‘Billion Dollar Whale’ by WSJ journalists Tom Wright and Bradley Hope tells in colorful details the 1 Malaysian Development Berhad or 1MDB story: a $5 billion fraud dubbed the ‘heist of the century’, uncovered in 2016 and perpetrated by a certain Joh Low who, rather surreally, remains at large. Its cast: eminent members of the government of Malaysia, sovereign funds managers in the Middle East, top celebrities, accountants and many private and investment bankers. The book gives a new dimension to the world of fraud and money laundering – essential reading for anyone working in the financial sector and arguably beyond. Human beings can be easily deceived, especially when they are set to gain from their own naivety. But when does it become gross negligence?
One particular aspect of the story, as in many frauds, relates to a phenomenon called ‘escalation of commitment’ following which individuals are said to be locked in a costly course of action and thus prone to doubling down, often against the odds. According to subject matter experts, this behavior pattern is driven by the social value typically ascribed to perseverance, the difficulty of ‘booking a loss’, or efforts to rationalize a past mistake. In the case of 1MDB, the fraudsters raised increasingly large amounts of money through bonds to fill growing financial gaps and fund their next spending spree.
The escalation of commitment phenomenon can extend to entire organizations, leading to resources misallocation on a grand scale. Ask the IMF about Argentina. Nations themselves can be subject to it. As reported in the drama TV series ‘Chernobyl’, escalation of commitment led to a catastrophe as the USSR invested its scarce resources in nuclear power generation, unconditionally committing itself to unsafe plants, with no alternative to domestic power generation. The words attributed to Valery Legasov, the scientist who sought to expose the engineering flaws of the Russian plant design, summarize these dynamics: ‘[Our secrets and our lies] are practically what defines us. When the truth offends we lie and lie until we can no longer remember it is even there, but it is still there. Every lie we tell incurs a debt to the truth. Sooner or later that debt is paid.’
Governments and their central banks seem to be currently subject to the same malady. The notion of a recession, however mild, associated with a stock market correction has become unbearable to leaders. The risk is admittedly real: The global economy has been slowing down alongside a trend which has been both accelerated and accentuated by the US-China trade war initiated a year ago. History clearly suggests that an ISM New Order Index below 50 typically precedes earnings decline and, with it, a bear stock market. With a latest read at 47.2 for August, it has become fashionable to warn that ‘winter is coming’ as per the chilling GoT premonition.
An economic slowdown into the early part of 2020 (now a base case) and a resetting of the stock market fundamentals globally may be natural, if not welcomed since it could set the stage for a new, healthy growth leg. But global leaders want none of it. Governments of all political parties stand ready to invoke Modern Monetary Theory (see ‘The MMT Detonator’) to launch expansive fiscal policies with a clean conscience whilst central bankers repeatedly state their firm commitment to support the economy, whatever it takes. Some even argue that fiscal and monetary policies should be fused, an approach promoted by Blackrock in a paper last month and coming pretty close to ‘helicopter money’.
Softening a down cycle through macro- and microeconomic policies is a valid objective. Everything suggests, however, that arguments will be found to pump up the stock market beyond what would be considered prudent from a financial stability perspective, as long as possible. Now, the monetary and fiscal policy initiatives implemented on the back of the Great Financial Crisis have created more wealth for the Establishment than for anybody else, deepening inequality within many countries. Why not do it again and in a bigger way?
It would not be surprising if historians someday see the aggressive pursuit of these expansionary policies not only as a tragic expression of the escalation of commitment syndrome, but also as the biggest organized heist in modern times.