The latest example of the price paid by whole nations due to failed pyramid schemes is, of course, Albania 1997. One third of the population was heavily involved in a series of heavily leveraged investment plans, which collapsed almost simultaneously. Inept political and financial crisis management led Albania to the verge of disintegration into civil war.
But why must pyramid schemes fail? Why can't they continue forever, riding on the back of new money and keeping every investor happy, new and old?
The reason is that the number of new investors – and, therefore, the amount of new money available to the pyramid's organizers – is limited. There are just so many risk takers. The day of judgement is heralded by an ominous mismatch between overblown obligations and the trickling down of new money. When there is no more money available to pay off the old investors, panic ensues. Everyone wants to draw money at the same time. This, evidently, is never possible – some of the money is usually invested in real estate or was provided as a loan. Even the most stable and healthiest financial institutions never put aside more than 10% of the money deposited with them.
Thus, pyramids are doomed to collapse.
But, then, most of the investors in pyramids know that pyramids are scams, not schemes. They stand warned by the collapse of other pyramid schemes, sometimes in the same place and at the same time. Still, they are attracted again and again as butterflies are to the fire and with the same results.
The reason is as old as human psychology: greed, avarice. The organizers promise the investors two things: (1) that they could draw their money anytime that they want to and (2) that in the meantime, they will be able to continue to receive high returns on their money.
People know that this is highly improbable and that the likelihood that they will lose all or part of their money grows with time. But they convince themselves that the high profits or interest payments that they will be able to collect before the pyramid collapses – will more than amply compensate them for the loss of their money. Some of them hope to succeed in drawing the money before the imminent collapse, based on "warning signs". In other words, the investors believe that they can outwit the organizers of the pyramid. The investors collaborate with the organizers on the psychological level: cheated and deceiver engage in a delicate ballet leading to their mutual downfall.
This is undeniably the most dangerous of all types of financial scandals. It insidiously pervades the very fabric of human interactions. It distorts economic decisions and it ends in misery on a national scale. It is the scourge of societies in transition.
The second type of financial scandals is normally connected to the laundering of capital generated in the "black economy", namely: the income not reported to the tax authorities. Such money passes through banking channels, changes ownership a few times, so that its track is covered and the identities of the owners of the money are concealed. Money generated by drug dealings, illicit arm trade and the less exotic form of tax evasion is thus "laundered".
The financial institutions, which participate in laundering operations, maintain double accounting books. One book is for the purposes of the official authorities. Those agencies and authorities that deal with taxation, bank supervision, deposit insurance and financial liquidity are given access to this set of "engineered" books. The true record is kept hidden in another set of books. These accounts reflect the real situation of the financial institution: who deposited how much, when and under which conditions – and who borrowed what, when and under which conditions.