The Bezzle

In his classic text on the origins of the great depression, The Great Crash, John Kenneth Galbraith came up with an ingenious concept he called 'the bezzle.' Basically, he argued that at any one point a certain number of people are filtering money out of the system through illicit means of embezzlement and fraud. In a time of easy money supply, rapid economic growth and widespread prosperity, people are much less likely to watch where every one of their pennies is going, and much more willing to lend money to people who may be less than scrupulous, meaning there's more scope for fraudulent activities. In Galbraith's terms, the size of the bezzle - the total amount of capital available to be defrauded from the system - grows. By contrast, in a time of economic contraction society seeks to account for itself, understand its finances, repay debts, and watch those pennies. The size of bezzle thus shrinks massively, and people who are busy committing frauds suddenly find themselves high and dry.

It's just a fancy way of saying that it's easier to play the system when the money's being spread around than when everybody's looking over their shoulder. But at a macroeconomic level, it's an interesting idea as it explains why you tend to get a wave of discoveries of corporate malfeasance at exactly the same time that economies start going downhill. Thus when the Great Hanshin Earthquake of 1995 knocked share prices in the already shaky Japanese market, the fallout exposed the corrupt dealings of rogue trader Nick Leeson, which subsequently brought down Barings Bank, an institution originally founded in London in 1762. Equally, the Keating Scandal so closely associated with Mr. McCain came at the end of the Reagan boom and beginning of the recession of the early 1990s. Similarly, it's not an entirely straight line, but it's hard not to associate the collapse of Enron in 2001 with the fallout from the rapidly collapsing dot-com boom.

Presumably, by drawing attention to the worst sins committed in the glory days, such efforts further undermine confidence in a particular financial system. So once the bezzle starts shrinking and dodgy dealing is exposed, a vicious circle dries up the bezzle even more.

So what fun is in store for us this time round? Presumably the scale of the crisis means that the bezzle will shrink extraordinarily rapidly, and that should mean a host of crimes are left exposed. We've already seen the uncovering of French rogue trader, Jerome Kerviel, caught in the midst of massive unscrupulous trades at Societe General, which have resulted in a loss of 4.9 billion Euros for his company - reportedly the largest single fraud in history. But reports are widespread that the FBI is investigating dozens of trading, banking and investment organizations, including Fannie Mae and Freddie Mac. Surely we must expect some more dirty secrets to be brought out of the closet as, over the next six months, banks are forced to come clean about their financial positions and admit the scale of their write-downs?

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