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The Match King (Interview with Prof. Frank Partnoy)

by Michael W. Stocker
Eyes On Wall Street |

Eyes welcomes Professor Frank Partnoy of the University of California San Diego, author of The Match King (PublicAffairs April 2009). The Match King is a tautly paced and erudite account of the life and times of Ivar Kreuger, one of the twentieth century's greatest financial innovators-and one of its most notorious scam artists. Partnoy talks to Eyes about lessons investors could learn from Kreuger, and the similarities and profound differences between Kreuger and Bernie Madoff.

Eyes: Why do investors need to know about Kreuger, a man who died nearly eighty years ago?

Partnoy: One of the lessons all of us take away from this financial crisis is that we need to remember history. So many of the financial innovations that recently brought down the banks and AIG are echoed in Kreuger's story. He was a creator of complex off-balance sheet transactions, he used special purpose entities, he incorporated subsidiaries in regulatory havens. And he manipulated financial statements so that investors wouldn't understand the truth about what was happening in the bowels of his companies. I think the tragedy is that we should have known about and understood Ivar Kreuger's story several years ago.

Eyes: In your book you give an account of Kreuger's key role as an innovator of financial products, and you have a great quote from Keynes, who called Kreuger "the greatest constructive business intelligence" of his age. With that in mind, is it fair to compare Kreuger to Bernie Madoff?

Partnoy: In many ways I think it's unfair to Kreuger. He, for much longer than Madoff, sustained legitimate businesses. The core of his operations was a compelling idea - the lending of money raised in America to struggling post-World War I European governments in exchange for a match monopoly. He put together these three actors - American investors, European governments, and match producers - in a way that generated gains for all three groups. And he sustained those businesses for many, many years.

Eyes: Despite their reputations as criminal geniuses, one of the things that is striking about both Kreuger and Madoff is that the frauds they perpetrated were in some ways very crude. How did they go undetected for so long?

Partnoy: One of the most perplexing aspects of confidence games is that it's so hard for the people involved in them to see what is happening. Both schemes basically involved paying out very steady, low double-digit payments to people over time, even when markets were volatile. And once people know that there's a track record of steady, 10 percent payments, they run screaming to get in. One of the lessons of Ivar Kreuger and of Bernie Madoff is that investors should run when they see steady reported returns from a fund. That's a sign not of a well-run business but of danger lurking in the shadows.

Eyes: Looking back both at the 1920s and at the decade preceding our current crisis, how large a role do you think market booms played in the success of Kreuger and Madoff's schemes?

Partnoy: The booms are important because they run parallel with investor psychology. As stocks rise, as companies develop new business models, as financial innovations spread, markets become ripe for financial fraud. Years of stock gains are like the fertilizer that enables fraudulent schemes to flourish and grow. Such gains prime the pump for fraud because they make it easier for companies to come along and tell a believable story about how they can deliver outsized returns.

Eyes: If there's one silver lining to be found when massive frauds are finally exposed, it's that briefly there is an appetite for reform. And one of the interesting points that you make in your book is that the Securities Act of 1933 and the Securities Exchange Act of 1934 were directly inspired by Kreuger's fraud. How likely is it, do you think, that Bernie Madoff will inspire similar kinds of reform?

Partnoy: I'm not especially optimistic. We didn't get reform immediately after the 1929 crash. We only got reform after the public became very upset about the frauds of Ivar Kreuger and Samuel Insull, and after the federal investigative commission under Ferdinand Pecora started to publicly flog bankers and bring them to their knees. Whether or not we ultimately get reform will turn on whether we experience more scandal and on whether there is someone like Pecora who can galvanize public opinion. It might be the case that Thomas Greene is able to do that with the current version of the financial crisis inquiry commission, but we'll have to wait and see.