Denial of Fraud and Cognitive Dissonance

A Ponzi scheme involves a financial scam in which early investors in a fake investment fund are promised—and often achieve, at first—immense returns on their investments. In reality, the fund’s returns are provided, not by the fund’s actual investment results, but by later investor’s contributions to the fund. (This is also called a pyramid scheme, because the lucky few at the early enrolled top of the pyramid of investors are paid by the many later investors ‘below’ them in the pyramid.) Such schemes can collapse when unforeseen circumstances either cause a shortage of new investors, or investors start pulling their money from the fund, as happened when the financial meltdown of 2008 tripped up the Madoff scam, the largest Ponzi scheme yet revealed. Ponzi schemes are named after Charles Ponzi (pictured, in a 1910 mugshot), whose version of the scheme was the first to become known throughout the United States.

 

The New York Times of Friday, March 12, 2010 ran an article by Floyd Norris, who points out that some financial scheme victims refuse to believe that they have been scammed, even after government authorities have revealed the scheme in all its sordid detail. As Mr. Norris relates, when the U.S. government tried to compensate the victims of the original Ponzi scheme, it ran into a problem with some of the victims:

 

To get the money, the victims had to turn over the notes [i.e., financial certificates] they had received from Ponzi. But many of them refused to do so when the cash was offered in 1931.

 

Those who refused, wrote Donald Dunn …, were “holding onto the belief that Ponzi somehow would yet make good on his promise of 50 percent interest.” …

 

That was probably not the first, and certainly not the last, example of what might be called “buyer’s denial.” It is the belief that somehow a fraud was not what it seemed to be, and that there was still a way to avoid losing the money the victim had foolishly invested.

 

In our day, as Mr. Norris points out, a similar drama is being played out with the victims of another scam. As he describes it, CMKM Diamonds illegally issued bilions of shares of stock that were, in reality, backed up by less than $500 dollars in real assets. Since this stock scam (not a Ponzi scheme) was revealed, a group of victims has banded together to sue for about $4 trillion. However, they are suing officials, not of CMKM, but of the U.S. government, alleging that government agents manipulated CMKM as part of a sting operation that left honest corporate officials and their investors twisting in the wind.

 

The reactions of these CMKM investors and some of the original Ponzi investors are examples, not just of denial, but of cognitive dissonance. Widely known to students of social psychology, cognitive dissonance is a phenomenon in which people are observed to undertake various mental gyrations to reconcile dissonant, ultimately unreconcilable thoughts. For example, a well-to-do person might think that she or he is a good, generous person, and yet refuses to donate money or food to a begging person on the street. How to reconcile the cognitive dissonance? Perceive the beggar as evil, lazy, or otherwise unworthy of help.

 

The scammed investors mentioned in Mr. Norris’ article are faced with a pair of contradictory self-oriented cognitions:

1. “I am a bright, prosperous person who makes good investment decisions.”
2. “I am being told that I’ve been taken in by a scam artist who has robbed me of a ton of money.”

 

Dissonant cognitions indeed! Apparently, for some victims, the response is denial: “I was not scammed at all!” Then, in the 1930s: “Ponzi will deliver.” Today: “It is all really the government’s fault that CMKM failed.” (Indeed, one of the academic experts interviewed for the Norris article describes these cognitive dynamics in terms very much like those of cognitive dissonance.)

 

A cognitive dissonance perspective may help civil officials understand resistant, “in denial” victims of scams. Of course, one research question would be, who do some victims exhibit what Norris calls buyer’s denial, and others do not?

 

Scams like this, on the one hand, are in the domain of microeconomics, investment, finance, and economic forensics. On the other hand, the emergence of cognitive dissonance in the behavior of some scam victims demonstrates a favorite point of mine, discussed in an earlier post: “Everything is Psychology.”

 

Reference

 

Norris, F. (2010, March 12). Dealing with fraud by denial. The New York Times [late edition], pp. B1, B8.

 

Copyright 2010 Mark E. Koltko-Rivera. All Rights Reserved.

 

[The image of Charles Ponzi, above, is in the public domain, and was obtained from Wikipedia.]