Why Fraud Is Exposed in Recessions

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Abstract

to understand, but perhaps these answers aren’t established facts. And what are some of these answers?<a href="https://www.aic.gov.au/sites/default/files/2021-04/rr19_fraud_and_its_relationship_to_pandemics_and_economic_crises.pdf">One</a> hypothesis why fraud is exposed in recessions is that fraud itself actually increases during recessions. Why? Because when people get desperate, they resort to desperate measures. If fraud is my only plausible option, then it’s easier to make such a decision. This answer doesn’t seem to require many assumptions; what you see is what you get! On the other hand, the more interesting issue is if there isn’t actually an increase in fraud (or if some of the exposure isn’t due to an actual increase in fraud), then why do we see what we do see? This gets to the second answer.The <a href="https://thereformedbroker.com/2013/04/04/45216/">second</a> (and more interesting) hypothesis is that fraud exposure increases because that’s what you would expect. You would expect fraud during asset/market bubbles, thus, when the bubble pops you would expect that fraud to be exposed. Why would you expect fraud during asset bubbles? Because it’s easier to take advantage of people (defraud th

Options

em) during economic manias. That’s just the nature of the mania! People suspend disbelief and engage in all sorts of irrationality, delusions, and wishful thinking. Is it not easier to defraud someone who is acting irrationally? Once the bubble pops, people wake up to reality. They want to know what the truth is, partly because they lost their money (and want it back). None of this is to say that when the market turns downward, fraudsters will be exposed right away. How long it takes someone to get exposed could depend on the nature of the bear market. For example, the bear market of 2000–2002 was a lot longer/stretched out than the bear market of 2007–2009. The latter collapsed very fast and made most of the move in September/October of 2008. Given how fast things collapsed in 2008, this might explain why Bernie Madoff was exposed very quickly (compared to other/historical cases).¹Notes¹I’m using the term ‘fraud’ broadly. I’m aware one can make distinctions between legal fraud and non-legal fraud, for example. Part of the issue is that some cases of fraud aren’t illegal at the time they are exposed. Certainly, there are always people who try to get around the law.</article></body>

Why Fraud Is Exposed in Recessions

Why does “widespread” fraud get exposed during recessions? Before we answer that, we need to quickly be clear about what I mean. I don’t mean that some instances of fraud aren’t exposed during times of economic prosperity — obviously, that does happen. Instead, the issue is why fraud gets more exposed during times of economic peril.

Also, someone might deny that there is an increase in the exposure of fraud during recessions. I’m not going to address that here. So, yes, I am “assuming” that it is a fact (or plausible) that the exposure (of) fraud increases during economic downturns. By “assumption” I don’t mean that I blindly believe it without evidence: I mean that for the sake of space, it will not be addressed here.

I think there are simple answers to this issue of fraud. They are simple to understand, but perhaps these answers aren’t established facts. And what are some of these answers?

One hypothesis why fraud is exposed in recessions is that fraud itself actually increases during recessions. Why? Because when people get desperate, they resort to desperate measures. If fraud is my only plausible option, then it’s easier to make such a decision. This answer doesn’t seem to require many assumptions; what you see is what you get! On the other hand, the more interesting issue is if there isn’t actually an increase in fraud (or if some of the exposure isn’t due to an actual increase in fraud), then why do we see what we do see? This gets to the second answer.

The second (and more interesting) hypothesis is that fraud exposure increases because that’s what you would expect. You would expect fraud during asset/market bubbles, thus, when the bubble pops you would expect that fraud to be exposed. Why would you expect fraud during asset bubbles? Because it’s easier to take advantage of people (defraud them) during economic manias. That’s just the nature of the mania! People suspend disbelief and engage in all sorts of irrationality, delusions, and wishful thinking. Is it not easier to defraud someone who is acting irrationally? Once the bubble pops, people wake up to reality. They want to know what the truth is, partly because they lost their money (and want it back). None of this is to say that when the market turns downward, fraudsters will be exposed right away. How long it takes someone to get exposed could depend on the nature of the bear market. For example, the bear market of 2000–2002 was a lot longer/stretched out than the bear market of 2007–2009. The latter collapsed very fast and made most of the move in September/October of 2008. Given how fast things collapsed in 2008, this might explain why Bernie Madoff was exposed very quickly (compared to other/historical cases).¹

Notes

¹I’m using the term ‘fraud’ broadly. I’m aware one can make distinctions between legal fraud and non-legal fraud, for example. Part of the issue is that some cases of fraud aren’t illegal at the time they are exposed. Certainly, there are always people who try to get around the law.