This paper discusses the relationship between fraud and financial crises. Fraud is envisioned historically as a violation of trust, and the classic triangle of smuggling…
Abstract
This paper discusses the relationship between fraud and financial crises. Fraud is envisioned historically as a violation of trust, and the classic triangle of smuggling, contraband and enforcement sheds light on developments in the financial sphere. Schematically, fraud emerges with economic prosperity, grows in a financial crisis when prices fall, and culminates in crash and panic when the scandal is revealed. Kindleberger points out that the propensity to defraud increases with the speculation that accompanies a boom. Fraud is recognised as a coincident indicator of prosperity. The paper considers the implicit consensus view that fraud and the cycle are linked, with long cycles including alternating phases of liberalisation/globalisation and contraction. If fraud is part of the cost of learning to deal with new fields and new frontiers in the appetite for risk, then fraud and crisis will inevitably find a fertile breeding ground in globalisation. Topics discussed include the distortion of decision‐making, the structure of incentives, information and regulatory implications.