[This is one of the finalists in the 2023 book review contest, written by an ACX reader who will remain anonymous until after voting is done. I’ll be posting about one of these a week for several months. When you’ve read them all, I’ll ask you to vote for a favorite, so remember which ones you liked]

At the time of its maiden voyage, the Titanic was considered an unsinkable ship. It was regarded as a marvel of engineering, a state-of-the-art vessel constructed by a shipyard with a long-standing track record and reputation for constructing high-quality, reliable ships. In the incredibly unlikely event of a hull breach, it was built with watertight compartments that were specifically designed to contain flooding. When 2,240 passengers and crew boarded the ship for its maiden voyage, probably none of them doubted its seaworthiness, and those that did could reassure themselves with the reporting of numerous newspapers touting the ship as “unsinkable.”

On one hand, it is kind of crazy that the Titanic sank. However, if you tried to explain to a caveman why the Titanic sank, the fact that it sank might be the least surprising part of the story. “So let me get this straight: a million-pound mass of steel and wrought iron carrying the weight of thousands of people set out to sea, and then at a certain point, instead of floating, this object sank to the bottom of the ocean?” The more difficult challenge might be explaining to him how it floated in the first place.

You can’t really understand the exception without understanding the rule. In order for him to understand why it was remarkable that the Titanic sank , you would first have to explain to the caveman how it was that a 52,310 ton vessel not only existed, but was able to float.

This is the gift that Dan Davies gives us in Lying For Money. Despite taking econ classes in college, and spending years as a business owner who has had to do things like raise money from investors, my understanding of how the modern economy operates often feels about as complete as a caveman’s understanding of how a cruise ship floats. The book delivers on the promise implied by its subtitle, How Legendary Frauds Reveal the Workings of Our World. Financial instruments (and other aspects of the economy) are things that are best understood in the breach: in the process of teaching us the various ways in which financial systems can break , Davies also teaches us how they work.

The Optimal Amount of [Bad Thing] Is Not Zero

If Lying For Money ‘s most important idea can be described in a single line, it’s that fraud is an equilibrium phenomenon – or, as Davies likes to put it, “It is highly unlikely that the optimal level of fraud is zero.”

Davies begins the book by talking about the Silk Road dark web drug market, and more specifically, the Silk Road exit scam. Davies points out that Silk Road was, in many respects, not that different from other online stores like eBay, apart from the fact that the payments were made in cryptocurrency, and the products were illegal.

A key difference between the online drugs trade and the normal economy, though, is that not all that many people are interested in building a career in online drug dealing and passing the firm down to their children. People grow up, leave college, or have the kind of short interaction with the legal system which suggests to them that a lifestyle change is in order.

Businesses often tended to close down. And having built up valuable goodwill on a dark market, it seems like a shame to just throw it all away as you disappear.

Thus, the exit scam: using the reputation you’ve established as an honest criminal, take money (in the form of cryptocurrency payments) from people with the promise that you’ll send them drugs (possibly even lowering your prices to induce a higher volume of orders), and then, instead of sending them drugs through the mail…just disappear with the money.

A casual observer seeing this scam might react in much the same way as the caveman watching the Titanic sink: “It seems as though this ‘anomalous failure mode’ would be the default thing you would expect to happen when you put a million-pound vessel made of metal on the water send untraceable money to a completely anonymous individual over the internet.” (Isn’t the weird part that people willingly participated with the expectation that this wouldn’t happen?)

Could something have been done to prevent this? Yes, as it turns out: the Silk Road drug market actually did have fraud-prevention methods in place: buyers could choose to place funds in escrow. But escrow adds friction and inconvenience in the form of added fees, and added wait time for sellers. Having bitcoin trapped in escrow can be a problem when the price of bitcoin is volatile, and to make up for this volatility, sellers who used escrow frequently had to charge higher prices.

Thus, a buyer on Silk Road was faced with the option of paying a higher price to a seller who used escrow, or buying from a seller who was willing to offer lower prices in exchange for not using escrow. The difference between these two was effectively the cost of fraud prevention: If the fraud protection became too expensive or inconvenient, people simply opted not to use it. (Conversely, if people get ripped off too often, then they will be more willing to pay the premium for fraud prevention: fraud is an equilibrium phenomenon.)

I experienced a version of this (in a legal online market) in the 00’s when I tried to make some money as a teenager selling trading cards through online stores like eBay. eBay is famous for siding with buyers in the event of a dispute, so whenever I sent an item, there was always a possibility that the seller would falsely dispute the charge by claiming the item never arrived. If each instance of fraud cost cost me $5, and this happened 5% of the time, then accepting a non-zero level of fraud would cost me an average of 25 cents per transaction. One way to avoid this was by purchasing delivery confirmation, which cost an extra 50 cents – in other words, I could pay 50 cents to prevent a 25 cent fraud loss. (As you might imagine, I opted not to do this: the optimum level of fraud is not zero.)

The point that “If the cost of fraud prevention is too high, people will choose not to use it” is illustrated particularly well in a chapter that discusses drug counterfeiting:

The battle against counterfeit drugs is also a case study of the problems in trying to create a zero-fraud system. The pharmaceutical industry has expended more effort than practically any other in building mechanisms to track products from the start of the process to the end, often at significant inconvenience to itself. Medical wholesalers, for example, used to manage their inventories of drugs by trading with each other on the ‘gray market’. This was quite important to the business model, particularly since drugs are perishable products which cannot be kept forever. But the gray market was such a conduit for fake drugs (particularly since, in states like Florida, a criminal record for fraud or even narcotics addiction was no barrier to being licensed as a wholesaler) that it ended up being regulated down to a fraction of its former size.

And yet fraud creeps back in. The ‘track and trace’ systems which have been mandated in more and more markets over the last decade have ensured that randomized serial numbers are applied to every packet of pills, and each link in the supply chain keeps an audit record when an item changes hands. In principle, this ought to make it impossible for fake drugs to enter the market.

In practice, what happened is what we might have expected from the original insight that fraud is an equilibrium quantity; as the audited chain has become more inconvenient, it has become less relevant. The majority of counterfeit pharmaceuticals bought in the developed world are now sold through unlicensed internet pharmacies.

The more protections you put in place to prevent counterfeit people from falling victim to counterfeit drug scams, the more expensive it becomes to obtain drugs through the approved channels. If it becomes too expensive, people will choose to eschew it entirely, and opt for cheaper markets where they will find lower prices (and fewer fraud protections). The implied conclusion here seems to be that the optimal level of counterfeit drugs entering the system is not zero: at a certain point, the marginal cost of counterfeit prevention is so high that the resulting higher prices are enough to drive customers out of the official channels, and into the waiting arms of unlicensed internet pharmacies with fewer protections.

High and Low Trust Societies

In discussing different equilibrium points for trust, Davies brings up what he calls the “Canadian Paradox,” which is an observation that a low-trust society will have less commercial fraud than a high-trust society (an example of one such high-trust society being Canada, which in 1985 was home of the Vancouver Stock Exchange, dubbed by Forbes Magazine’s Joe Queenan as the “Scam Capital of the World.”)

Why is commercial fraud so much more common in high-trust societies? Davies puts it succinctly: “Where there is trust, there is opportunity for fraud.”

In a low-trust society where everyone is suspicious of each other, it’s much harder to get away with writing a bad check, because everyone is closely scrutinizing every transaction, and/or unwilling to deal with people who aren’t already part of their ingroup of close associates. (In a society of kin-based trust networks, the threat of social fallout would presumably prevent you from defrauding your cousin or brother-in-law.)

Thus, Davies argues, when people are easily able to commit flagrant acts of fraud, this is actually a sign of a healthy high-trust society: it suggests the existence of default trust (which the fraudster then acted to exploit). If you live in a society where anyone can walk into a business meeting wearing a suit and be assumed to be reasonably trustworthy, it will be possible for a charismatic conman to pull one over on you, but the environment will also be much more hospitable to honest brokers as well. (Not only does this make a society more prosperous, it’s also just more generally pleasant when you don’t have to constantly be suspicious of your neighbors or counterparties.)

It can be tempting to hear stories of fraud victims who fell for obvious scams and presume naivety or stupidity on their part, but consider what it means when someone falls for an “obvious scam”: what does it say about their priors that they were approached by a stranger offering them favorable terms and, by default, assumed that they must be dealing with an honest broker? (Probably, it suggests that they live in a society where they’ve transacted with many actors who weren’t scammers. The scammer was able to catch them off guard because people who promise things, even strangers, usually deliver the goods!) In fact, scammers often attempt to fool their victims by mimicking the legitimate actors in the ecosystem they inhabit.

Suppose you are a venture capitalist and you’re approached by a Stanford dropout who says they’re starting a company. They don’t, technically speaking, have something that could be considered a “product” yet, but they do have a really cool idea for something that they claim might one day become a multi-billion dollar company, even though the thing that they’re suggesting has never been done before. They need $500,000 to get things off the ground (and they will probably come back to you later to ask for more money). Do you write them a check?

If you rely on a heuristic that says “a person matching this profile is probably a scammer and/or deluded and I won’t invest money in their company,” well done, you just avoided being a seed investor in Theranos. (It probably also allowed you to avoid investing in lots of other startups that failed for non-criminal reasons.) But that heuristic would also probably prevent you from investing in a bunch of companies that did go on to become billion-dollar successes.

Even a heuristic like “don’t invest in companies that fake product demos” won’t allow you to avoid the “false negatives,” as Davies points out, as many companies that present fake demos go on to create functional products and be worth billions of dollars, so if you consider that disqualifying criteria, you would have had to say no to Microsoft in 1983, when they faked a “live” product demo for an interface manager that didn’t actually exist yet. (Given that Microsoft’s split-adjusted share price has risen by approximately 325,000% since its IPO in 1986, investing in Microsoft is one of the more profitable things you could have done in the 80’s.)

In a low-trust society where people were more reluctant to invest in Stanford dropouts with big ideas, someone like Elizabeth Holmes would have a very hard time getting off the ground, but so would many more legitimate success stories. In Theranos’s case, the devil is in the details that go along with promising to deliver a product that does things that are physically impossible. Fraudsters tend to rely on the fact that “the details” in which the devil resides are not always easy or convenient to check on.

Chains of Trust are Attacked at their Weakest Point

Another theme that Davies frequently revisits throughout the book is the mechanisms that fraudsters use. There is a certain amount of “trust by proxy” that happens within every system: whenever I withdraw cash from an ATM or bank, I don’t inspect each bill to ensure it’s not a counterfeit, because I presume that the bank has already done that at some point (and I also assume that the bank is far better at detecting counterfeits than I am). Ditto for any pharmaceuticals that I buy from CVS or Walgreens (if I’m paying for the high cost of a highly-vetted drug supply chain, I might as well trust it).

And similarly, if you’re a Series C investor offered the opportunity to invest in an exciting new medical company called Theranos, due diligence is expensive. The company has previously raised a $500,000 seed round, a $5.8 million Series A round, and a $9.1 million Series B round – at this point, as an investor joining the Series C round, you’re already late to the party, and you might presume that the other investors who have collectively invested 8 figures in this company (plus the investors who are part of the current round) have already done their due diligence.

We all, to varying degrees, rely on a social web of trust, and as Davies repeatedly points out, “where there’s trust, there’s opportunity for fraud.”

In a lot of cases, outsourcing trust is necessary. If you’re an investor who wants to invest in a literal gold mine (or some other mineral deposit), you can’t very well go out to the site to look at samples yourself: for one thing, doing this would be tremendously inconvenient, and for another, you don’t have the equipment or the expertise needed to evaluate the site. Instead, you rely on an “assay report.” Someone goes to the site, picks up some rocks (or in more modern times, core samples that are harvested using a specific drilling techniques), sends them off to a lab that grinds them up and examines them, and then you look at the laboratory results to see if there is enough gold in the sample that it would be commercially profitable to build a mine there.

Thus, in the old days, a fraudster could raise money by “salting” a mine, planting enough gold dust in the sampled rocks that it would appear to be high yield. (This could, in dramatic fashion, be achieved by filling a shotgun cartridge with gold dust and firing it at some rocks, resulting in an apparently natural-seeming dispersal of gold dust.)

While the exact methods have changed, the principle hasn’t:

It still remains the case that if you can find a crooked geologist, and if your fake mine is remote enough to make inspections unfeasible, you can get away with a lot. As recently as 1997, a more or less valueless hole in the ground in Indonesia was valued by Canadian investors at $12 billion, on the basis of reports which seemed to suggest that it was the largest gold discovery in the history of the world.

Trust often tends to look like a chain: the investors trust the lab conducting the assay report to carry out an honest test, and the lab trusts that it is receiving an uncontaminated mineral sample. A chain is only as strong as its weakest link. If you’re able to bribe (or intimidate) a junior geologist into tampering with the core samples of a possible mining site, it’s difficult (if not impossible) for the fraud to be detected further up the chain. Every tier of the deception adds another layer of reputable-sounding third-party certification, which makes it appear that the site is more legitimate, but what looks like multiple data points (an assay report, a high rating from an investment advisor) are really all extrapolated from the same faulty (fraudulent) data point.

The Snowball Effect

Another major theme that Davies frequently revisits throughout the book is that frauds tend to grow bigger over time.

This is illustrated particularly well in a chapter that begins with the story of Charles Ponzi. Let’s say that in 1920, you want to raise capital, and decide that the best way to do it is by issuing Ponzi notes that can be redeemed for 50% more than their purchase price at the end of 90 days. After 90 days, how do you pay back $150 to the investor who gave you $100? You issue more Ponzi notes. (With any luck, your original investor will realize the power of compound interest and decide to accept more notes in lieu of cash, because the only thing better than 50% returns after 90 days is 125% returns after 180 days, but if they want their money back, then you’ll have to find new investors – and with each subsequent iteration, you’ll have more and more outstanding notes, and have to find more and more investors.)

The principle that frauds tend to “snowball” over time isn’t exclusive to the observation about the arithmetic inherent in any kind of pyramid scheme. Fraud requires lying, and in any ongoing fraud, you need to constantly keep telling new lies to cover the old lies. The fraud escalates in size, involving more and more people.

The book begins with a note to the effect of ‘warning: crimes are bad, don’t do the things described in this book or you’ll regret it.’ One can imagine a book about famous frauds in which this note is added at the publisher’s insistence, and delivered to the audience by a wink and a nod by the author, but in Davies’ case, the cautionary note feels sincere: the observation that criminals often report feeling “trapped” over time (and eventually feel relief when they are caught) seems like a natural consequence of the snowball effect, especially for individuals who didn’t set out to become “career criminals,” common for someone begins with a white collar crime. A fraud might start small, but to cover up the initial fraud, they have to commit increasingly greater acts of fraud, often growing to include more and more members of the fraudster’s social network, either as accomplices or victims. The criminal can’t really stop once they’ve started, because at any given point in the process, the only alternative to “commit crimes of escalating severity to cover up the original offense” is “get caught for the crimes you’ve already committed.” Once the snowball starts, it’s hard to stop it from rolling.

Davies ends his first chapter, saying:

Almost all of the fraudsters discussed in this book got caught. Some of them enjoyed a high lifestyle before they did. But many of them greeted their inevitable discovery with tears of joy that the whole wretched, stressful business had come to an end.

The Four Types of White-collar Crime

Davies loosely divides his book into four sections (plus an intro and outro and some asides about what his observations imply about the wider economy), each focusing on a different type of fraud, which arranges in order of ascending abstraction.

  1. The Long Firm. (Of the white collar frauds that Davies describes, the “long firm” is the easiest to understand from a conceptual standpoint, but the hardest to understand semantically, because it has nothing to do with lengths or firms: etymologically, it comes from the Anglo-Saxon “galang” – fraudulent – and the Latin “firma” – signature). “The most basic kind of fraud is simply to borrow some money and not pay it back, or alternatively buy some goods and not pay for them. … A long firm makes you question whether you can trust anyone.”

  2. Counterfeiting. “The only practical way to do many types of business is to trust that, for the most part, documents are what they appear to be, and that they prove what they claim to prove. Abusing this trust by creating false documents to verify false claims is counterfeiting. …A counterfeit makes you question the evidence of your eyes.”

  3. Control Fraud. “A control fraud differs from the simpler kind because the means by which the value is extracted to the criminal is generally legitimate – high salaries, bonuses, stock options and dividends, but the legitimate payments are made on the basis of fictitious profits and unreal assets, and the manager tends to take vastly higher risks than those which would be taken by an honest businessman. … A control fraud makes you question your trust in the institutions of society.”

  4. And lastly, Market Crimes. Davies admits that “market crimes’’ are the most abstract, and difficult to define: “More than any other, this kind of crime is a matter of judgment, local convention and practice, rather than one of cut and dried criminality. A blatant market crime in one jurisdiction could be considered aggressive but legal practice in another, and the definition of good business somewhere else. A long firm clearly falls under ‘Thou shalt not steal’, and a counterfeit under ‘Thou shalt not bear false witness’, but where’s the commandment ‘Thou shalt not trade securities while in possession of material non-public information’?” Still, even if norms may not be universal across time and geography, the existence of norms implies the existence of norm violations, and people don’t like it when they see a violation of the way they think the world (or markets) are supposed to work. “A market crime makes you question society itself.”

The Long Firm

The first section of the book on the first type of white collar fraud was, from my perspective as a layman (and business owner), the most illuminating when it comes to understanding how the cogs of the modern economy function.

When I hear the word “loan” or “credit,” I tend to think of financial institutions like banks. However, as Davies points out, the vast majority of credit is extended from one business vendor to another. He illustrates with a simple example:

If you’re selling sandwiches on the platform at the railway station, you get cash at lunchtime, but you need to buy bread and cheese in the morning. You could take out a bank loan to buy your supplies, but it’s more common to ask the food suppliers to give you the bread and cheese on credit. In general, in almost every industry, there is some general recognition of the fact that trade customers need to make and sell their product before they have cash to pay for their inputs, and that their suppliers are often in a better position to provide credit to bridge this gap than the financial system is.

Why is supplier credit so common? Because of the convenience factor. …

In the first place, it is comparatively cheap to provide. If the alternative to making a sale on credit is letting the goods hang around until the customer can raise the cash, there is a saving to be made by getting them moved out of your warehouse and into the customer’s. This is particularly the case for things like fresh bread, which has a limited shelf life. Second, and related to this, it drives sales. Being prepared to deal ‘on terms’ means that you can sell to start-up businesses and to customers who happen to be short of cash that week, rather than restricting yourself to only selling to people with ready money. And finally, it’s likely that a supplier will see somewhat less credit risk than a bank. For one thing, the supplier has an up-to-date picture of how the customer’s business is faring, simply by looking at the customer’s orders. And for another, when you provide bread and cheese on credit, you know that credit is being used to buy ingredients – a bank which lends cash is taking the risk that the loan might be used for a purpose other than the one for which it was intended.

If you give someone $10,000 in cash, they might decide to skip town with a suitcase full of money. There are considerably fewer cases of people skipping town with a truck full of bread. However, it’s entirely possible that our hypothetical sandwich seller might get his ingredients from suppliers on credit, sell the sandwiches, and – rather than using his revenues to pay back his suppliers – then take the money and skip town. This is the essence of the long firm.

This seems a lot like theft – “you take a bunch of stuff, then don’t pay for it” – but it has an advantage over regular theft due to when in the chronology the time takes place. If you steal $10,000 worth of bread and then try to sell it, you’re fencing stolen goods – which you might have a hard time doing if the cops are on the lookout for someone who just stole $10,000 worth of bread. You avoid this entirely with commercial fraud: you 1) get the bread on credit, 2) sell it, then 3) make off with the money instead of paying back the vendor. You only become a criminal in the final step: at the time that you’re selling the bread, you’re indistinguishable (to your customers and to the law) from any legitimate businessman.

Or…let’s say that you didn’t buy the bread on credit. You are Bob, the president and majority shareholder of Bob’s Sandwich Emporium LLC, so-named because it is a Limited Liability Company , a company whose purpose – as you might imagine – is to limit liability. When Sandwich Emporium LLC gets bread on credit, the debt belongs to the business. The creditors can go after Bob’s Sandwich Emporium LLC, but can’t touch the money in your personal bank account. So, Bob’s Sandwich Emporium LLC gets $10,000 worth of ingredients on credit, sells a bunch of sandwiches for $20,000 in revenue – out of which you pay yourself $20,000 for things like salary and naming rights (after all, you generously allowed Bob’s Sandwich Emporium LLC the right to use your name) – leaving the company bank account with no assets to cover its liabilities. Sandwich Emporium LLC declares bankruptcy, and its creditors are left empty handed. (Actually, this scheme even works if you sell the sandwiches at a loss : if you only got $9,000 revenue out of $10,000 worth of sandwich ingredients, you don’t particularly care, since you weren’t going to pay back your creditors anyway. And you can sell a pretty high volume of goods if you’re willing to operate at a loss!)

Doing this intentionally is, of course, illegal. But if you unintentionally run your business into the ground (while pulling money out of it in the form of salary and other benefits), then maybe you’re just bad at business (though in some jurisdictions like the UK, you may be guilty of “wrongful trading for incurring liabilities when you know or should have known that the company was bound for insolvency). Either way, you’re a credit risk, which is a barrier to any would-be fraudster.

Another type of common “long firm” fraud is the “bust out”:

[As] seen in the film Goodfellas and associated with organized crime. A moderately successful small business – a bar or restaurant, say – gets a new business partner for its owner. This can come about as the result of a brief period of financial distress and resort to a loan shark, or the bad guys can simply walk through the door with baseball bats. In any case, control has passed from a legitimate owner to a crook, and the new crooked owner can start abusing the trading record of the company to run up fraudulent credit.

A less-violent version of the bust-out (which may leave the previous owner completely oblivious as to what is happening until the cops come calling) is to buy a distressed business on an installment plan. The installment plan not only reduces the money that the fraudsters need to initiate the purchase, but perhaps more critically, it makes it appear as though the original owner is still in possession of the business, as they will have an interest in the company’s continued success so that the new buyers can continue to make payments, and will often leave their name on the company letterhead while payments are being made. Thus, an unwitting owner can be turned into an unwitting frontman for a long firm scam. Or, alternatively:

Even when fraudsters pay up front for a company, it can be surprisingly difficult for the selling owner to organize a final board meeting to formalize the transfer of title. The minutes of such meetings have a habit of getting lost, leaving the previous owner sitting around as the only remaining representative of a long firm, trying to convince the police that a bad boy did it and ran away. Never sell a company for cash.


Davies begins the chapter on counterfeiting by telling the story of Alves dos Reis. His career in forgery began in 1916:

He decided to take a Portuguese university diploma, copy it, attribute it to the ‘Oxford University Polytechnic School of Engineering’ and give himself qualifications in engineering, geology, geometry, physics, metallurgy, mathematics, palaeography, chemistry, mechanics and civil design. As well as teaching him that Portuguese notaries would stamp anything, this helped him get a job as chief engineer of Angola’s railway system. Despite the fact that his degree was a fake, Alves Reis managed to teach himself enough engineering on the job to avoid disaster, and returned to his homeland in 1923 with a little money of his own and a good reputation.

Neither lasted long.

Alves dos Reis’s story has many ups and downs, including one elaborate “the check’s in the mail” scheme which involved buying a failing railway company that was being bailed out by the Portuguese government, paying for the purchase of the company by writing checks from a New York bank (paper checks which would have to be carried by sea in a process that would take multiple weeks), then raiding the company’s treasury for the bailout funds and depositing the money into his own account before the checks arrived. (Davies omits the details of this particular episode from his biography of Alves dos Reis, as they’re not particularly germane to the discussion of counterfeiting, but the scheme seems too good not to share.)

After spending 54 days in jail for the aforementioned railway embezzlement, Alves dos Reis embarked on the fraud that would make him a notorious figure in Portuguese history.

The Bank of Portugal, wanting the latest in anti-counterfeiting technology, had previously decided to outsource their production to the trusted and prestigious London firm of Waterlow & Sons. The London firm had printed the legitimate bank notes and they entered circulation, largely without incident. Knowing this, Alves Reis forged a contract (and other documents), approached Waterlow & Sons, and claimed that he had been authorized by the Bank of Portugal to print more banknotes. The printing firm, believing Alves Reis was a legitimate representative of the Portuguese government, produced 200,000 banknotes with a face value of 500 escudos each, totaling 100 million escudos. At the time, this amount represented around 1% of Portugal’s GDP.

Some of the details of Alves dos Reis’s story could make for the plot of a heist movie, which might strain audience credulity when arriving at the scene where the scheme started to unravel. Because he had a literal license to print money, each of the notes he printed had a unique serial number (though, not knowing the exact serial numbers of the legal notes already in circulation, it was possible that one of his counterfeit notes might be printed with the same serial number for a previously-printed legal bank note that was already in circulation). By sheer coincidence, during an investigation into Alves dos Reis, one investigator happened to spot a counterfeit bank note that had been placed next to a legitimate bank note of the same serial number.1 At that point, the jig was up, and it was only a matter of time before he was caught and arrested.

The scheme ended up shaking the foundations of Portuguese society:

Inflation took off as confidence in the currency slumped. The Bank of Portugal ended up having to recall all 500-escudo notes and swap them for 1,000-escudo notes. The army staged a coup, and brought in the ‘Estado Novo’ dictatorship which ruled Portugal until 1974. For most of this time, the country was ruled by an economics professor, Antonio Salazar, who must have occasionally pondered the series of events that brought him to power.

The Portuguese Bank Note Affair remains one of the most tragic cases in which the weak link in a high-trust society (in this case, notaries) ended up pulling down the whole structure of trust itself.

Davies notes that counterfeiting currency is “something of a closed loop: once the paper is created, the crime is complete.” The crime doesn’t have a single victim; the victim is the whole of society, and the damage is the loss of trust that comes from knowing that counterfeits are circulating.

However, currency counterfeiting is also one of the least-common forms of counterfeiting: the profit from counterfeiting a single bank note is limited to the amount printed on it, and a lot of currencies come with anti-counterfeiting measures built in. Your job is easier (and your potential returns are much higher) if you counterfeit something like a contract.

In fact, this is exactly how Alves dos Reis committed his Portuguese bank note fraud: he didn’t run a fly-by-night printing operation in some hidden warehouse; he used a fake contract to trick a legitimate printing firm (which, up until that point, had been a source of legitimate Portuguese bank notes) into believing that he was authorized to print bank notes. Because the counterfeit notes came from the same printer, there was nothing physically distinguishing them as fakes. The only difference between the genuine bank notes and the counterfeits was that one set of notes had been printed with the official authorization of the Bank of Portugal, while the other had not.

Usually, the word “counterfeit” brings to mind the image of funny money and forged artwork, but nearly all of the profit in counterfeiting comes from commercial frauds. (As previously mentioned, as an enterprising gold miner you could send a counterfeit sample to a mineral lab to get an assay report to dupe investors into thinking you’re sitting on the mother lode. Or you could have a counterfeit blood test device to convince stakeholders to invest money to trust your blood-testing startup.)

Davies notes that sometimes “counterfeiting” – which Davies stretches past its strict legal definition, and in this chapter loosely defines as the act of trying to pass something off as something that it’s not – doesn’t necessarily require forging documents. For example, if you’re in the medical field, you could take this sophisticated approach:

In the 1990s, British Biotech was at the very earliest stages of testing an anticancer drug called marimastat. It filed plans with the FDA saying that it intended to test marimastat on cancer patients, and to measure its progress in reducing their tumors by monitoring levels of cancer antigens in their blood. The FDA’s immediate response was to say that “you cannot measure tumor size by counting antigen levels, they are not closely enough correlated in that way,” and that it would only accept data based on actual measurements of the tumors.

However, the FDA does not actually ban you from doing a trial it considers to be worthless (unless it’s also dangerous), and so British Biotech went ahead. It then commenced to send out a stream of positive-sounding press releases about how well the antigen-level trials were going, omitting to mention in any of them that so far as getting closer to an approved drug, they might as well not have bothered. The company ended up getting in serious trouble with the securities regulators, as it was felt that the investing public should not be expected to know quite so much about the FDA’s views on antigens.~~~~

In this case, no test results or approval documents were forged: the company got into trouble when they took something that was legal and real and truthful (“we got approval from the FDA to move ahead with antigen trials”) and used it to suggest something misleading (in this case, falsely implying “the approval to perform these tests gets us materially closer to obtaining FDA approval.”)

Counterfeit loans

Another form of counterfeiting is to take bad loans and try to pass them off as good loans, which is an example that’s more interesting for what it says about loans than for what it says about counterfeiting.

What causes a lender to do poorly and go out of business? An obvious answer would be “lending money to people who don’t pay it back.” That answer, in addition to being obvious, is also wrong. The lender knows that some of their borrowers won’t pay them back: that’s why risky borrowers pay a high interest rate. If 10% of your borrowers default, that’s not a problem if you predicted that 10% of your borrowers would default, because you priced that in when making the loan. If you assume that 5% of your lenders will default, and then 10% of them default, that’s where you run into problems.

“Good loans” are profitable for lenders, obviously. But “bad loans,” which trade at a different price, can also be profitable for lenders, provided they’re properly priced as such. The problem is when you have a bad loan that looks like (and is priced like) a good loan.

If you take a “bad loan” (like a subprime mortgage) and disguise it as a “good loan” (by repackaging it as a “mortgage-backed security” or “collateralized debt obligations”), that’s conceptually not so different from taking 10 karat gold and trying to pass it off as 18 karat gold: you’re selling a real product (which the buyer might have even been willing to buy at a fair price), but lying about the quality allowed you to charge them a higher price.

(Distributed) Control Fraud

If you look it up in a reference book, you’ll probably see “control fraud” defined as a type of corporate fraud wherein individuals in positions of power manipulate the company’s operations, financial statements, or internal controls for personal gain.

This wide definition encompasses so many different things that it doesn’t feel particularly useful. However, Davies is most interested in something more specific, what he names “distributed control fraud.”

As an example, he describes the UK’s Payment Protection Insurance (PPI) mis-selling scandal. PPI is an insurance product designed to cover borrowers’ loan or credit card repayments if they become ill, unemployed, deceased, or otherwise unable to earn income to make their payments. Davies comments on the reason that this new product offering likely seemed like a good idea to the bank managers who decided to start offering it in the early 1990s (and the reasons to be suspicious of it):

It was a long-dated insurance product in which the premiums were collected up front but the claims paid much later. As always, not all such products are intrinsically fraudulent, but if you are planning on doing something you shouldn’t, this is one of the tools you’ll want to have in your kit.

As always, the devil was in the details, with many bank branches selling a version of the product that Davies describes as “highly toxic”: the PPI sold to many consumers was not as comprehensive as most consumers would have reasonably expected it to be. But banks controlled an important distribution channel (they could sell customers the Payment Protection Insurance at the same time that the consumer was applying for a loan), and thus banks would end up charging premiums roughly 4 times what an independent provider would have charged.

Things got even worse in the way the products were marketed:

Branch staff were given aggressive sales targets for PPI, and overall revenue targets which would be impossible to reach without selling it to an absurd number of their customers. It was difficult for the staff to resist this pressure. Compared to previous generations of the same industry, counter staff were less qualified and worse trained. …

What happens when you take an under-trained sales force, give them a bad-quality financial product and tell them they will be disciplined or fired if they don’t sell enough of it? Nothing good, obviously. … Lots of it was hardly even ‘sold’ at all – the staff just added it on to the documentation and pricing and handed it over to the customer to sign, hoping they wouldn’t notice.

And when it was sold, harassed branch staff had this habit of lying massively about it; over-representing the benefits, concealing the full cost and, to a truly shameful extent, telling the borrowers that it was either a legal requirement or a condition of getting the loan and that they had to take out PPI even if they didn’t want to.

Given the number of customers who were outright lied to, this seems like blatant fraud on a wide scale. Who are the villains in this story? Do we blame the bank branch retail employees? Certainly, they made a moral choice to lie (lying to customers about the product they were selling, and in some cases lying about customers having knowingly consented to purchase the product).

But when you have thousands of bank branch employees lying to meet their quotas so they can keep their £10/hr job, they certainly don’t seem like criminal masterminds: none of them were getting rich off the scam. They were low-level employees who were responding to bad incentives. Should we instead aim the blame at the bosses who were responsible for creating the incentives in the first place?

The bosses … were responsible for creating the conditions under which the UK banking branch networks become a criminogenic environment. But, as far as anyone can tell, they didn’t tell the branch staff to misrepresent the PPI policies and were horrified and took appropriate action on the occasions when they found out what was going on. The problem was simply that they never did find out, because they didn’t make enough effort to find out.

This is why nobody went to jail over PPI. Prosecuting the small fry and letting off the big bosses is unedifying and leaves a bad taste. … But prosecuting the people at the top of the tree only works in situations when they meet you halfway by committing a crime. To the frustration of all, it is not a crime to set stupid targets for your sales force, nor is it a crime to fail to check up on them. At the time when the PPI scandal happened, it just wasn’t a crime to run your bank really badly.2

This is the essence of a “distributed control fraud.” Davies summarizes it by saying “it shows us how an organization can become criminogenic without ever really intending to, simply as the natural result of what happens when a dysfunctional industry meets a weak management structure, under pressure.”

Another way to look at control fraud (broadly, not just the specific kind of “distributed control fraud” that Davies discusses) is as a commercial fraud-tinged exercise in public choice theory: adding complexity to any system often means adding more managers, and as Davies remarks, “the worst thing about adding more managers is that managers are people, and people have their own incentives.”

Perhaps a more significant downside to complex systems:

The easier something is to manage – the more possible it is to take a comprehensive view of all that’s going on, and to check every transaction individually – the more difficult it is to defraud.

Vulnerability to crime, in other words, tends to scale with the cognitive demands placed on the management of a business. The more things a manager has to pay attention to, the easier it becomes to carry out a commercial fraud.

It seems to follow that the more centrally-planned an economy is, the more vulnerable it becomes to fraud, corruption, and exploitation by bad actors. (The extent to which various 20th century experiments in centrally planned economies support this conclusion is left as an exercise to the reader.)

Market Crimes

Distributed control fraud is abstract and difficult to label as “fraud” because it’s possible for the higher-ups to unwittingly create a criminogenic environment through incentives: in that case, it’s clear that a crime has happened, but possible that nobody goes to jail.

Market crimes are even more abstract, because not only is it unclear whether people behaved unethically, but the ethical standards themselves are what is in question:

More than any other, this kind of crime is a matter of judgment, local convention, and practice, rather than one of cut-and-dried criminality. A blatant market crime in one jurisdiction could be considered aggressive but legal practice in another and the definition of good business somewhere else.

Not only do different jurisdictions have differences of opinion about what constitutes a market crime when it comes to degree , but in some cases, the standards of what’s considered ethical market behavior can be completely reversed in polarity.

For example, nowadays we tend to frown upon price fixing and collusion: we expect different vendors within a market to compete against each other. If you ask for an explanation of why we think this should be the norm, economists will probably tell you something about price signals, and those making a more emotional appeal will talk about how it harms consumers, and companies have an ethical obligation to keep bidding lower and lower on price until their margins have been sliced razor-thin. However, says Davies, for the centuries leading up to the 18th century, “the intuition had been opposite – that a shopkeeper who undercut his fellow merchants was doing a shameful thing. Marx’s Capital, nearly a century later, still refers to ‘full-priced’ bakers denouncing their ‘underselling’ rivals to a parliamentary committee of inquiry.”

Adam Smith was breaking with centuries of tradition when, in The Wealth of Nations , he frowned practice of price fixing by describing it as a “conspiracy against the public.” And even though believed that price fixing had a pernicious effect, he believed that it would be “impossible indeed to prevent such meetings,” as any meeting that tried to ban conspiratorial price-fixing would have either been impossible to execute, or inconsistent with liberty and justice. (He wrote this in 1776, but had the US Constitution and Bill of Rights existed at the time, he might have argued that a meeting between two competitors to decide how to price their wares would be protected by the First Amendment.)

The things that we outlaw as market crimes tend to become “crimes” (as opposed to “things that are generally frowned upon”) specifically because of negative externalities. When the profits are centralized while the costs are distributed, it creates bad incentives, and laws are one way to solve this. (Davies begins a chapter by quoting SCOTUS Justice Benjamin N. Cardozo, who said “The final cause of law is the welfare of society.”)

“Market crimes” are violations of laws where the victim is “the market,” or more specifically, trust in the market. Inside traders damage public trust in the stock market. Market manipulation interferes with people’s ability to trust price signals. Cornering the market reduces market liquidity, market transparency, and disrupts price signals.

However, these “harms” to the market can seem pretty abstract, and enforcing laws and regulations to prevent them might not naturally square with our moral intuitions. Indeed, Davies points out, “Sometimes it can even be the case that the rules made by the market to protect its own integrity involve pretty palpable injustice to the people who end up on the wrong end.” Consider the example of Clarence Saunders, “the inventor of the modern self-service supermarket with his Piggly Wiggly chain”:

Don’t Mess With Markets (Or Those Who Regulate Them)

Piggly Wiggly Stores Inc. was a publicly-traded company with sound financials. However, there was a bit of confusion by investors over the difference between “Piggly Wiggly Stores Inc.”, “Piggly Wiggly Corporation,” and a third different company which went bankrupt at a time when it had run a number of locations franchised by Piggly Wiggly Corporation. (Many saw the words “Piggly Wiggly” and “bankrupt” in the same headlines and assumed that the story had something to do with the publicly traded company “Piggly Wiggly Stores Inc.”)

Thus began a “bear raid” on the publicly traded company (which, to be clear, was not the company that was going bankrupt, nor the company that had had them as a customer). Those who had shares in the company sold them, and those who didn’t own shares shorted it (borrowing shares so that they could sell them).

Clarence Saunders, seeing that stock in his company was trading at what he thought was an unfairly low price, executed a “short squeeze.” If you were witness to the /r/wallstreetbets Gamestop short squeeze in January 2021, you understand the basic concept, though the details are different:

For one thing (unlike Gamestop), Piggly Wiggly Stores Inc. was a firm that actually seemed to have sound financials. For another, Clarence Saunders was attempting to execute this short squeeze in 1922, when stocks were traded as physical pieces of paper, making the system of “IOUs” that enable short-selling much more tangible, and the market far less liquid (and thus easier to corner or manipulate). And perhaps most significantly, Clarence Saunders was not a third-party rallying people on an internet forum; he was buying his company’s shares using shares from his own personal funds, money he had borrowed (which ended up millions of dollars, a huge amount in 1922), and the company’s funds.

The act of using funds from the Piggly Wiggly Stores Inc bank account to buy shares in Piggly Wiggly Stores Inc. sounds a lot like a “buyback” (something which companies do from time to time; Apple seems to be a particular fan of the practice having done it most recently in 2022), but nowadays the SEC has strict rules about when and how buybacks can be executed, and many aspects of buybacks as we understand them today weren’t formalized until the 1980’s.

The good news for Clarence was that none of these rules restricting buybacks existed, meaning that none of what he did was, technically speaking, illegal. The bad news was that because the practice of “using your company’s cash to buy your company’s stock” hadn’t been established as “a thing that non-crooked companies generally do,” the authorities didn’t look favorably upon it; Davies remarks that “frankly it looks like the sort of thing that a control fraud would do.”

And in general, as with the rules against insider dealing, it is not all that good for the image of stock market investment in general for the prices of popular shares to be pushed about by secret plans made by rich insiders.

It was for this reason that the Exchange had passed a rule in 1922 empowering it to take measures to prevent market corners. And Clarence Saunders was the first person to fall foul of this rule. It was not a criminal charge that tripped him up, or even a civil lawsuit. It was a simple extension of the settlement period.

Saunders’ short squeeze had been premised on the low liquidity and a tight settlement period: the short sellers who had borrowed shares would be forced to buy shares at the end of the settlement period, and after cornering the market, Saunders was the only person who owned a significant number of shares for sale, allowing him to force the short sellers to buy from him at an exorbitant price in order to settle their loans.

But when the SEC responded by changing the rules and extending the settlement period by one week, the plan started to unravel: giving the short sellers an extra week to procure shares made a huge difference, because remember, this happened in 1922, when “stock certificates” were pieces of paper that could travel around the country. Rather than being forced to buy shares from Clarence’s office, the short sellers could visit small investors all over the South and Midwest who held Piggly Wiggly shares (in many cases, the brokers from regional offices would go literally knocking on the doors of retail investors who had bought shares from them, offering to buy the share for a price that was a significant profit for the retail investor but still significantly less than the price Clarence Saunders was trying to extract).

In the end, the price of Saunders’ shares still left him with a profit, but the profit from the stock’s price movement wasn’t enough to cover the cost of the interest on the $10 millions in loans he had taken out in order to buy shares to execute the squeeze (that was a lot of money back in 1922, and it didn’t help that the extension meant he was paying another week’s worth of interest on his loans). In the end, he went bankrupt. Davies ends the Clarence Saunders story with this:

He had played the game and won, but they had changed the rules.

These days, a corner like that would never have been allowed to get started; as soon as it became clear that you were manipulating the share price, the regulators would step in and require you to stop, then start to look through the books to decide which specific charge they were going to bring against you.

To some, that sentence might seem to uncomfortably rhyme with Lavrentiy Beria’s classic “show me the man and I’ll show you the crime.” In the case of the Soviet Union, the implied advice was “don’t become an enemy of the state.” In the case of Clarence Saunders, the implied advice is “don’t become an enemy of the market”:

This is the quintessence of a market crime; all Clarence did was buy shares at the going price, and everyone who dealt with him did so willingly and transparently. He did not deceive anyone; he literally took out advertisements in the newspapers saying what he was doing. But the market wanted to protect itself, and his conduct was disruptive to a set of economic institutions that other people rely on. So tough luck, Clarence. … he died a lot poorer and less happy than if he’d never borrowed $10 million to teach Wall Street a lesson.

Thus, a caveat for the following advice:

Alt text:@eigenrobot tweet: “america is a land of innovation and its baked into our constitution. our prohibition on ex post facto law, for example, means there’s immense alpha for firms that successfully productize new types of crimes

If you plan to put this into action, make sure that your “new type of crime” isn’t a market crime. “Ex post facto law” applies to the courts, but regulators have ways of punishing you even when you technically haven’t broken the law.

Market Crimes Aren’t Victimless

Despite portraying Clarence Saunders in a somewhat sympathetic manner, Davies makes it clear that he isn’t soft on “market crime.” Nowhere is this more clear than in the example of Quanta Resources Corporation, an operation with mob connections which found that it was a lot cheaper to dispose of toxic chemicals if you ignored the laws and regulations that were created to minimize negative externalities. (Once you find a way to illegally dump your waste, you can scale the operation up, as toxic waste disposal is a thing that many companies will pay for.) It might not look like the archetypal “market crime,” but Davies argues that it deserves to be categorized as such:

The illegal dumping of toxic waste hardly seems like a minor or technical offense – it’s one of the most serious corporate crimes of violence that there is, and given the orders of magnitude of people affected, it almost certainly significantly exceeds the worst excesses of the Mafia in terms of the number of deaths caused. But it is a kind of fraud (and one which often involves other frauds in counterfeiting safety certification), and as a kind of fraud, it is essentially a market crime. If anything, the inclusion of this category of corporate violence under this heading ought to disabuse the reader of any sense that market crimes are ‘technical’ or ‘victimless’; they include some of the most callous and despicable actions ever to be carried out under the heading of crimes of dishonesty.

Davies remarks on the possibility that fraudsters may delude themselves into believing they are like Robin Hood (the 13th century outlaw, not the 21st century trading app): your victims are often “rich people,” and you get to do it without violence (when toxic waste isn’t involved). In the case of abstract “market crimes,” people may even believe they are committing a “victimless crime.” However, these crimes aren’t truly victimless:

The victim is the market itself rather than a particular person who has lost an identifiable sum of money. Market crimes can be very lucrative, but they make other users of the market more reluctant to extend the trust that makes the system work.

The chapter on Alves dos Reis and the Bank of Portugal, while not an example of a market crime per se, serves as a good object lesson in how damaging public trust can undermine the economy (and political structure) of an entire country.

What’s not in the book

For this review, I read (and quoted from) both the 2018 UK version of this book, and the 2021 US version of the book. While the content is largely the same, there are a few differences. For example, in the chapter about control fraud, Davies uses the UK’s PPI mis-selling scandal as an illustrative example of “distributed control fraud.” In the US version of the book, this section instead focuses on several aspects of the US foreclosure crisis, such as “robosigning.” In a few places, certain sections are left intact but are rearranged, particularly in the intro, where each version chooses a different story to serve as its chapter 1 “hook”.

The 2021 US version also adds a few other examples that weren’t part of the 2018 UK edition, including Elizabeth Holmes’ Theranos, and Donald Trump’s Hotels & Resorts – I am unsure if these were added because they might be more relevant to the interest of US readers, or if the UK version of the book was completed and sent off to the editor too soon for “examples ripped from 2016 headlines” to make the cut.

If Davies were working on a new updated version of the book, what would he add? I think the answer is fairly obvious: 2022 saw the collapse of one of the world’s biggest cryptocurrency exchanges (FTX) after it was discovered that they had improperly been using customer deposits. FTX is currently going through bankruptcy, where filings seem to indicate that they owe at least $3.1 billion to roughly 1 million creditors, many of whom may not get their money back. FTX founder Sam Bankman-Fried (SBF) is facing an eight-count federal indictment including multiple counts of wire fraud, wire fraud conspiracy, and a charge of conspiracy to commit money laundering, among other charges.

Having first read the book in 2021 and more recently reread it with the benefit of “FTX hindsight,” many sections of the book seemed to “rhyme” with the FTX story, particularly the section on Charles Ponzi, for reasons that have very little to do with pyramid schemes.

Just as SBF’s story doesn’t begin with FTX, Ponzi’s story doesn’t begin with the Ponzi note. Ponzi’s story begins as the story of a legitimate businessman pursuing what appears to be an exciting arbitrage opportunity exploiting a difference in exchange rates between two countries. (Sound familiar?)

Ponzi was a publisher, and came to a realization when a prospective customer in Spain sent him an International Reply Coupon (IRC) to cover a postage expense:

While cashing in the IRC, Ponzi realized that while these coupons were convertible into a set amount of postage in each of the participating systems of the Universal Postal Union, they also sold for a set amount of local currency in each of the countries. The IRC system therefore defined a set of fixed exchange rates via its table of prices, and these exchange rates could differ significantly from the market rates…

Ponzi even carried out a trial transaction, sending dollars to a relative in Italy to convert into lire, buy IRCs and mail them back to Boston. He then took these coupons to the post office in Milk Street, exchanging them for US stamps worth around double his initial investment. It looked like a free money machine, and all he needed was more capital.

Sam Bankman-Fried’s origin story begins in a similar manner: his foray into cryptocurrency began with the Alameda Research trading firm, whose first mission was focused on an arbitrage opportunity that they discovered: the story, as SBF tells it, is that there was enough of a price differential between the price of cryptocurrency on US and Japanese exchanges that, if you were set up to trade in both markets, you could exploit the difference and make “free money.”

But running a trading firm costs money, and so Ponzi and SBF had to raise capital. Ponzi’s fundraising method was to offer a single investment product to would-be financiers: he promised investors 50% returns on a 90 day loan, and if they doubted Ponzi’s ability to repay the loan, they were free to recall it: at any date before maturity, investors could withdraw their initial investment with no penalty. (Very, very few did this, because that meant missing out on that 50% return.)

“High returns with no risk” sounds too good to be true, but a 2018 fundraising deck for Alameda Research makes exactly that promise:

Investment offerings


We offer one investment product:

15% annualized fixed rate loans (no lockup)



These loans have no downside – we guarantee full payment the principle and interest [sic] , enforceable under US law and established by all parties’ legal counsel. We are extremely confident we will be able to pay this amount. In the unlikely case where we lose more than 2% over a month we will give investors the opportunity to recall funds and we will still guarantee full repayment.

[source] [slide link]

15% APR on a risk-free deposit isn’t quite as generous as 50% returns in 90 days, but it’s probably about as high as you can offer while still sounding somewhat plausible. Investor credulity has its limits.

That being said, people are more willing to trust you if you’re an ingroup member. Most of Charles Ponzi’s early investors were, like Ponzi himself, members of Boston’s Italian-American community. Davies notes that affinity group membership can be a way to infiltrate a web or network of trust. An offer that sounds “too good to be true” might sound more believable if it’s coming from a member of your church congregation:

Pyramid schemes are so rife among churches that guides to pastors have been published on how to spot one developing in your congregation. These come complete with lists of biblical references to use in preaching sermons on the illusory nature of promised riches. (Ecclesiastes 5:5, for example, “Better is it that thou shouldest not vow, than that thou shouldest vow and not pay.”)

While I won’t enter a discussion of whether Effective Altruism is a “religion,” the EA community does seem to share some common traits with religious congregations. When someone is part of your congregation, they’re not just signaling shared group affinity; it’s specifically the sort of group where membership also signals moral virtue. (If you’re an Effective Altruist, you probably trust a fellow EA more than you trust a fellow rock climber, or a fellow Trekkie.)

SBF went to considerable time and expense to signal Effective Altruist group affiliation: in 2022, the FTX Future Fund gave more than $160 million to EA causes. In April 2022, he appeared as a guest on the 80,000 Hours podcast for a 3-hour interview with Rob Wiblin.

One of the main themes that runs through Davies’ book is the way that fraudsters tend to infiltrate webs or networks of trust. You don’t have time to vet everyone you associate with, and so you assume a certain level of transitive trust. When I listen to an episode of the 80,000 Hours podcast, I generally assume that the person Rob is sitting down to interview for 3 hours is not a crook. And Rob, for his part, probably also assumes he’s not talking to a crook when he schedules an interview with the founder of a company that has raised over a billion dollars in VC funding. It’s a reasonable assumption for him to make: were I a podcast host, or some other prominent member of the EA community, I’d probably trust the VCs to stand by the integrity of the firms they invest in for the same reason that I trust the bank to stand by the authenticity of the bills that come out of their ATM. It seems like a safe assumption that they have considerably more interest than I do in making sure everything is on the up-and-up, and considerably more resources to check to make sure that there’s nothing funny going on.

The longer things go on, the more you accumulate “credibility via association,” and the more entrenched you become in the network of trust. Of course, the longer things run, the more your financial problems grow. Ponzi’s financial problems grew for obvious reasons (it’s really hard to deliver 50% returns every 90 days). SBF had financial problems, too: FTX raided customer deposits (and relied on users continuing to “invest” in FTT, the platform’s native cryptocurrency). It’s putting into action something that Charles Ponzi was keenly aware of:

He was aware from the earliest stages of his scheme that he was only buying time and was relying on his ability to find another idea, as brilliant as the postal scheme but not as impossible to execute. He was decades ahead of his time in understanding that “assets controlled” is more important to a wholly dishonest actor than “assets owned.”

(Ponzi’s “free money” source of International Reply Coupon arbitrage was not as profitable in practice as it was in concept.)

SBF, much like Ponzi, was desperately in search of something that would actually make his operation profitable, as SBF wasn’t nearly as successful as he portrayed himself to be: according to bankruptcy professionals managing the entities that SBF helmed, between Alameda Research and FTX, he posted a net loss of $3.7 billion from inception to 2021. Raiding customer deposits – and getting people to “invest” in FTX’s native cryptocurrency FTT – gave them the liquidity to keep operating.

What lessons would Davies hope for us to learn from the example of SBF? Partly, the saga of Sam Bankman-Fried seems like a parable about laundering reputation and credibility: if it’s possible for people to buy respectability, then it’s important to realize that crooks often control assets that they can use to buy respectability (even if the assets aren’t theirs, strictly speaking). And at a certain point, the extra layers of respectability aren’t really “earned” or even “bought” so much as picked up through sheer inertia.

Some people have tried to use the FTX collapse as the basis for arguing for more regulation. But as Davies repeatedly reminds us over the course of the book, fraud is an equilibrium phenomenon. Consider the example presented in the book of the strict controls put into place to prevent counterfeit drugs from entering sanctioned channels, driving up drug prices to the point where some people are buying from unlicensed online pharmacy. If going through the sanctioned channels becomes too expensive, or too inconvenient, people will eschew the protection entirely and go for unsanctioned online pharmacies.

This is similar to what happened with FTX: FTX, seeing the US regulatory environment as too prohibitive to run a cryptocurrency exchange, opted to set up shop in the Bahamas, where considerably fewer protections exist. Many customers opted to follow them there. In several interviews, SBF was asked about why they’d set up shop in the Bahamas, and the answer he repeatedly gave was that the US regulatory environment was too strict. At the time, this did not seem to strike most interviews as a weird or suspicious thing to say: “of course nobody would want to do business in the US.”

If you want people to do things on the up-and-up, and they have the option of moving to a different environment that cares significantly less about things being done on the up-and-up, then making things more difficult in your jurisdiction will likely send more people over to the less-regulated one: this applies not only to fraudsters, but to many individuals who exist in the category of “normal people.” And when more “normal people” start doing this, this also makes it easier for bad actors to move around in the less-regulated channels while credibly masquerading as normal people who just don’t want to deal with all that pesky and unreasonable regulation. (SBF credibly masqueraded as such, making no effort to hide the reason he chose to do business in the Bahamas.)

(I’m not well-informed enough to know if the FTX collapse warrants regulatory action, but my one suggestion to regulators would be that if you’re going say “We need to pass this regulation to prevent the next FTX,” please consider if the thing you are proposing is something that would have actually prevented FTX.)

What’s not in the review

While Lying For Money is a great educational resource that improved my understanding of several parts of the economy, much of the value of the book comes from the sheer entertainment value of reading about famous, infamous, and not-so-famous frauds and capers. (Oftentimes, the not-so-famous stories are the most entertaining: one might imagine that when Dan Davies was selling the proposal, any book promising to cover “legendary frauds” had to include Bernie Madoff and Enron. The other, less-known anecdotes can be plucked out and included because they are interesting, rather than because Davies and his publisher felt a sense of obligation to include them.)

A good chunk of the entertainment value also comes from Davies’ (often dry) wit and frequent asides, which frequently appear as footnotes. For example:

The English language has an irregular verb to describe the problematic effects of performance contracts, depending on how much sympathy you feel for the person at the sharp end. I respond to incentives / You game the system / He is a crook.

Another sample footnote:

Forgive the digression, but the phrase ‘corporate drone’ is meaningless. Drones don’t do the work in beehives. Worker bees do. A ‘corporate drone’ would be someone whose only purpose was to fertilize the corporate queen and I can’t think of a single company that’s managed that way.

But the book’s 140+ footnotes aren’t just random witticisms. Some are simply informative tangents that deliver on the book’s other core value proposition, which is “teaching you things you didn’t know about how the world works”:

Americans and readers in other countries that don’t have a VAT might be scratching their heads a bit here. Why, why do this, rather than just charging sales tax on the final price? Basically, because when sales taxes get higher than about 8 per cent, people start making strenuous efforts to avoid them, and retail customers don’t report their accounts to the government but business customers do. So by charging the VAT stage by stage through the process of distribution, you get a series of automatically generated checks; when Freddy claims a refund of £200,000 it triggers a check that Jim-Bob has paid the same amount. As well as facilitating checking, the system of refunds for VAT already paid on inputs ensures that the tax doesn’t ‘layer’ – you don’t want the eventual tax rate on the final sale to depend on the number of different companies and wholesalers involved in the process.

If I tried to provide a “list of things that didn’t exactly fit in the review but were too interesting not to share,” it would probably double the length of this review. Fortunately, I don’t need to include that list, because Ozy has already written “Interesting Facts From Lying For Money,” which you can read at Thing of Things. (If you want to get an idea for the breadth of topics that are covered in the book, rather than a summary of its main “theses,” that’s the post you should be reading.)

  1. A big part of the fun of Lying For Money is reading stories with details that would be too outlandish to be considered plausible, except for the fact that they actually happened.

  2. Davies footnotes this by adding, “It has since been made one, in the UK at least. The 2013 Financial Services (Banking Reform) Act provides criminal penalties for a senior executive of a failed financial institution if they should have known that their institution was being run recklessly. Whether this criminal offence will survive its first contact with human rights legislation is yet to be tested at the time of writing; the corresponding US legislation under the Sarbanes-Oxley Act is regarded by a lot of lawyers to be probably unconstitutional.”