Lessons from the Match King

www.salon.com

Frank Partnoy is an author to take seriously. A former derivatives salesman, his 2003 book, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets, convincingly predicted how Wall Street's obsession with creating ever-more complex financial 'risk management' products would lead to disaster. Even earlier, in 2002, he testified before Congress on how a failure of regulation led to Enron's disastrously becoming a major player in the world of credit derivatives.

Back then, he was an iconoclast. Today his views are mainstream. Maybe that helps explain why in recent years he has turned his attention away from the present and back to the past. His new book, The Match King, tells the fascinating story of Ivar Kreuger, a Swedish industrialist and financial innovator dubbed by Partnoy as "The Financial Genius Behind a Century of Wall Street Scandals". Brought down by the market crash of the Great Depression, Kreuger – a friend of Greta Garbo, a counsellor to presidents and prime ministers – was an enigmatic, urbane, larger-than-life character whose story is tremendously relevant in our currently oh-so-scandalous economic era.

The Match King is a fun, thought-provoking read that might have seemed like an archaic detour if it had been published five years ago, but now should be required reading for would-be regulators.

Kreuger played fast and loose with investor money, and the collapse of his financial empire led directly to the ground-breaking securities regulations of the early 1930s, but he was not just the Bernie Madoff of the 1920s. Kreuger built companies that were real and paid sizable dividends to investors for decades. The true blame for the implosion of his businesses and the millions of dollars of losses suffered by his investors, writes Partnoy, should be shared:

"Ivar Kreuger became the face of the International Match scandal, but he should not have been the only target. Overeager investors, sloppy auditors, and pushover directors also bear much of the blame. Holders of Ivar's securities didn't demand more detailed information about his businesses. Ivar's auditors accepted his word as truth even when facts suggested otherwise. His directors did virtually nothing except cash their annual stipends.

"If these people had scrutinized Ivar's financial statements during the mid-1920s, they might have constrained the exponential growth of his capital raising. If they had simply demanded to know how Ivar could pay 25 per cent dividends while receiving 8 per cent interest on government loans, they might have generated enough skepticism to dampen the meteoric rise in the prices of his securities. But no one wanted to question Ivar on the way up, and his investors, auditors, and directors remained silent.

Not hard to see the lesson for our times there, eh? But the troubling fact is that while Kreuger got away with what would currently be considered unacceptable behaviour in part because there were ludicrously minimal transparency requirements for publicly traded companies prior to the Great Depression, the existence of the laws that came into being afterward did not save us from the remarkably similar-in-spirit abuses committed by Wall Street financiers in recent years. As we consider Wednesday's announcement of proposed new rules for derivatives regulation from the Obama administration, it's worth bearing in mind that simply having laws on the books clearly isn't enough. Investors need to be sceptical instead of greedy, reporters need to be critics and muckrakers, rather than boosters, and regulators need to be enforcers, rather than facilitators.

Because the times change, but people don't. Perhaps the strangest historical irony of the current economic downturn is how it has transformed the Great Depression from an episode of ancient history to a living, breathing morality tale of startling present-day relevance. The more we learn about the characters who engineered previous financial panics, the more we see how, in some respects, 'progress' is just an illusion. Ivar Kreuger was an awfully convincing salesman for his innovative 'convertible debenture derivatives' in the early 1920s. So, too, I'm sure, were AIG's credit default swap pushers and Citigroup's collateralised debt obligation traders. In both cases, the 'market' enabled the snake-oil sellers to get away with whatever they wanted.

And surely, right now, the next Ivar Krueger is busy being born.