Booms, Bubbles, And Cons: What Sam Bankman-Fried And Bernie Madoff Have In Common

Originally published at Forbes.com

It’s easy to describe the FTX crisis as “unprecedented.” After all, concepts like blockchain or cryptocurrency haven’t been around for decades, let alone centuries.

But it is anything but unprecedented. I have followed the crypto space closely in recent years and, while it is a unique segment of the overall market, it is not immune to the lessons of history.

As the pressure began to mount on FTX founder and CEO Sam Bankman-Fried, my wife happened to express interest in watching the four-part Netflix docudrama on Bernie Madoff’s infamous Ponzi scheme. (I assured her that I already understood the Madoff scandal, but I was wrong). Naturally, Madoff: The Monster of Wall Street got me thinking about Bankman-Fried and FTX—the similarities, differences, and warning signs for the future.

What they ultimately have in common is the very human ignorance—either willful or not—of the past’s insistence on being prologue. I spent more than four decades running institutions that either lent or invested money, and the scariest words I’d ever hear from young enthusiasts were “this time, it will be different.”

What history actually shows us is that “this time, it will probably be similar or the same as last time.” More often than not, there is historical precedent for current events—booms and busts, bubbles and bursts, and cons and crimes a la Madoff.

Think dot.com valuations of 30x revenue in the early 2000s or the inevitability of Chinese stocks or real estate investment trusts as “forever growth” machines. These are all real investments that got caught up in what former Federal Reserve Board Chairman Alan Greenspan called “irrational exuberance.” Time after time, too much money rushes in to catch the next “sure thing,” but the bust always comes when the market reverts to its long-term role as a valuation machine. Booms gain some momentum and credibility through the fact that, in the short term, the market becomes only a “weighing machine” of the proportion of buyers to sellers. But the scale balances out in the end.

Bubbles and bursts

Irrational exuberance is most dangerous when it is linked to an investment that is more fantasy than fact. Such investments thrive on the fear of missing out or the promise of a free lunch—“the big score.” The mortgage-backed security’s rising popularity leading up to the 2008 financial meltdown is one example.

Madoff’s self-proclaimed ability to “never lose money” is another. Like Ponzi schemes, bubbles work for a while. The proprietors of the scheme argue (and probably believe) that a bubble can go on indefinitely. But, when the bubble does burst, those proprietors try to distract from or delay the inevitable, perhaps even placing high-risk outside bets to revive the game and save face.

Cons and crimes

Like a bubble, a “con” is something that purports to be an investment, but wouldn’t survive any real examination of the scam. It is usually pitched as scarce or exclusive—think Madoff’s reputation at Palm Beach golf clubs.

Members of this unsavory group were often crimes from the outset, enriching the sponsors who obscured the actual location of the money involved. Madoff is clearly the leader in the clubhouse, but hundreds of small-scale cons take place every year that are crimes from the get-go. Many more are bubbles: When the expected payoff doesn’t work, the proprietor turns to scams and crimes to avoid facing the music. Both bubble and con operators live and die by the cash flow sword of Damocles, hoping for a miracle that tends to never come.

What booms, bubbles, and cons have in common is that true business leaders must avoid all of them. It is a leader’s job to recognize that they are all products of the same inherent human trait craving the “quick fix”—the easy solution. The illusion continues to work since the promised solution is so attractive.

Look no further than commercials. People are constantly sold that we can lose weight without exercising or changing what we eat. Weight-loss “gurus” like serial scammer Kevin Trudeau sell the solution that doesn’t exist.

What about the makeups, lotions, and potions that will suddenly make you “young and desirable”? Or the cars and clothes that make you “irresistible” to the opposite sex?

Trudeau-esque scamming has gone on for as long as there have been markets of any kind and the discretionary investment income that could be presented with choices. My favorite book on the subject is Charles MacKay’s 1841 Extraordinary Popular Delusions and the Madness of Crowds, in which he identified dozens of “manias.”

In light of Madoff and FTX, one that stands out is the South Sea Bubble from the early 1700s. The South Sea Company’s one-sentence prospectus read: “Shares in a venture of great advantage, but nobody to know what it is.” In this case, the proprietor claimed that, when all 5,000 shares were subscribed and delivered the 20 percent deposit, the details would be revealed but only to a lucky investor group. He then proceeded to vanish and was never found again, making the line “nobody to know what it is” all the more brutally honest.

For leaders, investors, and all of us, the lessons of history need to be learned. We can’t eliminate the inherent human trait that longs for the quick fix. Nor will the promoters of booms, bubbles, and cons downplay it. But we can identify that trait and try our best to avoid it.

Remember: If something seems too good to be true, it is absolutely false.