Is Cambist illegal or lying, and how does it make money?

When one is watching rugby in a pub, with a frothy Amstel, while awaiting a wood-fired pizza, you occasionally see adverts spin across the Supersport screen for Cambist. Cambist offers you a 19.5% return on your money, and is generally responsible for this type of obscenity:

Screen Shot 2014-07-30 at 7.25.13 AM

So what is Cambist?

Cambist is an online platform, that allows you to buy someone else’s debt contract.

To explain that, let’s step back a moment and start this story at the very beginning.

The World Of Micro-Credit

Meet Xolani, a hypothetical platinum miner and a hypothetical member of AMCU. Freshly excited by the end of the strike, and the new rise in his salary, he decides that the time is right to go and purchase a new flat screen TV. So he approaches Makro for financing, only to discover that Makro does not offer financing to platinum miners without a lot of contracts and proofs and collaterals.

Undeterred, he approaches a micro-lending institution (let’s call it “Bridge Loans”), and asks for a R4,000 loan to buy a flatscreen TV. They happily grant his request after getting some particulars about his employer, charge him a fat loan origination fee, and Xolani walks away with R4,000 and a three month R4,500* loan commitment at 5% per month.
*including the loan origination fee.

As it turns out, Xolani failed to realise that he would only be taking home R10,500 per month in three years’ time. So when he got his first paycheck after his return to work, and saw that the amount was lower than expected, he tried to forget that he had ever made that foolish decision to buy that flatscreen.

Bridge Loans duly noted that Xolani had not paid his first instalment. And after allowing the debts to accrue and the interest to compound for some months, they handed his debt contract over to a debt collector (let’s call them OneLaw).

OneLaw spent some time trying to call Xolani in order to discuss a repayment plan. Xolani, however, was still trying to forget about his flatscreen – and took it upon himself to ignore any and all calls that might remind him of it. Meanwhile, the debts and the interest continued to wrack up, subject to those limits in the National Credit Act (limits of ±60% interest per year, I might add).

Exasperated, OneLaw eventually handed the debt over to a law firm (let’s call them “Flemix and Associates”), and asked them to initiate legal proceedings against Xolani. An industrious attorney at Flemix quickly obtained an Emolument Attachment Order (affectionately known as a “garnishee order”) from a local magistrate, and sent it to Xolani’s employer. The garnishee order imposed a repayment plan on Xolani, and instructed the employer to deduct it from his paycheck directly.

Xolani’s employer is now sending Flemix and Associates a stream of income out of Xolani’s paycheck. That income then gets paid back to OneLaw (less a commission), who then on-pay it to Bridge (less a further commission).

The trouble is – now that R4,500 loan has grown into a R18,000 loan (and upwards, what with all the compounding and penalties), it’s going to take an awfully long while for everything to get repaid. Even if that process if fairly safe now that it’s an employer-deduction from the payroll – that doesn’t help the timing.

In the meanwhile, Flemix, OneLaw and Bridge are all big receivables and no cash.

Enter: Cambist

So the various people at Flemix, OneLaw and Bridge put their heads together and ask themselves: “How do we make this less of a cash-flow crisis?”

#IDEA

“Let’s securitise the debt! Or, rather, let’s see if we can sell this debt to someone in such a way that we don’t have to register as a Financial Services Provider or as a Credit Provider or any such regulatory onerousness. But think of all the free cash that’s sitting with the general public and, in particular, retirees who are looking for a fairly safe investment? We want the money – they want somewhere to put the money for a time. Let’s sell it!”

And, well, that’s where the online platform came from. You can go onto Cambist, and purchase a debt contract that’s secured by:

  1. A garnishee order; and
  2. Some kind of trust arrangement* (?)
    *Seems like there is a trust that holds these debt contracts in reserve, and if for some reason your particular debt contract stops performing (ie. your Xolani stops paying because he got fired), then you can return it to the trust and exchange it for a performing one.

And to be honest, on the face of it, it sounds like a properly sensible business idea.

Sure – it’s a little scummy with the 60% interest rate being charged to the low-income workers, and the obnoxious size of the loans now that they’ve compounded – but that’s an ethical issue, not a financial one.

That said – I am particularly suspicious of a trust arrangement that basically guarantees the debt.

Because why?

So I gave it more thought, and did more research, and of course there is some Cambist scandal.

What is all the scandal around Cambist?

Moneyweb has a few articles laden with rhetoric on this particular issue. Their main gripe: Bridge, OneLaw, Flemix and Cambist are all basically the same person.

An excellent infographic:

And almost all the Moneyweb articles (here and here) make some kind of complaint along these lines:

  • “this is so unethical”
  • “the abuse is widespread”
  • “oh the abuse”
  • “look at these interest rates”
  • “oh the abuse”
  • <insert heavy insinuations of wrongdoing here>

To which Mr Aldum gave a fairly stinging response (see here), which consisted mostly of:

  • this is all very defamatory
  • there is no “very cruel circle of lending and collections” – this was actually just a natural progression of business. You see, we started doing some micro-lending; this grew into Bridge; then we realised that we needed debt-collectors, so we formed a separate debt collection agency (OneLaw); then we wanted lawyers, so we found some (Flemix); then we needed to free up some cash flow, so we started Cambist. Initially, there was a strong connection – there is still a connection today, just less of one. We’re honest businessmen serving a need.
  • We really don’t do that many garnishee orders.
  • In fact, in the national statistics, the number of garnishee orders have actually come down over time.
  • If you think we’re abusing the system, show us proof. Just give us the case numbers of 100 examples. We challenge you, you Moneyweb charlatans.

Some Thoughts

I think that Moneyweb and the various Cambist critics have entirely missed something here. They are harping on about the abuse of garnishee orders and the terrible awful hideous high interest rates.

And even if it is a bit gross – the business practice is legitimate and that’s all fine. But the real problem in my mind, and allow me to emphasize this:

MICROLENDERS MAKE MORE MONEY ON LOAN ORIGINATION FEES THAN THEY DO ON INTEREST.

If you go back to the post I wrote on payday loans some time back (Willy Wonga.com’s Choke-a-Lot Factory), you’ll notice that 72% of the total interest+fees came from the loan origination fee. And that’s because even high interest rates on low value loans don’t amount to that much actual cash – the real return in the business of microlending is the upfront origination fee that gets earned as Xolani (or whoever) signs his name on the line.

Which means that microlenders would like to give out as many loans as possible (not for the interest – but for the origination fees). They are only limited by the amount of cash-on-hand as to how much they can lend.

But Cambist – Cambist allows Bridge to monetise their outstandings (with your money). They can then take that money and make more loans, earning more origination fees (and, hey, also more interest!).

Let’s go back to my story

In fact, they could even go back to someone like Xolani, just before he gets handed over to OneLaw, and say to him:

“You know what, bud? This debt is out of control. Tell you what – let’s consolidate your debts into one big debt, at a lower rate of interest. Say, well, 50% instead of 60%. How’s that for reasonable? We’ll take an origination fee, obvs. But here is some money that we obtained from a nice girl called Nanette, a business developer in Pretoria that’s in the business of financial freedom, etc. We’re only paying her 19.5% for this money. Deal?”

Is this part of the plan?

I have no idea.

But I’m just observing that there is no need for Bridge/Cambist/OneLaw/whoever to break any laws here. They could make more than enough money simply by taking your money and turning it into more loans. And, like, they have a captured lending base with which to do it. Sure – it has the potential to create a giant unsecured lending bubble. But whatevs, right?

Again – I am just posing the hypothetical. And noting that the whole debt consolidation process does sound a lot like a Ponzi scheme (because if we’re talking financial schemes, why not include a Ponzi scheme, amirite?).

But ethical concerns aside, wouldn’t you at least consider doing it?

*sits back*

*waits for criticism*

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

More on Immigration

Immigration-Reality

So I got lost this morning doing some research on Cambist (an online platform that my friend Tim told me to look at), and then I realised that it was going to be a much bigger post than I had time for.

In the interim, here is a new video clip that I watched recently on the economic impact of immigrants*.
*email subscribers will need to click through to the link to watch it.

I don’t really believe that things are half as rosy as they’re being painted – but I do think that immigrants are unusually entrepreneurial. I originally gave a list of reasons in this post (“The Cost of Anti-Immigration”), but I’d like to add this argument as well:

  1. According to this article, over two fifths of people find their jobs through networking.
  2. For new immigrants that don’t really have established networks, that means the job search is that much more difficult.
  3. So one of their best options will be to start something themselves.

It just makes sense that immigrants would have start a disproportionate number of new businesses.

It’s just a thought.

Herbalife, Death Blows, and Ponzi Schemes

Cast your minds back to this magnificent moment on CNBC, when billionaires Carl Icahn and Bill Ackman had a live bitching spat for almost 30 minutes.

Well, that was meant to reach a climax this week, when Bill Ackman declared that he would be delivering a “death blow” to Herbalife in a three hour webcast. But more on that in a moment. First:

The Background

  1. Bill Ackman is a famous short-seller.
  2. He borrows shares from people, sells them, and then tries to persuade everyone that the shares are worth nothing.
  3. When (or “if”) the share price crashes, he can then buy the shares back at the lower price, return them to the lender, and pocket the difference.
  4. If the share price doesn’t close lower, then he makes a loss.
  5. I drew a picture of how Bill Ackman operates:

20140728-074351.jpg

Some people might think that’s a bit rude.

But that’s just the way of markets. And lest we forget, short-sellers brought us the Enron scandal. Short-sellers have the greatest incentive to deliver the real inside scoop of the general badness of big corporations – which is why they’re good to keep around.

The trouble is, it’s difficult to tell:

  • if Bill Ackman is just trying to manipulate us into thinking Herbalife is evil; or
  • if he really has a good point; or
  • if he really thinks that he has a good point, but is horribly mistaken.

The manipulation part is illegal – and I doubt he’s doing that. I mean – I guess. I have no idea. But it just seems a bit crazy to do something illegal in such a public way with Carl Icahn and the Herbalife execs out to accuse you of anything that’ll get you off their backs.

So that really leaves us with “good point” or “horribly mistaken”.

The Herbalife Claim

So Herbalife works as follows:

  • Herbalife sells weight-loss products.
  • And it does so through a “multi-level marketing” scheme.
  • Which works like a pyramid scheme – but it’s just sleazy, not illegal.

Only, Bill Ackman is saying that the multi-level marketing scheme employed by Herbalife is actually a pyramid scheme, and therefore illegal, and therefore Herbalife is worth nothing.

Let me try to illustrate that. I’m going to start by saying that Ponzi Schemes, Pyramid Schemes and Multi-level Marketing all work in much the same way.

The Ponzi Scheme

The Ponzi Scheme works when one person (the “fund manager”) promises high returns to investors, and uses the money of new investors to pay the returns to the old investors:

  1. Start by finding some investors, and take their money.
  2. Find more investors, take their money, use some of that money to pay back the original investors. 
  3. Use your track record to find even more investors, take their money, and use that to pay returns to the earlier investors from Steps 1 and 2. 
  4. And so on. 
  5. Until it all falls apart. Or you disappear with the money.
  6. Named after Charles Ponzi, who found fame doing this with postage stamps.

The Pyramid Scheme

The Pyramid Scheme works like a Ponzi Scheme – only, instead of the fund manager doing all the work, he says to his investors:

  1. Here is a really awesome opportunity.
  2. You’ll get higher returns for every new investor you bring in.
  3. And they’ll get higher returns for every new investor that they bring in – oh, and did I mention that you’ll also get even higher returns for every new investor that they bring in?
  4. And so on down the line.

So it turns every person in the pyramid scheme into the leader of his own pack of investors (ie. everyone is a “fund manager”), spawning their own packs of investors (or “fund managers”), and onwards until it collapses.

Multi-level Marketing

Multi-level marketing works in almost the same way as a pyramid scheme – but instead of money, there is the commissions on the products you sell, and you also earn commissions off the sales of the salespeople you recruit.

So:

  1. Herbalife charges you money to be an authorised distributor of their product (you have to pay for a starter pack, etc).
  2. Herbalife then sells you product.
  3. You sell some of the product to your customers, and earn a profit.
  4. You also sell some of your product downstream to the salespeople that you recruited into the company, and earn bonuses and royalties back from Herbalife.
  5. The sales people that you recruited now either sell the product to real customers, or earn bonuses and royalties by on-selling downstream to the distributors that they sponsored to join the Herbalife sales force (which will also result in more royalties and bonuses to you).
  6. And so on down the line.

Bill Ackman’s question:

“So is Herbalife really selling stuff to paying customers?”

“Or is Herbalife selling stuff to Herbalife salespeople who are selling it to Herbalife salespeople who are selling stuff to Herbalife salespeople and so on until the salespeople run out of other salespeople to recruit and it turns out that Herbalife products have no real market other than the distributors that are part of this pyramid scheme?”

Bill Ackman believes the answer to the latter question is “Yes, this one”. Because “distributors earn 10 times as much from recruitment as they do by selling the company’s overpriced products to bona fide retail customers”.

And Herbalife’s response is mostly:

“That’s scandalous and outrageous. Agreed – about 78% of our members buy product from us and we have no idea if they on-sell it or use it for their own consumption, but at least they get to benefit from our wholesale discount. And how do you know that they’re not selling it for profit? And oh yeah – this is NOT a pyramid scheme!”

The Presentation

Bill Ackman’s presentation last Tuesday was, well, underwhelming. Sure – he compared Herbalife to the Nazis and got all choked up when he started talking about his great-grandparent. But he did nothing more exciting than that.

And embarrassingly, the Herbalife share price went up by 25% during his presentation.

So you might think that Bill Ackman is dead in the water… And in the red by plenty of margin.

Here’s another question though

Why is Herbalife not suing Bill Ackman for defamation?

Sure – a civil litigation suit would give Mr Ackman discovery rights, and access to internal financial data that he currently doesn’t have… But if he’s so clearly wrong, then what’s the problem?

Just askin’.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

Office Politics: Time Management a la Pomodoro

tomato_wall_clock

So in my new bent to discover all things productive, I have found the “Pomodoro” technique for time management.

And ironically, I’ve elected to write about it on a day that I have no time (I am writing this from an airport lounge – my flight boards in… *checks time*…twenty minutes).

Which is almost enough time.

The basic idea:

  • Housewives everywhere use this device:

tomato clock

  • It’s a timer.
  • You should use it too.
  • Work on a task for 25 minutes
  • Then take a break.
  • Repeat thrice.
  • Take a longer break on the third time.

A diagram:

Why it works:

  • Most tasks tend to be ambiguous.
  • And the deadlines not immediately pressing.
  • So you tend to work slower. And do quizzes on Buzzfeed. And get coffee*.
    *I know this because I recently downloaded the Hours app to test my attention span.
  • But if you isolate the time period with a timer, then you create deadline-like conditions.
  • Also, it’s habit-forming (there’s a routine of working for 25 minutes, followed by a reward of 5 minute breaks).
  • I like habits.

For more, read this article: “Get Unstuck”.

The flight is boarding. Happy weekend, all!

Rent or Buy: Paying Off A House In 7 Years?

So there was a recent opinion piece on moneyweb: How To Pay Your House Off In 7 Years.

A pretty broad claim was made:

  1. Pay 10% extra each month;
  2. Pay a constant percentage of your take-home salary; and
  3. Make your payment on the 25th (when you get paid) rather than the 1st – because this could take a year and a half off your mortgage period*.
    *I am raising a HUGELY sceptical eyebrow at this one.

Do this, and you could pay off your house in 7 years.

This tip comes from this website: justonelap.com, where you find some disclaimers to said opinion:

  1. It may mean that you need to buy a smaller home.
  2. Increase your monthly repayments by 10% each year (rather than just by your salary increase), in addition to the 10% extra each month.
  3. Keep your savings in your home loan in order to reduce interest (presumably, whatever savings are left, after all the extras).

Allow me to illustrate some compounding:

  1. In year one, let’s say that your mortgage is R12,500 per month.
  2. So instead, you pay R13,750 (up by that initial 10%).
  3. By year 2, you’re up to R15,125
  4. Year 3, R16,638…
  5. And so on until year 7, where you’re up to R24,360. Nearly double what you had to pay initially.

So on the one hand – each additional Rand you put in is a contribution to capital, so you automatically save interest. On the other hand, are there better ways to use the money?

Anyway, here’s some modelling.

What does increasing the mortgage repayment by 10% each month and/or by 10% per year do to the loan period?

Here’s the way a mortgage works:

  1. Each month, you pay back a portion of the initial capital.
  2. The interest is calculated on the capital that’s left over.
  3. Over time, with a fixed repayment, you’re paying progressively more capital, and progressively less interest.

So if you can accelerate the capital repayments, you do two things:

  1. Pay things back quicker in general (because you’re paying more, obviously); but also
  2. You make your fixed repayments more efficient (because less of the payment will be allocated to interest).

A graph of a 20 year mortgage at 9% on a R2 million property with a 10% deposit:

Screen Shot 2014-07-24 at 9.25.35 AMSo here’s what happens when you pay an extra 10% per month:

Screen Shot 2014-07-24 at 9.25.57 AM

Bottom line: you cut 4 years off your mortgage repayment period.

Here’s what happens when you escalate your mortgage repayments by 10% a year (that is: you attempt to keep your mortgage repayments as a fairly constant proportion of your salary – sort of):

Screen Shot 2014-07-24 at 9.26.35 AM

Bottom line: you cut your mortgage period in half.

Here’s what happens if you do both (an extra 10% per month, and an annual escalation of 10%):

Screen Shot 2014-07-24 at 9.27.01 AMBottom line: the extra 10% per month takes off an extra year, if you were already escalating at 10% per annum.

Here’s what happens when you pay on the 25th:

Screen Shot 2014-07-24 at 9.41.59 AMPermit me to zoom in:

Screen Shot 2014-07-24 at 9.42.55 AMYou save a month. Unless I’m missing something dramatic.

fake-sad-face

The justification:

  • I pay my first instalment a week early. So I save a week’s worth of interest, which goes toward capital.
  • But then my second instalment is no longer a week early. It’s exactly a month later. In which case, I pay a full month’s interest on the full capital amount.
  • The only saving is on my very first payment. Which, over 240 months of repayments, gives me a month off.
  • Again, unless I’ve missed something.
  • If someone has an alternative viewpoint, please point it out. I’d love to say “So listen, making your mortgage payment a week earlier means that you save a year and a half – for doing almost nothing!”
  • But as it stands, I just don’t think that’s true.

So let’s just ignore that last, and assume that you pay an extra 10% per month, and you do an annual escalation of 10%. It means that you’ll have paid off your bond, in full, by year 9.

An Alternative

Because I love alternatives.

Instead of paying the money into your bond, let’s put the extras (the 10% per month and the 10% escalation) into a Satrix equivalent. Assuming a 15% annual return, here’s the growth path of your investment (alongside the capital portion outstanding of the standard mortgage):

Screen Shot 2014-07-24 at 10.02.31 AM

Assuming that higher return, you could take the Satrix investment and use it to pay off the outstanding capital somewhere in the beginning of year 8.

But if I’m honest – I wouldn’t trade in a mortgage saving for a satrix return. The mortgage rate is almost a guaranteed return. In other words, once you’ve committed to buying a house, every rand of extra capital repaid “earns” a return equal to the mortgage interest rate. And you’ve already committed to the repayment process, so there’s less to be gained from going elsewhere.

So if you’ve already bought a house, pour money into the mortgage. But ignore the advice around the 25th. That’s what I’m saying.

For more in this series of home-ownership:

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

The Investor Diaries: Week 18

What’s happening with the investors:

Screen Shot 2014-07-23 at 8.15.30 AM

Screen Shot 2014-07-23 at 8.15.53 AM

So not a lot has changed since last week. And the indicators:

Screen Shot 2014-07-23 at 8.33.27 AM

You’ll notice that the Repo Rate went up by 25 basis points? That came into effect last Friday.

I find that very few people actually understand rate hikes, or why they happen, or how on earth they’re meant to make a difference. So I thought that I might spend the rest of this post explaining it.

How The SARB thinks

So the South African Reserve Bank has a single mandate: “keep the inflation rate between 3% and 6%”. But it also has some other (minor) considerations, namely: “But, you know, we need to keep in mind that destroying the economy in the pursuit of that mandate would be a tad foolish.”

In all of this, the SARB has one tool with which to play: the repo rate.

Here’s what the SARB thinks/knows/believes will happen if they lower the repo rate:

  1. Lowering the Repo rate means that it’s cheaper for the commercial banks to borrow money from the SARB (and, correspondingly, it’s more expensive for them to keep money at the SARB).
  2. So the banks, because they’re competitive, pass on some of that to cheapness to their customers.
  3. People with mortgages and hire-puchase agreements (on cars, etc) suddenly find that they’ve got a little more spare money each month, because their monthly repayments have come down. So maybe they’ll spend more.
  4. Businesses with mortgages and hire-purchase agreements suddenly find that they’ve also got a little more spare money each month, so they can perhaps afford to hire more people, or do more expansion, or whatever.
  5. In addition, it just became a bit cheaper to borrow money – so perhaps people/businesses that hadn’t made some big purchase decisions beforehand might choose to make those purchases now.
  6. Meaning that demand is stimulated – which would cause some inflation. But acceptable inflation when the economy is slowing down.

The problem:

  1. Lower interest rates mean that foreign investors might start to earn lower returns on their investments (at least, that’s the theory).
  2. And in particular, there will be lower forward rates in the foreign exchange market (which is driven by interest rates).
  3. So foreign capital might start to leave South Africa in the search for higher returns.
  4. Which would cause the Rand to depreciate.
  5. Which would make imports quite expensive.
  6. Which would hurt any industries that are reliant on imported goods.

And the opposite is true when the SARB raises the repo rate:

  1. Raising the Repo rate means that it’s more expensive for the commercial banks to borrow money from the SARB (and, correspondingly, it’s more lucrative for them to keep money at the SARB).
  2. So the banks, because they’re businesses, pass on the higher costs to their customers.
  3. People with mortgages and hire-puchase agreements (on cars, etc) suddenly find that they’ve got less spare money each month, because their monthly repayments have gone up. So they’ll spend less.
  4. Businesses with mortgages and hire-purchase agreements suddenly find that they’ve also got less spare money each month, so they might need to cut back and/or attempt to sell off assets in order to maintain their solvency..
  5. In addition, it just became more expensive to borrow money – so perhaps people/businesses that were about to make some big purchase decisions might choose to delay those purchases.
  6. So demand is suppressed.
  7. Oh, and higher interest rates would cause the exchange rate to appreciate (normally).
  8. Making South African exports quite expensive.
  9. Which would hurt any industries that produce goods for export.

I would also point out on this whole exchange rate story that foreign capital is flighty. It almost only ever negatively impacts. And I say that because:

  1. People doing long term investments into South Africa don’t make impulse decisions to get into and/or out of SA on the back of a 25 basis point rate movement. They’re concerned with things like “long-term sustainability” and “profit margins”. Of course exchange rates matter – but they’re a risk that can be managed.
  2. The foreign capital that wreaks havoc on the exchange rate is speculator flows, which move into and out of bond and equity markets.
  3. So the SARB needs to consider that whatever it does, the exchange rate will be affected opportunistically.

The Current Situation

The SARB has found itself awkwardly placed. On the one hand, inflation is up to 6.6% – which has them concerned because now they’re outside their mandate. But on the other hand, there is an economy that’s looking pretty stagnant with all the strikes and the depreciated Rand. Here’s ETMAnalytics‘ graph of the SARB’s GDP forecasts over the last year:

Screen Shot 2014-07-23 at 9.27.57 AM

 

So the SARB might want to raise interest rates to stop the inflation, but raising interest rates also suppresses demand, which would prolong all this poor growth.

Either way, the SARB has elected to do something: they’ve raised the repo rate by 25 basis points. Which is really quite conservative.

And now we’ll wait to see what difference it makes.

 

Why Do We Still Get Emails From Nigeria?

We’re all familiar with the Nigerian bank-employee/government-minister/lawyer that has found you on the internet and identified you as the long-lost only surviving relative of some poor deceased cocoa lord with an heirless fortune that you can claim, if you’ll just contact the sender on <prepaid cellphone number>. And pay a little something to secure your claim. And then pay a little more as a deposit on the estate duty. All of which you can just take out of the fortune when it gets paid back to you.

Or not.

So here’s a question: if everyone is so familiar with these mails, why do we still continue to receive them? I mean, it must be time for a change. The scam is tired. It’s been around since the internet began. And the relatives that fell for it are now wiser and poorer.

Which brings me too a follow-up question: doesn’t it seem like the supposed fraudster on the other end of the line is incredibly, well, stupid to think that we’ll keep falling for this tired old ruse?

The cynics amongst my readers might be expecting me to answer this question by saying “Yes, but there is no end to the infinity of human stupidity”.

house wrong

Okay, not entirely off track. But maybe, not in the way that you expect.

So to answer that question, allow me to introduce a tangent.

The Wisdom Of Solomon

An extract:

1 Kings 3:16-28 (King James Version)

17 And the one woman said, “O my lord, I and this woman dwell in one house; and I was delivered of a child with her in the house.
18 And it came to pass the third day after I was delivered that this woman was delivered also. And we were together; there was no stranger with us in the house, save we two in the house.
19 And this woman’s child died in the night, because she lay upon it.
20 And she arose at midnight, and took my son from beside me while thine handmaid slept, and laid it in her bosom and laid her dead child in my bosom.
21 And when I rose in the morning to give my child suck, behold, it was dead. But when I had considered it in the morning, behold, it was not my son whom I had borne.”
22 And the other woman said, “Nay; but the living is my son, and the dead is thy son!” And this said, “No; but the dead is thy son, and the living is my son!” Thus they spoke before the king.
23 Then said the king, “The one saith, ‘This is my son who liveth, and thy son is the dead’; and the other saith, ‘Nay; but thy son is the dead, and my son is the living.’”
24 And the king said, “Bring me a sword.” And they brought a sword before the king.
25 And the king said, “Divide the living child in two, and give half to the one and half to the other.”
26 Then spoke the woman whose the living child was unto the king, for her heart yearned for her son and she said, “O my lord, give her the living child, and in no wise slay it!” But the other said, “Let it be neither mine nor thine, but divide it.”
27 Then the king answered and said, “Give her the living child, and in no wise slay it. She is the mother thereof.”
28 And all Israel heard of the judgment which the king had judged; and they feared the king, for they saw that the wisdom of God was in him to do judgment.

Or to summarise:

  1. Solomon was in a she-said-she-said situation.
  2. So he introduced a new variable (“Divide the living child in two“).
  3. And watched how the two women reacted.

Why? The game theory:

  1. There are two women, one of whom is clearly a psychopath (I mean, whether she’s replacing one child with another, or trying to claim another woman’s child – neither is a normal response to her child’s death).
  2. But how to tell which is which?
  3. If he threatens to kill the child, the psychopath would not react in quite the same way as the child’s real mother. If anything, she would rather see the child live with another woman than see it die.
  4. So introduce that into the mix and see what happens.
  5. *rolls dice*

In game theory, this new variable is known as a separating equilibrium.

Which brings me to my next fun historical example…

Trial By Ordeal

Earlier this year, I visited the Museum of Torture in Vienna. It was vastly less exciting than it sounds – there was a lot of dust and it was very small. But I did learn that medieval life was very unpleasant, and seemed to revolve around cauldrons of boiling water. Specifically, in trials by ordeal. How those worked:

  1. Let’s say that you were accused of theft/murder.
  2. You would be ordered to do one of the following:
    1. Insert your hand into a kettle of boiling water in order to retrieve a ring.
    2. Grab onto a red-hot iron bar.
    3. Other painful variations along this theme.
  3. The above would be conducted by a priest.
  4. If you emerged unharmed, you were innocent.
  5. And if you were harmed, then you were clearly guilty, and got punished again.

So obviously, it doesn’t sound like the most…unbiased of outcomes.

And yet, it worked? According to this article by economist Peter Leeson, ordeals exonerated the accused about two thirds of the time (he uses some historical records from Hungary, which record the results of 200 trials by ordeal). So either there was a lot more miracle happening in the Middle Ages, or something else was happening.

Mr Leeson’s argument:

  1. The miracle at play here was never really the issue.
  2. The trial by ordeal is just another example of a separating equilibrium.
  3. Recall that the trial by ordeal was conducted by clerics; and that people had full belief in Iudicum Dei (God’s judgement) in a way that we don’t really have today.
  4. This means that, when faced with a trial by ordeal, the innocent would expect some kind of divine exoneration; while the guilty would be faced with a bad outcome from the ordeal, as well as the punishment that followed it.
  5. So the priest conducting the ceremony could see the innocence/guilt in the accused’s willingness to undergo the ordeal.
  6. He would then rig the ordeal to match the outcome.
  7. And this has the awesome side-benefit of keeping the populace generally believing in the power of Iudicum Dei, which would further strengthen the power of the separating equilibrium effect.

Fascinating, right? If you want to hear more, here’s the Freakonomics podcast that inspired almost all of this post: What Do King Solomon and David Lee Roth have in common?

So back to the Nigerian emails…

The Emails From Nigeria are Separating Equilibria

Here’s the scenario that the Nigerian Princeling faces:

  1. The world is filled with greedy people.
  2. But not all of them are gullible.
  3. I don’t want to be dealing with people that think my story sounds plausible, but then insist that I prove myself. That’s too many people.
  4. No – what I want is to field calls from the really gullible people, who are going to deposit money into my account without asking too many awkward questions.
  5. So what I need to send out is an email that’s filled with bait, but I’ll make it quite obvious that it’s a scam.
  6. That’ll weed out all the rational ones. And the vaguely rational ones.
  7. And I’ll only get calls from the really gullible ones. Which is exactly what I want.

And that’s why we still get them.

*bows*

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.