Is it possible that scandal is somehow an essential ingredient in capitalism? That a healthy free-market economy must tempt a certain number of people to behave corruptly, and that a certain number of these will do so? That the crooks are not a sign that something is rotten but that something is working more or less as it was meant to work?
—Michael Lewis
Corruption is dishonest behavior in search of wealth or power and found in virtually all places and time periods since the start of civilization. Corrupt acts are unethical and improper, but not necessarily illegal. Scandals are well-known incidents that involve some combination of moral outrage, wrongdoing, and disgrace. From the beginning bribery and smuggling have led the corruption list, but the list of illicit behaviors keeps growing as the economy and culture get more complex. Certain periods in American history were known as particularly corrupt, with the post-Civil War Gilded Age a standout.
Classical economists at least since Adam Smith have emphasized laissez faire, free markets, property rights, and limited government. This allows business people the freedom to invest, innovate, and make buckets of money. Freedom also allows people to lie, cheat, steal, and manipulate in the name of money making. This section follows the liars and cheaters as well as the incentives to swindle and manipulate. Of course, the system is survival of the fittest (and economist Joseph Schumpeter described creative destruction as a major economic force), meaning ruthless behavior fits a winning strategy.
Of course, many villains were just plain crooks: Charles Ponzi of Ponzi scheme fame, William (“Boss”) Tweed of New York’s Tammany Hall, or Philip Musica of McKesson and Robbins. On the other hand, Enron’s Ken Lay or Jeff Skilling did not consider themselves crooks; nor did John D. Rockefeller or Sam Insull. This latter category is of most interest, particularly the gray areas of possible illicit behavior that may be justifiable or illegal.
Consider the two basic and long-term categories, smuggling and bribery. Smuggling has been around from the time when specific trade items were banned.1 Smuggling was fundamental to the development of American colonial economies almost from the beginning. Under Britain’s mercantile rule, shipping was dominated by British merchants and enforced by the royal navy. American merchant success often meant smuggling or bankruptcy. Some of the most successful Americans were the most accomplished smugglers (called “free traders” in the colonies), including John Hancock and John Jacob Astor.2 Bribery could be considered a “gift,” “consulting fee,” or a “contribution.” The key point is bribes are manipulative. They often become standard practice; true for various political machines such as Tammany Hall in New York City or any number of countries today.3
There is no lack of candidates for the biggest scandals ever. Table S-B.1 presents a list of some of the most infamous. Enron may be perceived as the biggest ever, both in terms of size (billions of dollars), duration (with increasing manipulation and outright fraud over more than two decades), number of executives convicted and sent to jail (a couple of dozen), and impact on need for regulation (resulting in the Sarbanes-Oxley Act). Others close to the top were Credit Mobilier (because of its sheer size and corruption by Washington politicians) and Teapot Dome (amazing arrogance and greed, plus the only scandal resulting in the conviction of a sitting federal secretary, Albert Fall).
Table S-B.1 Major business (and government) scandals4
Scandal |
Time period |
Description |
South Sea Bubble |
1711–21 |
The South Sea Company was a British joint stock company given monopoly rights to trade with South American colonies in exchange for acquiring the national debt of Great Britain (in an exchange for stock—that is, bond holders received South Sea stock for their bonds, the company a government annual annuity of £600,000). Investors assumed massive income (and dividends) from the colonial trade which did not happen, but a stock price bubble was created. It was discovered that massive bribes were paid to establish the company; the stock crashed and perpetrators prosecuted. |
Mississippi Bubble |
1717–20 |
French finance scheme created by Scots financier John Law (who reformed much of France’s finances) to colonize and exploit the Mississippi River Basin (which merged with the Banque Royal and assumed French national debt). Another speculative bubble was created. The scheme was not successful and the company failed, taking down the French economy with it. Law fled to Italy. |
Credit Mobilier |
1865–72 |
The trans-Pacific railroad was a Civil War political decision, with speculators taking advantage; Credit Mobilier was the construction company of the Union Pacific (UP), owned by UP speculators and charging outrageous rates. It’s a major scandal because they bribed legislators and other Washington insiders and got caught by the press (with later Congressional investigations and indictments). |
Raid on the Erie |
1868 |
The Erie Railroad (called the “Scarlett Woman” of Wall Street) was used as a manipulation devise by speculators Daniel Drew, Jay Gould, and others thanks to convertible bonds. Commodore Vanderbilt went after the Erie to complete his railroad domination of New York and beyond. Both groups used legislature and judicial bribes and other tricks to get or maintain control. Drew and gang used convertible bonds to create more stock and beat Vanderbilt. |
William (“Boss”) Tweed |
1863–71 |
Tammany Hall was the political machine of the Democratic party in New York City. Tweed was the most corrupt Tammany leader (perhaps the most corrupt politician in American history). Corruption started with voter fraud, rebates from contractors, missing cash from borrowing, “gifts” of stock and cash and other forms of extortion from companies doing business in the city (including the Brooklyn Bridge), owning New York Printing and charging exorbitant prices to the city and businesses. He (and his “gang”) was prosecuted by future governor Samuel Tilden and died in jail. |
Teapot Dome |
1920–27 |
Oil interests beginning with Jake Hamon “bought” the presidency for Warren G. Harding. New Interior Secretary (former Senator) Albert Fall leased Teapot Dome and other oil reserves to oil companies for substantial bribes. Harding’s political boss Harry Daugherty as the new Attorney General ran the Justice Department as his own political gestapo for personal gain. The corruption was discovered in Congressional hearings and indictments followed. Only Fall went to jail for criminal acts (although oilman Harry Sinclair spent time in jail for lying to Congress and jury tampering). |
Ivar Kreuger |
1923–32 |
Kreuger’s Swedish Match became the largest match manufacturing company in the world, much of which was based on bribery and fraud. New stock and bond issues (much of it from American investors) kept cash coming in to pay operations and dividends (despite a failing organization) using made up financial statements. Kreuger killed himself when the company collapsed. |
McKesson and Robbins |
1927–37 |
McKesson, a large pharmaceutical, was run by ex-bootlegger Philip Musica, who set up a dummy Canadian subsidiary to create fraudulent profits of $20 million (over 20 percent of total assets) funneled to himself and confederates. He was caught by a whistleblower. Musica could get away with the con for years in part because of poor audit practices of Price Waterhouse. Audit standards were started soon after. |
Lincoln Savings |
1984–89 |
After the savings and loan industry was deregulated in 1980, the crooks moved in. The worst was Lincoln Savings, an Arizona S&L acquired by Charles Keating. Manipulative accounting hid losses from high-risk and fraudulent lending and other practices and ultimately led to failure in 1989. Keating served almost 5 years in jail. The bailout of the S&L industry cost taxpayers billions—and should have been a warning about the perils of financial deregulation. |
BCCI |
1980–94 |
The Bank of Credit and Commerce International (BCCI) was an Abu Dhabi rogue bank acquiring American banks and “buying” distinguished lobbyists. Criminal activities included bribery, arms trafficking, money laundering, and tax evasion. Investigators first discovered money laundering and audits discovered unexplained loan losses of hundreds of millions, possibly the largest bank fraud ever. |
Michael Milken |
1970s–88 |
“The junk bond king” created a market for bond trading group at Drexel Burnham, with savings and loans and insurance companies major buyers of junk (below investment grade) bonds. His empire depended on leveraged buyouts, insider trading, illicit private partnerships (including Ivan Boesky), and other illegal acts. Milken and Drexel were charged with racketeering; Drexel went bankrupt and Milken was sentenced to 10 years in jail. |
Enron |
1985–2001 |
Perhaps the most infamous business scandal, Enron started as a gas pipeline company under CEO Kenneth Lay. Deregulation led to gas trading and the start of multiple deceptive acts involving trading fraud, derivatives, special purpose entities manipulation, and a strategy to beat quarterly earnings expectations with increasingly illegal acts. Discovery came with bankruptcy in 2001, followed by Congressional investigations, indictments and convictions of top executives and many others. Increased regulation followed with Sarbanes-Oxley Act, additional SEC and FASB pronouncements, and a new audit regulator, the PCAOB. |
WorldCom |
1980s to 2002 |
WorldCom followed Enron into bankruptcy in 2002, followed by the passage of Sarbanes-Oxley within a few days. This telecom giant survived the tech crash of 2000 only after capitalizing some $11 billion in operating expenses (unlike Enron, a very simple fraud). Discovered by internal auditors, CEO Bernard Ebbers was indicted and convicted of securities fraud and conspiracy and sentenced to 25 years in prison. |
Health South |
1984–2002 |
America’s largest provider of inpatient rehab centers, HealthSouth used revenue fraud (overcharging Medicare and other insurers, adding nonexistent costs to billings) and multiple forms of accounting fraud to manipulate earnings. CEO Richard Scrushy and other executives were charged with fraud and most convicted and sent to jail (Scrushy got off by claiming the bad accountants did it). This was the first accounting fraud case after Sarbanes-Oxley which required to CEO to pledge the accuracy of the financial statements (which proved ineffective). |
Subprime Mortgages |
2006–08 |
The Great Recession of 2007 to 2009 was largely caused by predatory mortgages and their repackaging into structured finance instruments (mortgaged-backed securities, collateralized debt obligations, etc.). When housing prices collapsed, so did the mortgage bubble. Major banks were largely responsible for these instruments which soon nosedived in value, leaving overleveraged banks insolvent. It took billion-dollar bailouts and trillions of dollars of guarantees, stock and bond purchases, arranged acquisitions and takeovers to avoid a depression. Reform legislation (particularly the Dodd-Frank Act) was passed, but many experts believe another financial collapse is likely. |
Bernie Madoff |
1960–2009 |
Madoff was a New York broker and former chairman of NASDAQ, who created an investment business that was a giant Ponzi scheme. He took in billions of dollars of client money, claimed to invest it and returned a substantial dividend. With the Great Recession, he ran out of cash when investors attempted to cash out and confessed to the SEC and FBI. He was convicted of securities fraud, wire fraud, mail fraud, and money laundering. He is serving a 150-year sentence. |