Published on November 14, 2025 7:51 AM GMT

I. 

Most large-scale fraud follows basically the same story: 

1. Some trader or executive gets in a position where they can use a bunch of other people’s resources (either via borrowing them, or being given custody over them)

2. They spend some of those resources to increase their perceived creditworthiness/trustworthiness

3. They use this to gain control over more resources

4. They use those additional resources to buy more creditworthiness, which they then use to get more resources, and so on

5. Eventually some market shock or similar event causes people to re-evaluate the creditworthiness of the trader or executive, at which point the whole thing collapses and their debts get called in (often in the literal form of a margin call, sometimes in the form of a criminal conviction)^[1]

The exact mechanism by which each one of those steps is achieved is different from case to case, but the overall result is the same. Everyone is sad, and society updates how we evaluate the trustworthiness of others.

Going through a few concrete examples: 

FTX

1. FTX builds a crypto exchange into which other people deposit their money (and attract investment)
2. Using that money they fund huge marketing campaigns to position themselves as “the trustworthy crypto exchange”
3. This causes people to trust them more and deposit more money into the exchange and invest more into them
4. FTX uses more of that money to cover up their losses and invest more into huge marketing campaigns
5. Crypto prices collapse, people try to withdraw their money from FTX, they fail, Sam goes to prison

Enron

1. Enron takes investor money promising above-market returns
2. Enron uses the money from recent investors to pay out earlier investors with huge returns
3. This attracts more money invested in Enron
4. They use that additional money to pay out even larger dividends
5. The whole thing collapses under pressure as Enron has basically exhausted the market of interested investors

Theranos

1. Elizabeth Holmes takes investors money promising to produce great medical imaging devices
2. Using that money, Elizabeth Holmes recruits a bunch of people with strong reputation that vouch for her
3. This attracts more investment
4. She uses that greater investment to hire more people, run more marketing campaigns, etc.
5. Eventually Theranos fails to deliver the promised products, investigations start, and the whole thing collapses

Some other case-studies which are left as an exercise for the reader:  WeWork, Wirecard, Lehman Brothers, Ponzi, Madoff, and many cases of academic fraud including Amy Cuddy and “power posing”.

II. 

The key vulnerability that is being exploited in the above is (roughly) that there was some way to translate a dollar of resources into the ability to control more than a dollar of stewardship over other people’s resources. When this becomes possible, at least some individuals will see the opportunity to leverage up on other people’s resources, bet them big, and hope they get to walk away with the winnings (and, if they lose, leave the empty bag to the people whose resources they borrowed).

This phenomenon extends beyond the realm of large scale fraud. The Stanford president resigning after decades of academic fraud leveraged into one of the most powerful positions in academia is one such interesting case that seems worth going into in more detail.

Early in his career Tessier-Lavigne published a number of high-profile papers in neuroscience journals. These papers already contained significant data issues and were probably fradulent but this was not discovered until much later. 

1. Using the trust and prestige gained from those fradulent papers, Tessier-Lavigne received a number of large government grants and high-prestige faculty positions
2. Tessier-Lavigne, using those resources, now hires dozens of post-docs and research assistants and announces multiple (later retracted and found fradulent) breakthroughs in neuroscience and Alzheimer prevention
3. Those breakthroughs, in turn, led to him receiving even more prestigious positions, and Genentech hiring him as CSO
4. Using his position as Genentech CSO and highly acclaimed academic, his ability to discredit anyone concerned about his results, and his ability to hype up his own papers, continuously increases, until he is eventually offered the position of president of Stanford University (possibly the most prestigious academic position in the world)
5. This eventually collapsed when journalists investigate his old work and found many cases of scientific misconduct

It’s also not just academia and large scale fraud. A common corporate drama story is someone squeezing short-term profits out of some assets they are managing while (unbeknownst to upper management) lowering long-run returns. Then, being hailed as a success they move on to a bigger project where they can repeat the same playbook, having used up less than a dollar of the resources under their stewardship to end up with more than an additional dollar of more resources under their control. 

Excerpts from the book Moral Mazes summarizing this dynamic: 

Both Covenant Corporation and Weft Corporation, for instance, place a great premium on a division’s or a subsidiary’s return on assets (ROA); managers who can successfully squeeze assets are first in line, for instance, for the handsome rewards allotted through bonus programs. One good way for business managers to increase their ROA is to reduce assets while maintaining sales. Usually, managers will do everything they can to hold down expenditures in order to decrease the asset base at the end of a quarter or especially at the end of the fiscal year. The most common way of doing this is by deferring capital expenditures, everything from maintenance to innovative investments, as long as possible. Done over a short period, this is called “starving a plant”; done over a longer period, it is called “milking a plant.”

[…]

For instance, I could negotiate a contract that might have a phrase that would trigger considerable harm to the company in the event of the occurrence of some set of circumstances. The chances are that no one would ever know. But if something did happen and the company got into trouble, and I had moved on from that job to another, it would never be traced to me. The problem would be that of the guy who presently has responsibility. And it would be his headache. There’s no tracking system in the corporation. Some managers argue that outrunning mistakes is the real meaning of “being on the fast track,” the real key to managerial success. The same lawyer continues: In fact, one way of looking at success patterns in the corporation is that the people who are in high positions have never been in one place long enough for their problems to catch up with them. They outrun their mistakes. That’s why to be successful in a business organization, you have to move quickly.

[…]

At the very top of organizations, one does not so much continue to outrun mistakes as tough them out with sheer brazenness. In such ways, bureaucracies may be thought of, in C. Wright Mills’s phrase, as vast systems of organized irresponsibility.

III.

Now, the issue is of course that there are many different ways people evaluate track records and many different chains in the great web of reputational deference. Most resources can somehow be traded for other resources, and so it’s hard to guarantee that creditworthiness itself is never for sale. Or more generally, the process that allocates creditworthiness is often much dumber than the most competent individuals, and in the resulting information warfare, it’s hard to guarantee that nobody can be duped out of more than one dollar worth of stuff with less than one dollar worth of investment. 

That said, paying attention to the specific mechanism of “purchased creditworthiness” is IMO often good enough to catch a non-trivial fraction of social dysfunction, shut down fraud early on before it gets too big, and be helpful for staying away from things that will likely explode in violent and destructive ways later on. 

Some maybe non-obvious heuristics I have for determining whether someone might actually be leveraged up on a bunch of creditworthiness purchases and is likely to explode in the future: 

Don’t trust young organizations that hire PR agencies. PR agencies are the obvious mechanism by which you can translate money into reputation. As such, spending on PR agencies is a pretty huge flag! Not everyone who works with PR agencies is doing illegitimate things, but especially if an organization has not yet done anything else legible that isn’t traceable to their PR agency or other splashy PR efforts, it should be an obvious red flag. 

Charity is a breeding ground for this kind of scheme. Many charities are good! Nevertheless, a lot of charities do just use most of their money to do more marketing to get more money, with basically no feedback loop that is routed through actually helping anyone. The absence of needing to provide market value make the fundraising feedback loops here particularly tempting. 

Pay a lot of attention if an organization is quickly ramping up their PR spending. If an organization becomes overleveraged like this the payoff necessary to maintain creditworthiness becomes greater and greater. Often also the cost of purchasing additional dollars of creditworthiness goes up over time as the most credulous creditors have been exhausted, or suspicion mounts. This means many organizations in the throes of a cycle like this will ramp up their spending on PR a lot.

Beware of encountering an organization that has many accolades for being “the most trustworthy” or “the most innovative” or “the most revolutionary”. On a competitive level, organizations that optimize for appearing trustworthy are often doing so because they have no other business proposition to optimize for. Of course, most of the time the most trustworthy institutions are indeed trustworthy, but seeing an organization that is a big outlier in its perceived trustworthiness, or where the actions of the CEO seem centrally oriented around optimizing for trustworthiness or reputation, often indicates this kind of runaway leveraged game. 

IV.

At the institutional design level, the lesson here is “don’t sell trustworthiness”. Mutual reputation protection alliances are one of the most common ways in which creditworthiness ends up for sale: “A powerful potential ally with many resources approaches you with an offer: I say good things about you, you say good things about me, everyone is happy” (or the weaker version “you don’t say bad things about me, if I don’t say bad things about you”). 

Of course, what you are doing when agreeing to this deal is to fuck over everyone who was using your word to determine who is trustworthy and creditworthy. Often this enables exactly the kind of runaway dynamic explained in this post playing out in social capital instead of dollars.

As is common for adversarial situations like this, I doubt there is some generic silver bullet here. Ultimately every reputation allocation mechanism will have vulnerabilities, and those vulnerabilities will be easier to exploit from a position of greater trust and reputation. All we can do for now is to be vigilant, see when the mechanisms go wrong, and try to build incrementally more robust mechanisms and institutions for determining credit- and trustworthiness.

FAQ

OK, but shouldn’t I be happy if I give money to a charity that can raise more than a dollar from other people if I give it a dollar?

I like to think through this case via the lens of public good funding. Public goods are legitimately often underfunded, because the benefits are diffuse, and it’s hard to coordinate to all pay into the commons appropriately. 

In those cases, you can provide real surplus value by using money to raise more money from other people if ultimately the total funds you raised are less valuable than the benefit you produce to society via the real services you (eventually) provide.

Because coordination problems loom large in public goods funding, good public goods projects often look like a creditworthiness-purchasing-scheme early on, but actually provide real value by solving a difficult coordination problem among public good funders, using those funds.  

Does this really always collapse? I feel like sometimes it just happens, and everything is fine and normal? 

In some situations, creditworthiness and trustworthiness are evaluated in an environment that has a lot of Keynesian beauty contest nature. I.e. a large amount of resources and power accrues to whoever people think will be the most popular target for those resources. Coups and more broadly political elections tend to have a lot of this nature, especially when conducted using insane voting systems like first-past-the-post voting.

In those situations someone’s creditworthiness might genuinely increase the more investment they have attracted, as the fact that they have attracted more investment is indeed a very strong predictor of their likelihood to be the receiver of the Keynesian beauty contest price. This still often explodes and causes lots of issues, but in a way that seems more fundamental to the dynamics of Keynesian beauty contests than any inherent deception going on.

In the cases of military control or elections, the key thing that resolves the inherent instability and overleveraged nature of this situation is that in filling the role of leader, a truly important and difficult coordination problem will have been solved, and from that position all the people who invested in the winner can be made whole. This is not the case if you are e.g. running a straightforward ponzi scheme with no payout on the horizon. 

How is this different from just Ponzi schemes? 

Ponzi schemes are just one instance of this general dynamic. Yes, Ponzi schemes rely on being able to purchase more than one dollar of creditworthiness for less than one dollar, in the form of paying out your early investors and promising your later investors the same. But many other situations I list above are not the same as Ponzi schemes. I certainly wouldn’t call the Stanford President situation a straightforward “Ponzi scheme” and also don’t really think it fits what happened with FTX or Theranos. 

I think the broader category is more useful for making a broader range of accurate predictions about the world. 

1. ^{^}

   In some rare cases the scheme might also never fully collapse, but simply result in someone more permanently taking ownership over the resources the others have given them stewardship over. See the FAQ for some of my thoughts on this.