South Florida is awash in illegal money, and even federal investigators can no longer ignore this area as the center of corruption.
Miami continues to uphold its well-earned reputation as being the capital of vice and corruption, as the Herald writes, here. Miami is the capital of Medicare corruption, yet again, and has become the focus of federal efforts to reduce fraud. According to the Herald, Medicare “paid $520 million to Miami-Dade healthcare agencies for treating diabetic patients, more than what the agency spent in the rest of the country combined”. Think about that, Medicare spent more in Miami-Dade than the rest of the country!
The Herald noted that the county is home to just 2% of the nation’s diabetic patients eligible for Medicare. The assessment that Miami-Dade represents a disproportionate amount of medicare and health-care fraud throughout the United States has, incredibly, taken federal investigators decades to reach. But, there’s more: 1) “Miami-Dade providers accounted for over half of the $1 billion paid out nationally in 2008 for the treatment of homebound patients with diabetes and related illnesses”; 2) “The county’s percentage of diabetics is lower than the rate of in other Florida areas with heavy elderly populations; 3) “No other part of the country…comes close to Miami-Dade, which is dubbed the nation’s healthcare fraud capital; 4) “Medicare spends more than $15 billion on all home-care services nationwide, with one of every $15 spend in Miami-Dade”; 5) “Medicare’s average cost for each home healthcare patient with diabetes runs $11,928 every two months…that’s 32 times the national average cost of $378”.
With these stunning statistics, why hasn’t Miami-Dade been flooded with FBI agents, investigators, prosecutors, and other agents? Badges of fraud are fairly easy to detect, predictable, and confirmable. What else do investigators need to confirm this fraud? Signed affidavits from the fraudsters? It’s obvious that Miami-Dade County is awash in fraudulent Medicare activity, and federal investigators should freeze payments immediately and send teams of investigators to our area. Confirming the extent of this fraud should not be difficult, and could result in significant savings to Medicare.
The interesting dynamic to this situation is that once Medicare officials decide to clamp down on this type of fraud, how will their efforts affect South Florida’s local economy? Miami-Dade has been a hotspot of mortgage fraud, Medicare fraud, money-laundering, and Ponzi schemes. Slowly, surely, federal agents and prosecutors have been working to stamp these out, and have been progressively ramping-up their investigations. The effect of these efforts on the local Miami-Dade economy could be disastrous, as fraud has been such an integral part of Miami-Dade’s culture for decades. Efforts to eradicate fraud could severely weaken the local economy, and perversely, lead to more hardship in South Florida. The trickle-effect of fraud eradication efforts could undermine local retailers, who depend on this influx of illicit money, and undermine an economy already ranked among the worst in the country. Is it fair to conclude that a substantial portion of South Florida’s economy is dependent on fraudulent activities?

Allen Stanford’s Ponzi scheme is a stark reminder of our collective inability to discern wisdom from crowd behavior, especially in financial decisions.
The Miami Herald today published an expose, here, of Allen Stanford’s final, desperate days to prop-up Stanford International Bank, in Antigua. Stanford Bank had sold $7 billion worth of fake certificate of deposits to unsuspecting investors, including the Libyan government, which was defrauded of nearly $140 million. The well-researched story, covering nearly 2 full-spread newspaper pages, details Stanford’s increasing desperation and failed attempts to attract additional investors to his Ponzi scheme in its final days.
In searching for a theme, a unifying theory of Stanford’s fraud, it became apparent that there was none. Stanford’s fraud was brilliant for its massive scale, its sheer audacity and the garish opulence of Stanford’s monthly personal expenditures, but sophisticated it was not. In fact, Stanford’s scam was frighteningly simple: as long as sufficient investors were lured into depositing their savings at Stanford International and the stock market continued to escalate, Stanford and his group could continue to live extravagant lives of leisure and deception. The fraud would continue as long as inflows of funds, or investors providing new sources of cash, exceeded outflows of funds, or investors redeeming their certificate of deposits. As in Bernie Madoff’s fraud, which likely occurred for 3 decades, Stanford’s fraud, which occurred over a decade, would collapse as soon as this dynamic was inverted, or outflows representing redemptions exceeded investor inflows.
For much of the last decade, this dynamic remained viable and steady for both Madoff and Stanford. The economic collapse of 2008 reversed this equation, and redemptions quickly exceeded investor deposits. As a result of the stock market collapse, investors required cash and redemptions quickly increased. Coupled with unsustainable personal expenses by both Madoff and Stanford, cash reserves were no longer sufficient to maintain the facade, and their paper empires collapsed. These Ponzi schemes were brilliant in their sheer simplicity, in their ability to collectively dupe regulators, investors, sophisticated feeder-funds, employees, and banking analysts for years, if not decades. But they were terribly unremarkable, unsophisticated and blindingly simple in scope and dimension. They occurred because institutions and individuals failed, no refused, to perform any due diligence and research prior to investing their savings. Regulators, who have been exposed as paper tigers, were unwilling or unable to perform basic due diligence and perform even routine analysis, which likely would have exposed these frauds years ago.
The Herald article reveals Allen Stanford the man, a charming, shrewd and cunning businessman who bungled nearly every legitimate attempt at building a business or successful real estate venture, and who resorted to very simple financial statement fraud in an effort to keep his empire afloat. The remarkable element of both Madoff and Stanford’s frauds is that both of these thieves were un-remarkable, unsophisticated, and routinely simplistic. Their fraudulent enterprises were kept afloat by charm, persistence, cunning, and a unique ability to persuade otherwise sophisticated and worldly individuals to abandon skepticism and prudence. But-for the collective ignorance of crowds, these frauds would never have occurred. Collective rumor, especially in Madoff’s fraud, fueled investor hysteria and drove massive amounts of money into these schemes.
These frauds ultimately demonstrate that, contrary to currently popular belief, there is little wisdom in crowds and groups of individuals, sophisticated or not. Group dynamics in financial fraud events are susceptible to the same errors in judgment, perception, and hysteria traditionally associated with non-fraud events, such as the housing bubble or other asset bubbles throughout history. Groups of people, random or not, are clearly incapable of making informed decisions regarding their financial futures and their investments. Individual investors must perform their due-diligence irrespective of their identification or association with a group or other dynamic, or face the consequences and their losses.

Societe Generale recently published a white paper that purports to be a “worst-case-scenario” of economic predictions, but which ultimately makes a persuasive case for an economic meltdown akin to that experienced by Japan throughout its “lost decade” of the 1990’s.
The report is primarily aimed at presenting its clients with practical financial guidance should this scenario prevail, but provides extensive historical and analytical comparisons to the current economy and Japan’s lost decade. Among the striking comparisons and economic features of both the US and Japanese crises, these are the most compelling:

Ballooning public debt: “Debt is the main constraint on US GDP growth, but reducing the excessive debt burden is likely to stall economic activity.” Lower government spending will limit consumption and GDP;
End of bear market rally: The rally was “fueled by restocking and fiscal stimulus”. Normal consumer spending will be unable to pick up the slack;
Deflation is the real immediate risk, not inflation: “The printing of money by western economies has been used only to replace the credit destroyed”;
Banking crisis;
Property bubble: the largest asset bubble in the nation’s history spawned massive, artificial consumption which will likely not be replaced;
Corporate debt crisis;
High valuations going in;
Stock market crash;
Low interest rates.

The report makes some general observations:

Household deleveraging will reduce overvalued properties to a new “equilibrium”. Output will also reach a new equilibrium, as “previous output was largely the product of a consumption bubble”.
Assuming that the savings rate stabilizes at 7%, which is the current level, it will take consumers 9 years to reduce the debt/income levels to those seen in the 1980’s.
If governments are unable to adequately service their massive debts, then the only option is default. In Dubai, this option appears to be already on the table, as its sovereign wealth arm announced a six month suspension of interest payments on its debt, here.
Inflation, resulting from a devalued and weak dollar, could help ease excessive debt, as it is essentially inflated away, but would likely lead to stagflation, hyper-inflation and revaluation. Ultimately, the interest rate hikes needed to control inflation would hurt consumers as debt servicing costs would surge.
A growing transfer of wealth is occurring from advanced economies to emerging economies.
The bear scenario would lead to a deflationary spiral, as high unemployment and low consumption will drive prices ever lower. “A second round of home foreclosures in the US would lead to further write-downs on bank balance sheets, and even more government public deficits as the debt transfers from financial institutions to the state through more rescue packages.”
In the bear scenario, “avoiding depression is the focus here, though a long and arduous recession can be expected under this scenario.”
The bear scenario would ultimately lead to: a) severely reduced household wealth, as equities and property markets are hammered; b) Long and short term interest rates would remain low, as central banks battle deflation; c) massive transfers of liabilities from households to governments; d) unemployment would reach record levels, which would further destabilize the economy and consumption; e) consumption would be effectively stalled for long periods, leading to an eradication of considerable excess global production capacity; f) Excessively high government debt will force advanced economies into a painful period of deleveraging and contraction, leading to sharply reduced levels of service and government budgets.

Although the report tempers its support for the bear scenario as a likely outcome, the stark contrast between Japan’s economy of the 1990’s and our own economy is striking, and makes this scenario at least plausible and realistic. The Societe Generale report clearly signals the risks to our economy, much the same way that many analysts noted the sharp rise in housing values and warned of housing’s imminent collapse. The housing bubble was predictable, quantifiable, known and observable, yet it was ignored and even ridiculed because of the massive consumption bubble that it generated. The US economy and Wall Street’s near-obsessive compulsion with short term goals and profits ensured that the housing bubble and the artificial consumption it generated were ignored to the detriment of the larger economy, while preserving historic profits for a very rich and limited few. Will we again ignore looming crisis and bury our heads in the sand for the benefit of a few?

The many layers of Scott Rothstein’s Ponzi scheme continue to be peeled back, revealing a tangled web of Madoff-like feeder funds, alleged co-conspirators, and vast sums of money being transferred throughout the world.
The Miami Herald reports, here, that Rothstein moved money to Venezuela, Switzerland and Morocco, and used dummy Delaware corporations to disguise his ownership stakes in real estate holdings and other assets. The Miami Herald also reports, here, that a feeder fund may have contributed close to $2 billion to Rothstein over a 2 year period.
Unfortunately, the media’s focus has been on Rothstein’s opulent living arrangements, including fancy cars, boats, condominiums, watches and mansions. These assets, as dramatic and sensationalistic as they are, represent but a miniscule portion of total contributions by investors. Even assuming that Rothstein accumulated $100 million in trinkets, baubles and cars, that still leaves the vast portion of the money unaccounted for. For those of us unaccustomed to wealth, it is incomprehensible to understand how difficult it is to spend vast sums of money on tangible goods and assets. No, most of the investors’ funds were not spent on Rothstein’s junkets, but were likely dissipated throughout the world in a flurry of wire transfers, and are quite likely parked in exotic locales that have poor regulatory structures or banking laws.
Investigators will first determine the amount of gross receipts into Rothstein’s funds. This will be accomplished through interviews with investors or bank statements and records, assuming, of course, that suitcases packed with cash were not the primary mode of receipt by Rothstein.  Investigators will also marshall the remaining tangible assets and attempt to reconcile Rothstein’s expenditures and cash outlays. Even assuming a wide margin for error and unknown expenditures, investigators should know with some degree of accuracy the amount of missing funds. As difficult as it is to spend hundreds of millions of dollars on tangible assets, it is even more difficult to legally move these funds throughout the world without leaving telltale signatures and audit trails. Following the dissipated money throughout the world will be time-consuming but not terribly difficult or challenging. The challenge will be in recovering the funds, which have likely been withdrawn or divided into much smaller “packets” within the recipient countries.  Pursuing these funds into jurisdictions unfriendly or hostile to the United States may become the Achille’s heel of the investigation.
As the lawsuit in the Herald article indicates, it is impossible to conceive of a fraud of this magnitude that did not involve co-conspirators or at least “fraud-friendly” acquaintances. The mere act of recordkeeping, reconciling, transferring, and manipulating vast amounts of money requires a team of personnel, each of which understood that a fraud was occurring or likely. At a minimum, Rothstein’s garish lifestyle must have triggered alarm-bells in his colleagues, partners, associates, and bankers. Lawyers, even top-litigators, simply cannot earn “stupid-money”. Even if Rothstein’s role as  money manager was factored into his lifestyle, potential investors must have questioned the size and scope of the legal settlements that served as the basis for their investments. Did no one, colleagues or potential investors, deign to ask, “Where and from whom is Scott obtaining legal settlements sufficient to generate these returns”? Did lawyers in the firm compare notes and determine which partner or associate was performing work or billing on these cases, even if not filed in court yet? Again, this was a spectacular failure to perform due-diligence and demonstrates that crowds of purportedly intelligent professionals and entrepreneurs can be easily duped and misled.
Further, even assuming the legitimacy of these structured settlements, Rothstein’s commissions could not have generated the funds required to fuel his extravagant lifestyle, which reportedly cost Rothstein at least $10 million per month. Finally, lawyers at the firm must have understood or could easily have performed back-of-the-napkin calculations regarding the firm’s expected gross revenues and expenditures. The discrepancy between these two numbers should have alarmed these folks, who may now become defendants in dozens or hundreds of civil, if not criminal actions. Complicit stupidity or active fraud?

As Wall Street became the destination of choice for MIT and Harvard mathematicians and physicists throughout the last decade, alarm bells should have sounded at our regulatory and policy-making institutions.
An interesting op-ed piece by Calvin Trillin appeared in the New York Times recently, here, that caps a recent trend exposing the so-called genius of Wall Street as a fraud. Other Times writers, including Joe Nocera, here, Dennis Overbye, here, and Steve Lohr, here, have tackled the subject of Wall Street’s smarts, but none as succinctly as Mr. Trillin. In the op-ed, Mr. Trillin claims to have met a man in a Manhattan bar who summarized the cause of the financial system’s near-collapse: “Because smart guys had started working on Wall Street.” This overly simplistic analysis became profoundly interesting as I continued reading, and developed into the following rubric:

Fortune and academic standing on Wall Street are historically inversely correlated, with Wall Street’s millionaires graduating in the lower third of their class;
The lower third, who usually made generous livings on Wall Street, became enamored of potentially huge fortunes, and began leveraging their businesses;
Top graduates, who typically became physicists or judges (tip money on Wall Street), instead began calculating arbitrage risks for hedge funds and other investors;
The top graduates, who were very smart, invented credit default swaps and other derivatives, enabling the lower third to become obscenely wealthy;
Wall Street nearly collapsed largely due to derivatives and credit default swaps developed by these very-smart people.

This theory, while enticingly simple, truly exemplifies what occurred on Wall Street as a result of the oversimplification of risk into quantifiable and discrete components. Although I have written about this before, here, this discussion has largely been ignored by both the regulatory structure and policy making institutions in the United States. We continue to be highly exposed to complex financial instruments that few understand or even acknowledge. The potential domino effect of interrelated industries and institutions is just now beginning to be understood.
Smart-thinking has enabled Wall Street to develop complex and leveraged financial products that have never been tested or vetted in less than optimal conditions and whose potential downstream impacts are unknown, while leverage has magnified the institutional risks of these products ten-fold. We literally outsmarted ourselves into believing that we had created structured products that could withstand severe economic headwinds, but without any understanding of how these products behaved or how they would impact the financial institutions they serviced.
We’re no better off than we were 10 years ago, when top graduates began migrating in large numbers to Wall Street, we’ve simply transferred most of their failures to the taxpayer. Where does it stop?