San José State University
Department of Economics
Thayer Watkins
Silicon Valley
& Tornado Alley




In November of 1924 a Portuguese businessman on the verge of bankruptcy came up with a plan for counterfeiting unequaled in history in its audacity. With no resources except boldness he set about acquiring the power to print his country's currency. Amazingly, he succeeded and except for a fluke of fortune he would have gotten away with it.

The man's name was Alves Reis. He was the son of a man who lost the family savings in investments in the Portuguese colony of Angola just at the time Alves Reis was ready for college. Alves Reis spent a year studying practical engineering and then quit to get married. Reis then needed to earn a living for himself and his bride. The year was 1916 and World War I was raging. Reis decided to emigrate to Angola to seek a livelihood. To enhance his employment prospects in Angola he forged a diploma for himself in engineering from Oxford University in England. The forged diploma was merely a translation of the diploma of a Portuguese university, but it included some impressive seals. To enhance its credibility he had it notarized by a notary in Portugal. Notaries usually certify the signature of signers of documents and only attest that the signer is the person he says he is. They give no judgment on the authenticity of the document being signed but people tend to treat notarized documents as being officially approved.

In Angola Alves got a job with the local government's Public Works and another as a supervising engineer with the repair shop of a railroad. At the railroad Alves developed a reputation for efficiency because of his willingness to put on overalls and find out for himself what was wrong with a train. After a few years he quit his jobs and went into business for himself importing and exporting. He made a small fortune and returned in triumph to Portugal. In Portugal he acquired an American car dealership. He was encouraged to takeover an ailing company called Ambaca. The company had $100,000 cash on hand, but Reis did not have the $40,000 of capital necessary to gain control of the company. He made use of his car dealership to kite $40,000 in checks which gave him enough funds to buy control of the company. Once in control he used the company funds to cover the checks he had written to buy control and had $60,000 left over. He used that $60,000 to buy control of the Angola Mining Company. He acquired some Dutch partners who were interested in trying to make something of Angola Mining. But before he could get anything going he was arrested for taking $100,000 from Ambaca. While in jail he studied everything he could about the Bank of Portugal. He found that the Bank of Portugal was actually a private company but that it had exclusive right to issue currency for Portugal. Under a law of 1887 the Bank of Portugal was supposed to limit its issuance of currency to twice its paid-up capital. The Portuguese Government had been pressuring it to issue currency to cover government deficits so by 1924 it had issued currency equal to one hundred times its capital. Reis also investigated the organizational structure of the Bank of Portugal and found that it had no department for checking for duplicate serial numbers on bills.

Reis got the embezzlement charges dismissed and only had to face the charge of fraud in connection with his check kiting operations. He had to spend only 54 days in jail and when he came out he promoted the notion through newspaper advertisements that he had been unjustly imprisoned as a result of a criminal conspiracy against him.

Reis then set about promoting a scheme he had worked out while in jail. He told potential business partners that he could arrange a contract with the Portuguese Government and the Bank of Portugal such that in return for a loan to Angola equivalent to $5 million he would receive the right to have printed up the equivalent amount in Angolan currency. The notes for Angola were exactly the same as the notes for Portugal except that the word "Angola" was stamped on the bill. A note of Angolan currency was worth far less that than a note of Portuguese currency of the same denomination.

Reis typed up his supposed contract with the Bank of Portugal. All contracts in Portugal have to be notarized and the notary certifies that the contract is not for any illegal purpose. Reis had his contract notarized. He then took the notarized contract to the British consulate and had them certify the authenticity of the signature of the notary. The British consulate affixed an impressive stamp to the notarized contract. Reis did the same thing at the French and German consulates. With all these impressive stamps Reis' bogus contract began to look official. But the contract did not yet have the signatures of the officials at the Bank of Portugal.

To get an authentic copy of the head of the Bank of Portugal Reis carried out an ingenious ploy. A relative of Reis owed that bank official a significant amount of money which he had not paid. Reis paid the money for his relative and the bank official sent Reis a polite thankyou note which of course had his signature on it.

Reis then had an assistant retype the supposed contract with a translation in French. He then forged the signatures of the officials to the new contract and then cut the notarizations from the first version of the contract and taped them to the second. Furthermore he glued two large denomination Portuguese banknotes to the contract as examples of the notes which were to be printed. Now it appeared that he had a signed and notarized contract to have Angolan currency printed in return for a loan to Angola.

On the basis of this contract Reis secured the backing of some Dutch entrepreneurs who had previously considered going into business with him. The next step was to get one of the companies which printed Portugal's currency for the Bank of Portugal to print the notes he wanted.

One of Reis' partners first approached a Dutch printer to have the printing done. The Dutch printer declined because the two banknotes to be printed were the work of a British firm, Waterlow and Sons Limited of London. The Dutch firm gave Reis and his colleagues a letter of introduction to the British firm. This letter made it seem that the Dutch firm was convinced of the authenticity of Reis and his contract. Sir William Waterlow accepted the authenticity of the contract, and the shady nature of it was passed over as another example of the corruption of Portuguese officials. When Reis' partner stressed the need for the utmost secrecy in the project Waterlow was not surprised. It also turned out that the specific notes that Reis' group wanted printed were the work of a competitor. The officials at Waterlow began to focus on the opportunity of taking away a customer of their competitor.

Meanwhile through some ingenious strategies Reis obtained copies of the private letterhead stationary and signature of the Governor of the Bank of Portugal. With these Reis provided forged letters authorizing the printing of the banknotes. Waterlow agreed to print the notes and Reis' people said they would take care of having "Angola" stamped on the bills so they could not circulate in Portugal itself. The original limitation of the printing to the equivalent of $5 million was forgotten and the target was set at the equivalent of $125 million. Reis had achieved the counterfeiter's dream, absolutely flawless counterfeit currency. The only drawback was that the currency was all in the relatively large denomination of 500 escudos ($25) and had to be exchanged for other denominations to avoid arousing suspicion. A distribution network of blackmarket currency traders took care of that problem.

Reis had to share the proceeds of the operation with partners and got only 25 percent after costs, but Reis' "costs" included $850,000 in supposed bribes he was paying the Governor and other officials at the Bank of Portugal. His partners didn't question his need for funds to pay such bribes.

With the funds he received Reis became a man of wealth and influence in Portugal. He was the largest depositor in many banks. He bought mansions and other luxuries. His spending began to fuel an upturn in the stagnant Portuguese economy. He created a new bank, the Bank of Angola and Metropole. He also set his sights on buying control of the Bank of Portugal. If he could gain control of the Bank of Portugal he would be able to erase all trace of his illegal operations and could go on to control Portugal itself.

There were suspicions from time to time that someone was counterfeiting 500 escudo notes, but each time the bank experts checked they found the suspected notes were legitimate.

Reis' downfall came as a result of a fluke of fortune. A teller in Oporto, a city of some distance from Lisbon, came to the conclusion that Reis and his crowd must be counterfeiters. He had absolutely no evidence for his conclusion, but he was so convinced that he had a bank official telephone the Bank of Portugal in Lisbon. The telephone line was faulty and the bank people in Lisbon thought Oporto bank people were saying they had evidence of counterfeit bills. The Bank of Portugal sent people to get the evidence. When they found there was none they had the currency holdings of Reis' bank in Oporto confiscated. In desperation they sorted the bills by serial numbers and found several duplicate serial numbers. Since the notes printed by Waterlow and Sons were supposed to be for circulation in Angola there was no reason not to use the same serial numbers as the notes circulating in Portugal. This gave the Bank of Portugal the evidence of counterfeiting they needed and when they contacted Waterlow and Sons in London the whole scheme came to light.

Reis was arrested and held incommunicado for 108 days despite a constitutional prohibition against holding any citizen incommunicado for more than 48 hours. When the trial finally began it became a circus because of forged documents that Reis produced that implicated his prosecutors in the scheme. Some began to suspect that some of the officials in the Bank of Portugal had to be involved and that Reis was being railroaded to prevent the true extent of the conspiracy from being revealed. In one bizarre episode the judge in the trial walked over to the Governor of the Bank of Portugal who was present as a witness in the trial and grabbed him by the lapels and shouted, "You are under arrest! At my orders! You are under arrest in the name of the law!" He then told a policeman, "Take them to a police station right away." The Governor and another official of the Bank of Portugal were led off to the police station.

Reis was finally convicted and sent to prison where he was converted to a fundamentalist protestant sect. He spent nearly twenty years in prison, many of them in solitary confinement.

In 1932 a former economics professor, Salazar, became dictator of Portugal. His regime was socially and economically conservative. The social conservatism is indicated by the fact that only the heads of families could vote and then only if they met a minimum education requirement. He curbed inflation by balancing the budget and tightly controlling the growth of the money supply, but this created a severe recession. By 1935 a popular joke was making the rounds of Lisbon. In the joke Salazar is lamenting to an old friend about the sad state of the economy. His friend says, "It is no problem at all. It can be solved with a mere ten escudos." Salazar asks how it could be solved with such a small amount of money. His friend replies, "We just spend it on cab fare to go to the prison where Alves Reis is. We take Reis out of his cell and leave you in his place."

When Reis died in 1955 the British journal The Economist said of the counterfeiting scheme, "The perpetrators, however reprehensible their motives, did Portugal a very good turn according to the best Keynesian principles."


Murray Teigh Bloom, The Man Who Stole Portugal

Penn Square Bank of Oklahoma City

Mark Singer's book,Funny Money, is the story of Penn Square Bank of Oklahoma City, Oklahoma. Penn Square Bank was the bank in Penn Square shopping center. It was a small, neighborhood bank until control of it was acquired by William "Beep" Jennings in 1972. Jennings proceeded to promote a more agressive style of operations. For example, he created a special department to make loans to the oil-and-gas industry in Oklahoma. The OPEC oil price increases which started in 1973 had made energy exploration a much more lucrative venture than it had been before. But there was an adverse selection problem in the energy exploration field. As a bankruptcy lawyer acquaintance of Mark Singer, the author of Funny Money, expressed it, "You've got thirteen thousand oil and gas companies in Oklahoma; maybe fifteen hundred are looking for oil and gas, the rest are looking for investors." (p.12)

At the start Penn Square had capital of four million dollars. Under the rules for national banks, of which Penn Square was one, the largest loan that Penn Square could make to a single customer was ten percent of its capital; i.e., $400,000. This meant that if a borrower wanted a million dollars, Penn Square would have to find another bank to provide the other $600,000. Very soon Penn Square was making loans in excess of its limits and quickly selling the "overline" to other banks. There were some banks, notably Continental Illinois and Seattle First National, that were eager to buy such "overlines." It was a way that they could participate in the higher interest rates on oil-and-gas lending in Oklahoma without having banking operations in Oklahoma. Buying loans made by Penn Square not only gave such banks a way around the restrictions on interstate banking but they were counting on banks like Penn Square to have expertise about local conditions that it would be impossible for them to acquire.

Penn Square began to market most of their loans to "upstream" banks like Continental Illinois and Chase Manhattan. These large U.S. banks were presuming Penn Square was doing all of its homework and only making good loans. Penn Square was focusing more on the one percent fees it earned for making the loans and on the service fees it received for servicing the loans for the upstream banks which purchased the loans. Servicing meant collecting the interest and principal payments and forwarding them to the loan buyer.

This situation of Penn Square receiving fees for writing the loan but not shouldering the risk associated with the loan was dangerous. Penn Square had an incentive to ignore negative factors in the loan applications and soon many of the loans were made with incomplete documentation. Jennings developed the notion of character banking; i.e., lending on the basis of his perception of the character of the borrower rather than the financial fundamentals of the loan project. Jennings often made verbal committments to the borrower without formal applications being completed. The paperwork was to be handled later. But this made it difficult for Penn Square's loan officers to do a proper job on the paperwork for the loan. If the committment on a loan had already been made and the funds withdrawn, how could the loan officer include negative aspects in the paperwork. To do so would have created an embarassing situation in a bank audit or jeopardized the sale of the loan in the secondary market.

The practice of Penn Square servicing these loans for upstream purchasers also created a financial hazard. Penn Square was selling hundreds of millions of dollars of loans. When some borrower was not meeting payments on a loan Penn Square had an incentive to make the payments itself rather than allow the loan to be revealed as bad and cause the upstream banks to hesitate to buy more. Later Penn Square could make a new loan to the insolvent borrower and then sell that to some upstream bank. To the upstream banks all their loans purchased from Penn Square appeared to be performing well.

Jennings hired loan officers who would make loans as easily as he did. This meant not only aggressively soliciting business but streamlining the application process. The head of the oil-and-gas department was Bill Patterson. Patterson was a jolly guy who his fraternity brothers called "Monkeybrains." He married into a wealthy Texas family which owned banks. Patterson was given a job at one of the family banks but was allowed only to do menial things. An officer at this bank said that there was no way that Patterson would ever be trusted to loan out a dime of the bank's funds. Patterson left and obtained a position at Penn Square Bank. Jennings perceived him as a hard working employee who would not question Jennings' easily lending policy.

Not only did Patterson accept Jennings lending policy he managed to put it into overdrive. One lender told of being in Patterson's office to negotiate a four hundred thousand dollar loan. While these negotiations were being carried out Patterson was carrying on negotiations with two other customers on two telephones. With this loose control of lending one can easily imagine how the quality of the loans made by Penn Square reached record depths. Not only was there the problem of the riskiness of the ventures and the inadequacy of the creditworthiness of the borrowers, but there was a major moral hazard problem. The borrowers often spent the funds for airplanes and cars instead of oil drilling equipment and so forth.

Many of the borrowers recognized that they had "debtor leverage." If a borrower owed ten thousand dollars a bank was likely to take legal action to collect, but if the debt was ten million dollars the creditor often had as much, if not more, to lose by forcing the debtor into bankruptcy. The debtor could use that leverage to extract another loan from the creditor.

When bank regulatory authorities became critical of Penn Square's dubious loans, Patterson and others could retort that Continental Illinois, one of the biggest lenders in the U.S., was willing to buy them so they couldn't be that bad. Even borrowers were finding vindication in this easy money world. "If my banker is willing to lend me millions to carry out this project then maybe it is not such a wild venture after all."

Some of the borrowers used the funds to make political campaign contributions and gained political influence. J.D. Allen, a heavy borrower from Penn Square was made a co-chairman of the finance committee of the Republican National Committee. After the collapse of Penn Square J.D. Allen filed for bankruptcy with $317 million in debts.

Another major customer of Penn Square Bank was Robert Hefner III. Forbes magazine listed him as one of the richest individuals in America with assets of around $150 million. Actually his net worth was negative.

When Penn Square Bank collapsed several upstream banks had losses each in the hundreds of millions of dollars. Seattle First National Bank was merged with Bank of America to prevent failure. Continental Illinois was saved only by a $5 billion bailout by the Federal Reserve System.


Mark Singer, Funny Money

Equity Funding

Equity Funding was originally based upon a new concept in insurance programs. Traditional life insurance policies are a combination of insurance and a systematic saving program. Pure insurance, called "term insurance," provides protection during a certain period of time and has no residual value. The premiums on term insurance should vary with age and health condition. Standard life insurance provides for constant premiums by charging more during the insured's younger years to cover the additional cost of providing protection during the insured's older years. The excess premiums paid during the younger years are accumulated and invested by the insurance company. The rate of return paid to the insured by the companies is very low compared to the rate the companies earn on the accumulated funds. For example, the insurance companies may make nine percent on the invested funds but pay the insured only two percent. Thus the systematic saving program part of a life insurance policy is profitable for the insurance company. The insurance companies are willing to pay agents a substantial amount to sign people up for life insurance programs.

When life insurance companies invest the accumulated excess premiums in common stock they make a substantially higher average rate of return, but it is not guaranteed. Some insurance programs, called "participating," share the gains from investment in the stock market with policy holders. But participation in the gains of stock market investment means the policy holders share in the risks. However, generally the policy holders' share is low compared with the share going to the owners of the insurance company.

Equity Funding's concept was to sell customers a program which involved:

The concept was sound, and more importantly for the financial world, it sounded reasonable. Five individuals with backgrounds in insurance and insurance administration founded the company around 1960. There is uncertainty about the time because various members of the group had formed ventures together before Equity Funding came together and members left the group. Finally in 1970 Stanley Goldblum emerged as the head of the company. Goldblum prior to going into the insurance business had worked in the meat packing plant of his father-in-law. He, through hard work and native talent, had worked himself up to being plant manager, but he wanted more than was possible in that position.

Equity Funding became a major success on Wall Street. Its reported revenues and profits were growing steadily at a high rate. The stock traded at a high price/earnings ratio and so Equity Funding was able to acquire other companies through stock trades. Although the concept behind Equity Funding seemed sound the company, in actually, never made a profit. When it was reporting earnings of over $10 million per year in the early 1970's it had losses of over $6 million per year. The losses were disguised and turned into profits by creative and fraudulent practices. Much of the difference between actual losses and reported profit came from creating false insurance policies and selling them through the reinsurance market. But by buying up other profitable companies and combining their real profits with Equity Funding's losses Equity Funding's management was able to bring the losses down to about a half million dollars per year.

It is not known for certain when Equity Funding began creating fake insurance policies but in 1969 they carried out a program of giving their employees "free insurance;" i.e., insurance that the employees did not have to pay premiums for during the first year. Of course, after the free first year the employees could cancel the insurance policy or let the premiums lapse. What made this ploy unsavory was that Equity Funding sold these policies in the reinsurance market knowing full well that they would likely be cancelled. It was later found however that Equity Funding kept paying the premiums for a period of time.

While a number of people within Equity Funding objected to the creation of fake policies none notified the authorities. Some wanted to secure a new job before blowing the whistle that would likely put them out of work. Finally in 1973 the auditors uncovered the scam of fake policies and Equity Funding collapsed. Twenty one people were indicted and 18 of them, including Stanley Goldblum, pled guilty. The other three were convicted in court.

Afterwards people looked back and laughed at a statement made by Stanley Goldblum in a press release made before the fraud was uncovered. Goldblum, commenting on the apparently extraordinary record of insurance policy sales by Equity Funding, said "Quite obviously, this kind of production can only be generated by a professional, thoroughly dedicated group of people."


Raymond L. Dirks and Leonard Gross, The Great Wall Street Scandal

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