Saturday, October 3, 2009

The "Dreier Model"

In December of 2008, Marc Dreier was arrested for perpetrating an incredible Ponzi scheme. As this riveting Vanity Fair article details, Dreier's tale mirrors the sequence of events, both practical and psychological, that seem to always play out in these schemes. Quoting the article:

Great things were always expected of Marc Dreier, and he expected them for himself. He needed the hotshot litigating career and a life stuffed with rich men’s toys. He needed a Hamptons beachfront house. Thus began a four-year Ponzi scheme—involving audacious impersonations and $380 million stolen from 13 hedge funds—which all unraveled just days before the Madoff scandal broke, bringing the 59-year-old attorney a 20-year prison sentence.
Anyone who reads this account will surely be fascinated by the details of Dreier's scheme. They will marvel at the sheer audacity of Dreier's fraud, ponder his deeper psychological motivations, and wonder how anyone in these circumstances could imagine that such a scheme could end in anything other than ruin, disgrace, and a life in prison.

Let me offer you another angle. If you read this account or the details of countless prior Ponzi schemes and you abstract the essentials from the details, you will notice a pattern.

First, the perpetrator is always at some pivotal point in his life inducing consideration of something nefarious. In this case, Dreier was undergoing a mid-life crisis brought on by the unfulfilled expectations of a prodigious Harvard graduate and the jealousy of his peers that had seemingly achieved so much more.

Second, the scheme is always believed to be only a quick fix or a temporary means to some legitimate end. In Dreier's case, after being denied loans to start his own law firm, he believed that the first theft would enable him to start the business and that he would ultimately return the money he stole.

Third, the first amount was not enough to "fix" the problem and the thief finds the temptation to steal again irresistible. After creating a phony $20 million note which he sold to a hedge fund, Dreier simply did it again. He was able to create money out of thin air, a power that few would be able to resist.

Fourth, the thief achieves some sort of nominal "success" in terms of creating the perception that he has achieved something real and to some extent actually does succeed in creating some actual business. This temporary "success" creates delusions of grandeur. As Dreier expanded his firm with stolen money, he brought in real lawyers who generated real revenue and even opened a Sushi restaurant in Los Angeles. In fact, the legal community took notice of this interesting new model - the so-called "Dreier Model":
Within the legal community, Dreier was viewed as a rising star. He told anyone who would listen that Dreier L.L.P. was a new kind of law firm, one where lawyers could work with freedom, unburdened by old-school bureaucracy and administration, all of which Dreier handled himself. In a 2007 article for The National Law Journal, Dreier argued that the “Dreier Model,” as he christened it, freed attorneys from petty bickering over profits and allowed them to operate as true legal entrepreneurs.
Fifth, the ever expanding business fueled by money created out of thin air, requires ever greater amounts of capital to keep it afloat and to satiate the perpetrator's appetites and need for public glory. At the peak, Dreier created $380 million of bogus notes that he sold to 13 different funds. Among other things, he used the money to buy $40 million worth of art for his lobby, a yacht, and a beach house in the Hamptons.

Sixth, something happens to stop the spigot and the house of cards begins to crash down. To the bitter end, the thief resorts to ever more audacious maneuvers to keep the scheme going although he senses that the game is over. I won't ruin the article for you - just read it.

Seventh, the perpetrator is arrested and sentenced to prison where he discovers what is truly important in life, repents his sins, and spends his remaining days in a semi-trance depressed, humiliated, and suicidal.


What struck me in analyzing this pattern was that it is exactly the pattern followed by the Federal Reserve system in creating the boom-bust cycle.

The Federal Reserve is able to create money out of thin air just as Dreier did when he sold fake notes to hedge funds. The credit expansion, meant only to temporarily ameliorate or "smooth out" an economic downturn, initially masquerades as actual investment capital, lowering interest rates and stimulating capital investment. As this fake money filters through the monetary system where it is mulitiplied by fractional reserve banks, businesses and consumers find themselves awash in easy money and use it to fund virtually every desire. Rather than a system built upon thrift and hard work, easy money creates a kind of moral decadence as everyone and anyone gets money for nothing - one might say that people are "freed from the petty bickering over profits".

Of course, at some point the party must stop. Prices begin to rise and to head off an inflationary panic, the Fed closes the spigot of liquidity. The hangover begins. Investments once thought to be profitable are seen as malinvestments and must be liquidated. Firms and individuals must deleverage to raise cash as loans are called in. Waves of bankruptcy's exacerbate a downward spiral. Ultimately, such a process is necessary and vital to restoring economic growth upon a foundation of real capital, savings, and productivity.

It can be seen that the only difference between the individual perpetrator of a Ponzi scheme and the Federal Reserve is that the former properly receives condemnation, scorn, and a prison sentence whereas the latter receives the imprimatur of Nobel Prize winning economists and encouragement from the government to simply continue the scheme. Economists do not call the Fed's inflation of the money supply and manipulation of credit the "Dreier Model", they call it Keynesian economics.

Unfortunately, I do not see Paul Krugman, Ben Bernanke, Barney Frank, or Timothy Geithner sharing a cell with Marc Dreier or Bernie Madoff anytime soon.

8 comments:

Harold said...

Wow.

Burrough is good. His article reads like a suspense novel. I agree with your analysis, especially the second and seventh points.

"Second, the scheme is always believed to be only a quick fix or a temporary means to some legitimate end."

Pragmatism run amok. As if you can cheat reality "temporarily" without consequences.

"Seventh, the perpetrator is arrested and sentenced to prison where he discovers what is truly important in life, repents his sins, and spends his remaining days in a semi-trance depressed, humiliated, and suicidal."

It'll be interesting to see what happens to Madoff.

"Unfortunately, I do not see Paul Krugman, Ben Bernanke, Barney Frank, or Timothy Geithner sharing a cell with Marc Dreier or Bernie Madoff anytime soon."

And that's the really troubling part. What Madoff and Dreier did pales in comparison to what these guys can accomplish. What will be the result?

"Justice does exist in the world, whether people choose to practice it or not. The men of ability are being avenged. The avenger is reality. Its weapon is slow, silent, invisible, and men perceive it only by its consequences - by the gutted ruins and the moans of agony it leaves in its wake. The name of the weapon is: inflation."


Rand, Ayn "Egalitarianism And Inflation." Philosophy: Who Needs It.

:-/

Doug Reich said...

Harold,

Great quote. There is no better analysis of the philosophical meaning of inflation than the article you quoted.

You are right about the comparison paling. The Fed has created over $1 trillion this year alone. Madoff and Dreier are pikers compared to what the government can do.

Thomas said...

"First, the perpetrator is always at some pivotal point in his life inducing consideration of something nefarious. In this case, Dreier was undergoing a mid-life crisis brought on by the unfulfilled expectations of a prodigious Harvard graduate and the jealousy of his peers that had seemingly achieved so much more."

This is the part that always gets me. Stories like this reliably propel me into a kind of existential mien. Human beings are so ugly. We're pathetic creatures, spending our 70-whatever years walking on the planet all worked up about other human beings having an edge on us.

Ugh. It can all be so depressing to think about.

This is how people wind up finding religion, right?

Doug Reich said...

Thomas,

Well, one way to propel yourself into an "existential mien" (love that btw) is to make a faulty metaphysical generalization like "human beings are so ugly". Such a premise would be cause for depression at a fundamental level!

In fact, the generalization is not true but your comment led me to think and make some integrations between something you said and a prior post.

I think you are right that many people have a false belief as to what will make them happy. Many believe that if they are just better or have an "edge" as you say on others that they will win some sort of game. This approach to "happiness" was a central theme of The Fountainhead and relates to a concept Ayn Rand called "second handedness".

http://aynrandlexicon.com/lexicon/second-handers.html

Quick quote you can find at link:

"Isn’t that the root of every despicable action? Not selfishness, but precisely the absence of a self. Look at them. The man who cheats and lies, but preserves a respectable front. He knows himself to be dishonest, but others think he’s honest and he derives his self-respect from that, second-hand. The man who takes credit for an achievement which is not his own. He knows himself to be mediocre, but he’s great in the eyes of others. The frustrated wretch who professes love for the inferior and clings to those less endowed, in order to establish his own superiority by comparison . . . . They’re second-handers . . . .

They have no concern for facts, ideas, work. They’re concerned only with people. They don’t ask: “Is this true?” They ask: “Is this what others think is true?”....


This concept is the root of all fraud. You can see it explicitly in the article and in a 60 minutes interview with Dreier that aired last night. He needed to be seen and acknowledged as a success by others. He was not content with his own achievement.

The integration between this and a prior post is that it relates to a false view of selfishness that I discussed in the Michael Moore post. The view that real "selfishness" consists of deceit, fraud, or coercion to obtain some goal is common and is essentially Moore's view of "greed" or self-interest and why he assails capitalism on a moral level.

When selfishness is defined properly and consideration given to what truly constitutes self-interest, it can be seen that Dreier's behavior or others like him is not "selfish". It is the opposite of selfish. He has no ego. He is an empty shell who seeks the validation of others and places that above his own independent knowledge of his own achievement.

This principle is absolutely crucial to understanding an egoist ethics and making the case for capitalism and rational self-interest. Not only is it difficult to understand conceptually, it can be difficult to practice.

Let me know if that helps dispell your mien!

C. August said...

Great post.

I printed this out this morning and just had a chance to read it. At that point, Thomas had just left his comment and I thought, "Woah! 'Human beings are so ugly'? I need to respond to this right away!"

And well, you already did. Bravo.

Doug Reich said...

Thanks C.

Again, I think Thomas' conclusion was wrong but his observation that so many suffer from this kind of second handedness is right on. It is an epidemic that stems from an improper view of selfishness.

Look at the whole kind of MTV/hip-hop culture and even the Wall Street culture and you see this obsession with being PERCEIVED as wealthy. They put the emblems and consequences of wealth above and before the actual causes of wealth. It's as if having the "things" will impart the character, values, and talent needed to be such a producer.

Anyway, did anyone see the Dreier interview on 60 minutes? I was impressed with how honest this guy is now about what he did. It's almost as if he is two people. Crazy.

patrick said...

"Unfortunately, I do not see Paul Krugman, Ben Bernanke, Barney Frank, or Timothy Geithner sharing a cell with Marc Dreier or Bernie Madoff anytime soon. "--and that is a pity. I cannot see this happening either. It should have happened already, I;d like to throw Greenspan in there with the lot. These officials collectively have made about one trillion dollars of wealth just disappear, I do not understand how such a crime can happen and the people responsible get away without consequence.

Doug Reich said...

Patrick,

The reason why "central planners", who cause more death and destruction than all the criminals combined, are excused is that under an altruist ethics, their intentions are regarded as "good", whereas, the intentions of those who seek profit are regarded as evil. I addressed this idea in this post if you are interested.

http://dougreich.blogspot.com/2009/09/chavezs-walks-red-carpet-van-joness.html

The moral theory of altruism creates this kind of double standard where people like Stalin, Mao, and Castro are excused by the left even though they murder tens of millions of people, but anyone who seeks profit is villified whether they obtain their wealth through actual production or through fraud. Of course, the latter should properly be condemned but the more important point is that "profit seeking" as such is regarded as evil. Then legitimate producers are lumped together with those who commit fraud.

Meanwhile, the government counterfeits trillions of dollars causing economic dislocation that distorts the flow of capital and wreaks havoc and destruction which affects millions of people but they are regarded as well-intentioned...