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Don’t bank on it! Why we fall for financial scams. By Neil Collins

Features |

Sam Bankman-Fried

Why do we fall for get-rich-quick schemes that are too good to be true? Because we have a terrible fear of missing out, says Neil Collins

Look, I know you are far too clever to jump on every passing investment bandwagon, but you will, you know. We all do. The fear of missing out (FOMO) runs through our psyche. If only I had bought Amazon when it seemed like a daring idea and some clever people had noticed. If only I had decided that Apple shares were so cheap that I must have been missing something. So of course I was wide open to the Next Big Thing.

It’s a comfort that even the smartest make investment howlers. It is unlikely that George Shultz, Larry Ellison, Henry Kissinger or Rupert Murdoch understood the scientific theory behind Theranos, the magical blood-testing machine that turned out to be no such thing.

But the clever, rich people were in there, and each assumed that someone else had done the hard work. So they ponied up hundreds of millions of dollars to get aboard a promise of tests from a single drop of blood. Could so many clever people be wrong? Well, yes. The process didn’t work, and the company was a fraud.

It probably helped that Theranos was run by a striking and charismatic blonde called Elizabeth Holmes. Investors’ willing suspension of disbelief owed much to her charms. It also owed much to her determination to set lawyers on anyone asking awkward questions.

It took the Wall Street Journal’s Jon Carreyrou and his brilliant book, Bad Blood, to start the process that eventually sent her to prison.

This brings us to a mop-haired youngster by the unlikely name of Sam Bankman-Fried.

Photogenic in a different way from Ms Holmes, Sam looks like a lovable scamp. But, in the frenzy over bitcoin, he saw that the real money was to be made by running an exchange for crypto tokens such as bitcoin, which he called FTX. This allowed coins to be traded by the smart investors without the tedious business of converting the proceeds to dollars.

Conveniently, it stored your crypto tokens, promising to back each dollar’s worth with a real dollar deposit.

He also set up a firm called Alameda Research, which itself could trade on FTX. Like other crypto exchanges, FTX created its own digital token, and essentially allowed Alameda to borrow the dollars that FTX was holding for its clients in return for depositing its own tokens. By the time the scam was fully uncovered, it appeared that FTX had only $900 million in real assets, and a stonking $9 billion of liabilities.

This vast shortfall helped explain how FTX had managed to spray billions at adverts at the Superbowl, donations to Democrat politicians, celebrity endorsements, high living and anything that took Sam’s fancy.

Even so, the amount he and his cronies got through must be a world record, especially since he doesn’t seem to have a pot of gold stashed somewhere out of range of the US authorities. He’s just been convicted of fraud.

Then there was Bernie Madoff. He founded a fund-management business which showed consistent returns to investors. They spread the word, and the money flowed in. Investors were discouraged from cashing in with warnings that they might not be allowed to reinvest, and FOMO did its usual work.

In fact, there was no investing going on. The consistent returns were generated by Bernie pretending that he had bought a share on Monday that ended the week higher. He ran this remarkable make- believe machine for over 20 years. When he finally admitted to the fraud, the paper value of the ‘portfolios’ was $65 billion.

Collective suspension of disbelief is endemic to stock markets. The South Sea Bubble of 1720 is the classic example, and the mad dash for internet stocks at the turn of this century saw investors throwing out solid (boring) shares to get aboard. We would rather not be reminded of Baltimore Technologies, Dimension Data or Colt Communications – all three were FTSE 100 index stocks before they disappeared as fast as they had arrived.

You have probably heard of Arm Holdings, Britain’s leading chipmaker, whose owners were desperate for a stock-market listing. Despite the entreaties of Rishi Sunak, the vendors went to New York. By restricting the number of shares being sold, the owners managed to pitch the offer at $51 a share, valuing Arm at $52 billion. Whether it was the $82m in fees paid to the 28 banks supporting the offer or just plain old FOMO, the price jumped on day one and then fell over – down to $48 last week.

A current example of credulous investors is Hipgnosis, set up to exploit the gold in them thar old pop songs. As any oldie could tell you, these songs never die, and they definitely do Not Fade Away. The composers are selling the rights, some for hundreds of millions of dollars, and the likes of Hipgnosis are buying them.

It looks as though it will end in tears because, in truth, it is almost impossible to find a formula to value them.

But it’s a fashionable new asset class – and wouldn’t you like to have a few, perhaps to add to those disastrous non- fungible tokens you bought last year.

Neil Collins was City Editor of the Daily Telegraph

This story was from December 2023 issue. Subscribe Now