Bank fraud- RP style

I am following closely developments regarding the Legacy Group and the financial fraud that they supposedly committed. While the Legacy case has numerous similarities to the Madoff (pronounced as Made off) Scheme in the US, there are striking differences.

The fraud basically begins with the promise of huge returns for deposits and investments. Both Legacy and Madoff ask their clients to trust them with their money, explain somehow that they are good financial investors and they can produce substantial returns.

In the case of the Legacy Group, they provided "double your money in 5 year scheme with free insurance." An interest rate of about 20% per year.This a substantial return given the microscopic 0.8% interest rate on regular ATM savings accounts (less 20% withholding tax). The amount of return should really be a cause of concern for potential depositors and investors. Government concessionaires of public utilities such as water, electricity and toll ways are only allowed a net return of around 8%.

The only other investment I know that produces 20% return are the 5-6 schemes of loan sharks (locally known as Bumbay). And people know that the loans made by loan sharks are very risky: no collateral, no credit investigations done, no receipts.

In the case of Bernie Madoff, he did not really promise huge returns but showed consistent annual returns of around 10%. Which is a substantial amount given the relatively low level of interest rates in the mid-2000s, at around 4% to 5%. 

How were they able to produce huge returns? Through a ponzi or pyramid scheme! Returns on the investment of person 1 are paid by the investment of person 2 and 3. Returns on the investment of person 2 are paid with money from persons 4 and 5, and so on and so forth.

With huge returns, existing investors encourage their friends, relatives and office mates to invest also. As the number of new investors increase, the amount the perpetrator can stash away increases. It also benefits that fraud master if existing investors re-invest their money.The pyramid's base continue to grow until there are no more new investors or new money to invest. And then, the pyramid collapses.

In the case of Albania (a small country in Europe), the collapse of a nationwide Ponzi scheme led to the collapse of the financial system and the government. Riots ensued with more than 2,000 people killed. Similar riots led to several deaths due to the collapse of ponzi schemes in Latin American countries.

In the case of Legacy and Maddoff, the government halted their operations before the pyramid collapsed. Some people who were able to pull-out their money early enough actually made profit. Now, here are the differences. In the case of Madoff, people invested their money. As an investment, they knew that they can either gain or lose money. Because Madoff committed fraud, they can get some of their money once Madoff's assets are liquidated. Fraud was committed against the investors. Given the opportunity, these investors (which included charitable institutions and schools) would probably lynch Madoff to death.

In the case of the Legacy Group, they took in the money as deposits, not investments. As deposit, it is protected by the Philippine Deposit Insurance Corp. (PDIC). They made sure that the huge bulk of the deposits were under PhP250,000, the maximum insurance payment the PDIC can provide. Hence, in case the Legacy banks collapse, it is actually the PDIC (and the government) which loses money (and some people that deposited more than 250,000). Fraud was committed against the government. Some depositors were actually mad at the government for taking away their "high return-investments." 

Perpetrators of ponzi schemes are intelligent people, to bad that they use their talents for fraud. Behind the Legacy Group is Celso Angeles, Jr., a graduate of Ateneo and AIM, the premier business schools in the Philippines. He worked in the US for almost 10 years where he probably mastered his craft. Bernie Madoff, on the other hand, was a former chairman of NASDAQ, one of US major stock exchanges. Both men probably used their excellent pedigrees to gain trust from potential investors.

Anyway, the Legacy Group's attempt was not the first time that the government was duped using the banking system. Once upon a time, there was a businessman who owned a small bank and a rapidly growing real estate company. To be able to sell houses in his subdivisions built on the hillsides of Rizal, he provided housing loans through his bank. In effect, he transferred money from depositors to his real estate company using his bank.

Eventually, home buyers were not able to pay their loans and the bank went bankrupt, but the business did not mourn. He already earned a lot from it. Most of the depositors were compensated by the PDIC. No cases were filed, no investigations were done. He is now a successful politician and will probably run in 2010.

That is bank fraud- RP Style.