coming forward. And greedy, naïve people of all sorts line up to throw good money after bad.”
We hurtle from one ponzi scheme to another. It’s a rush to disaster that can only be stopped by our own willingness to learn and essentially take care of our own money.