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Risk: Danger + Opportunity

The Discussion Issue

It is easy to consign risk into the category of "negatives" for investors and businesses to avoid, but that would be a mistake. After all, great companies don't become great by avoiding risk and investors don't make superlative returns investing in risk free assets. They do so by seeking out and exploiting risk that they are better at dealign with than their competitors. In fact, the essence of risk is captured in the Chinese symbol for crisis (big risk), which is a combination of danger and opportunity. It brings home the lesson that if you want one, you have to live with the other. Investors who seek opportunities, while claiming not to like danger, are easy prey for fraud.

Greed, delusion and Fraud

Good con men through the ages have known that to to succeed, you need to find easy marks, human beings who are not necessarily stupid but who are greedy, and who then let their greed get in the way lf good sense. While most of us believe that we would never be so gullible, the reality is that there is a sucker inside each and every one of us waiting for an outlet. In this week's puzzle, we explore the gray line that separates a good investment from a con game and how easy it is to stray across the line.

  1. We start with a Wikipedia description of the original Ponzi scheme. (I have no intellectual pretensions. I find Wikipedia to be adequate for most topics..) As you read the description, put yourself in the shoes of one of his victims and think about how you might have been drawn into this scheme, what doubts you may have had and how you would have alleviated those doubts.
  2. Then, follow up with this story about Bernie Madoff. Again, while it is easy to get lost in the gossipy details, think about the victims here and how they were drawn into thes scheme. Most of them seem like sensible people and some would be considered sophisticated investors. So, what did Bernie Madoff offer that made investing with him so appealing?
  3. Finally, in a morbid afterthought, I have attached the obituary of Robert Citron, the treasurer of Orange County at the time of the pension fund fiasco that we talked about in class. Making Mr. Citron the victim of New York bankers first, consider why he may have been drawn into their web. Then, think about the rest of the victims here (the rest of Orange County) and why no one felt the urge to ask tough questions.

Key Questions

  1. If you were offered an investment, what are some of the cues that you would use to decide that it is "too good to be true"?
  2. Will the identity of the person making the offer (What if it is a broker from a penny stock brokerage? What if it is John Paulson) make a difference in your reaction to that offer?
  3. Will the timing of the offer (In the midst of a market collapse or surge? In a boombing or busted economy?) make a difference in how you respond to the offer?
  4. Now, think like a con man. Given your answers to (1), (2) and (3), what are some of the ways you would structure your con to get it past investor defenses?