The Explainer: A Legacy of Fraud

That was Niall Ferguson speaking at the London School of Economics, explaining how a gathering of bankers, irritated over his warning that an economic crisis was at hand, petitioned the organizers of the conference he appeared at to show Mary Poppins next time around. That story was the genesis of his bestseller, “The Ascent of Money.”

Ferguson pointed out that a lack of knowledge of financial history has been one of the prime causes of our present global economic crisis. Tonight we’re going to adapt his thesis and suggest to you, that a perennial problem in the boom and busts that clog our headlines is a profound ignorance on the public’s part, of the dangers of politicians, bankers, and regulators being too cozy with each other. A problem we’re seeing at home and which is on spectacular display abroad, too.

Tonight: a legacy of fraud. I’m Manolo Quezon. The Explainer.


I. Deposit-gathering zombies

Last year the Bangko Sentral padlocked 13 rural banks belonging to, or affiliated with, the Legacy group of companies, alleging unsafe and unsound banking practices, insufficient assets to cover liabilities, and poor liquidity. The Legacy banks attracted depositors with promises of 20 percent interest.

According to the Inquirer, the  genesis of the Legacy group’s scheme was the “Legacy Savings Program” in the first bank Celso de los Angeles bought, Rural Bank of Parañaque, which offered was a five-year, double-your-money time deposit scheme with additional come-ons such as free insurance.

And, unlike most banks where you have to go to a branch to talk to staff and set up an account, Legacy basically engaged in direct selling to get deposits. Which is against banking rules.

That attractive rate of interest got people to deposit their money in Legacy’s banks. Now a bank makes money on deposits by taking your money, lending it to others, and charging a rate of interest on the loans higher than the interest it’s promised its depositors.

But if you offer a freakishly high rate of interest, that means you have to charge an even more freakish rate of interest on loans from deposits; a difficult thing to do.

But what if you engage in abnormal banking practices? That is, what if you use your banks, not as real banks, but instead, as a means to gather deposits which then aren’t loaned out, but redistributed to pay interest to your original depositors?

We’ve seen such schemes before, in previous episodes of this show. They’re called Ponzi Schemes.

Now a Ponzi scheme works so long as everyone thinks everything’s fine and dandy and new deposits come in to cover the old depositors expecting abnormally high returns on their deposits.

Indeed, as with the stock market, a clever Ponzi scheme is guaranteed to grow as investors interested in getting rich quick schemes wonder if they aren’t being stupid in passing up a scheme that’s too good to pass up.

In “The Ascent of Money,” Niall Ferguson said there are five steps in the boom and bust of a stock market bubble, in which individual stocks or a bunch of stocks and thus, the market, artificially goes up in value, until people realize there’s no way earnings will match expectations, and everyone stampedes away from the stock or out of the market.

Ferguson writes, all bubbles go through the followed five stages:

1) Displacement, as economic change brings a chance for extraordinary profits;

2) Euphoria, as investors take advantage of the opportunity,

3) Mania, as novices, crowds and swindlers rush in;

4) Distress, as insiders see their prospects for profit declining because of the mania and start selling; and

5) Revulsion, as all stampede for the exits.

Ferguson says that what helps stock market bubbles, and for our purposes tonight, what might have helped boost Legacy’s stock or reputation among investors, is either official connivance, or indifference, to a growing bubble, or outright fraud and manipulation by insiders, or both.

The Philippine Daily Inquirer recently published a four-part report on the Legacy Group and why it’s banks failed.

Part I was titled “Legacy banks’ double-money scheme: Former PDIC chief was alerted 3 yrs ago.” It tells the story of a phone call. Former Prime Minister Cesar Virata, then president of the Bankers Association of the Philippines, called up Ricardo Tan, then President and CEO of the PDIC which is  the government agency that insures all our deposits. If you remember our episode on the Great Depression, deposit insurance is a legacy of the American New Deal, to protect the middle and working classes and to help ensure confidence and prevent bank runs during times of financial panic.

Virata and other bankers were worried over banks offering double your money schemes to depositors, sometimes with cars as incentives. When the PDIC and the Bangko Sentral started looking into these too good to be true schemes, all trails kept leading to one man: Celso de los Angeles, who is now mayor of Santo Domingo, Albay , and who’d been in hot water over banking irregularities once before, in the 1980s.

According to Tan, investigators said that de los Angele’s 13 rural banks were to have  “fictitious deposits, [rotating] collateral from one bank to the other, unsafe and unsound [banking practices] and improper documentation.”

This worried the PDIC which already had an exposure of 4 billion pesos as of 2006, when Tan left PDIC.  In 2007, according to the Bangko Sentral, the banks whose deposits the PDIC insured were found to be insolvent—that is, bankrupt. By the time the banks all closed, they’d racked up an exposure of 14 billion pesos. That’s the amount PDIC would be obligated to pay depositors to cover their accounts.

Part II, was titled “Nograles invited banks’ prober to dinner”.  It tells the story of how The Philippine Deposit Insurance Corp. (PDIC) started investigating what is now known as the Legacy Group rural banks four years ago during the term of then PDIC president Ricardo Tan.  The report said that Tan was asked out to dinner in 2005 by then House Majority Leader Prospero Nograles, through his “subaltern” George Regalado. At the dinner, where Celso de los Angeles made an appearance, Speaker Nograles allegedly interceded on behalf of the Legacy group, asking Tan to “go easy” on Legacy because it had helped fund the campaign of Vice-President Noli de Castro. The Speaker subsequently strongly denied any wrongdoing while the Veep says that he did receive campaign support from de los Angeles.

Part III was titled “Legacy owner on BSP’s 1984 watch list”. It pointed out that Celso de los Angeles had been involved in rural banking before. He was connected with three banks, Thrift Savings and Loan Association, Federated Thrift Bank, and Rural Bank of Calumpit, that the Central Bank ordered closed in 1984. Celso de los Angeles ended up facing 28 cases of estafa, none of which prospered in the courts. He was blacklisted by the Central Bank.

In 1999, de los Angeles reentered the banking industry by buying a controlling share in the Rural Bank of Parañaque  but it wasn’t until 2002 that he formally asked the Bangko Sentral to take him off its blacklist. To facilitate his Legacy group’s getting a Bangko Sentral OK to operate banks, he cleverly engineered removing his name from appearing on the boards of directors of any of the banks belonging to the Legacy group.

And  finally, Part IV, titled “The Legacy: Broken hearts, lives, dreams,” cataloged the human cost of the bank failures.

Now if the Legacy Bank were simply a straight forward Ponzi scheme, you’d have the typical story of the rise and fall of yet another investment scheme that suckered big shots and small fry and left most of latecomers ruined.

But what makes the Legacy scheme even more interesting –and shocking- is that it involed a key concept for tonight: Moral Hazard.

moral hazard

noun Economics

lack of incentive to guard against risk where one is protected from its consequences, e.g., by insurance.

Every investment represents risk, and in our episodes on the stock market and the Subprime Crisis, among others, we looked at how people try to factor in risk when making investments. Except that you can’t eliminate risk altogether.

Or can you?

It’s alleged that Legacy tried to make investments, for insiders at least, risk-free, by using deposit insurance as a government guarantee to cover any private sector risk depositors might face.

Here is how a congressman, Raul Daza, says it was supposed to work:

 “I myself was offered by one of these banks high interest rates and a brand-new Toyota Camry, provided that I deposited a huge amount and split it into several accounts of not more than P250,000 each so I would be covered by the deposit-insurance law. I found the offer too good to be true.”

When we return, why untangling the Legacy mess took too long. A story that, it seems, is primarily all in the family, literally and politically.


II. Own it to rob it


That was a CBS News clip on the spectacular story of a flamboyant Texas billionaire who fled the USA after his banks collapsed, causing bank runs in Mexico and the Caribbean and an investigation into how he might have profited on the bank failures to the tune of 8 billion dollars.

As you can see, it’s an altogether too familiar story: a flamboyant millionaire who’s cozy with powerful officials, and who manages to make billions but leaves others to clean up the financial mess he leaves behind.

By way of Ferguson’s book, comes this startling phrase:

“The best way to rob a bank is to own one”

And Ferguson tells us that this was also the title of William K. Black’s 1998 college thesis at the University of California, Irvine, and also the title of Black’s 2005 book.

It’s a real phrase.

On June 13, 1987, William Crawford, the California savings and loan commissioner, testified before the US Congress on the growing Savings & Loan crisis of the 1980s.

Would you like to read what he said?

“We build thick walls, we have cameras, we have time clocks on the vaults; we have dual control—all these controls were to protect against somebody stealing the cash. Well, you can steal far more money, and take it out the back door. The best way to rob a bank is to own one.”

The question everyone’s asking is how could Legacy have gone boom and bust without officialdom noticing and preventing it in time.

And this introduces us into the second half of this show, which asks you to ask yourself, why is it that our institutions seem to have such a hard time getting to the bottom of cases of fraud.

A clue’s provided by Apolinario Mabini.

Faced by a proposal by members of the Malolos Congress to float a loan for the Republic, Mabini opposed it on the principle that members of Congress proposing a loan –and a loan only they, as the richest sector in Philippine society were prepared to subscribe to- were essentially creating government debt to enrich themselves by means of the interest they’d earn on bonds on that debt.

Let’s give the industry and the institutions involved in the Legacy problem a human face.

These are all high-value face cards in the economic deck of our country. You will have to decide which ones are Jokers.

Here you have the Bangko Sentral. Our face card is Tetangco, the Governor. When the PDIC told him it needed a loan, the loan required was so big, he referred the matter to the monetary board.

Here you have the PDIC. It needs money to prevent its going bankrupt in order to pay the deposit insurance on the Legacy bank deposits. It’s headed by Jose Nograles.

Here you have the Monetary Board. Among its members is Nely Favis-Villafuerte. More on her, later.

Here you have the House of Representatives. It’s leader is Speaker Prospero Nograles. He happens to be the brother of Jose Nograles, head of the PDIC.

And among the members of the House which made a lot of noise investigating Legacy, in which its own Speaker, Prospero Nograles was an investor and who possibly convinced his fellow congressmen to invest, too,  is a Bicolano congressman named Luis Villafuerte, whose wife happens to be Nely Favis-Villafuerte, who sits on the monetary board, and who is one of those who decides if it should loan the PDIC, headed by Jose Nograles, money to pay the Legacy depositors, who might possibly include no less than Prospero Nograles among the beneficiaries who, as a congressman testified, had been advised to limit their deposits to chunks not exceeding 250k, because that was the amount covered by PDIC insurance in case the banks went bust.

And here, last but not least, you have Celso de los Angeles, the object of interest of all these institutions. Now he happens to be a contributor to the Veep’s campaign. He also happens to be a business partner of the Speaker. He is a mayor in Albay, affiliated with the administration and it’s ruling coalition.

Now in case anyone forgets, when did the Bangko Sentral and the PDIC start getting nervous about the way Legacy was doing its business? 2006. When did the BSP conclude the Legacy banks were bankrupt, and so, would mean the PDIC would have to bail out the depositors? 2007.

At this point, the Bangko Sentral tried to place some of these banks under receivership but the rural banks, acting in together, were able to block the BSP by means of a Temporary Restraining Order (TRO) from a Manila Regional Trial Court and a Court of Appeals division that then took its sweet time on the BSP’s urgent appeal for a reversal of the TRO.

But that’s merely circling your wagons. Eventually the cavalry has to come to the rescue.

Where would the cavalry come from?

Apparently, according to this newspaper column that appeared in September, 2008, from the House of Representatives.

House Bill 3827, titled “ An Act Suspending the Required Capital Adequacy Ratio Prescribed by the Bangko Sentral ng Pilipinas to All Rural Banks for a Period of Two (2) Years,” was filed.

It was sent to the Banko Sentral and the Rural Bankers Association for comment. The Rural Bankers Association opposed the bill, in these words.

It said that the Capital Adequacy Ratio current required by the BSP, which means you have to have enough capital available to cover at least a significant portion of your obligations,

“ is the bedrock of prudential regulation. It serves to protect depositors and promote the stability and efficiency of the financial system. The proposed suspension of the CAR, while temporary, may create an environment for an erosion of this bedrock; it may unintentionally open a window for behaviors posing moral hazard detrimental to the rural banking sector as a whole. This, the suspension of CAR, may well be a set back for the increasingly improving and growing rural banking sector.”

Aha. There’s our concept for the day –“Moral Hazard.” The Banko Sentral, in commenting on the proposed bill, told the House it was proposing a reckless suspension of regulations:

“The proposed prudential safeguard contained in House Bill 3827 for banks to just maintain a ‘condition of liquidity adequate to protect the interest of depositors and creditors’ does not address the solvency issue and cannot therefore be relied upon to adequately protect depositors and creditors in the long run. Liquidity and solvency are two different things. While the former ensures that on a regular basis the bank is able to meet the withdrawals of its depositors and pay its obligations as they fall due, the latter ensures that the value of the bank’s assets are at least equal to its liabilities plus a sufficient buffer for contingencies. A liquid but insolvent bank means that it only survives because of continued flow of deposits and borrowings that ultimately cannot be paid. And the longer such a situation is allowed to persist, the bigger the potential hit for the public when the music finally stops.”

That, it seems, was the end of that. How could the House continue to push for a law that the BSP and the rural bankers themselves said would cause more problems?

But then you also know what the House finally proposed, and achieved –raising the coverage of deposit insurance from 250 to half a million pesos.

The cavalry formation was first spotted in October, 2008, when House Bill No. 5315 sponsored by Speaker Prospero C. Nograles and Congressman Jaime Lopez  proposing the raising insurance coverage on deposits from 250 to half a million pesos, was endorsed by Jose Nograles, head of the PDIC and brother of the Speaker.

Jose Nograles said he backed the Prospero Nograles bill because the bill in turn was viewed as part of the so-called Financial Defense Package proposed by Governor Joey Salceda of Albay, where Santo Domingo town happens to have another administration stalwart, Celso delos Angeles, as its Mayor.

But unfortunately, by December of 2008, the game was up.

Now if you’d like to read more, visit Niall Ferguson’s website,

And we’ll have links to some of the articles we’ve quoted tonight. But when we return, we’ll ask, as this Inquirer editorial asked:

How on earth can the public and innocent depositors, expect our institutions to sort out this ethical and financial mess?


My view


Overlooked, as the House of Representatives made noises about the collapse of Legacy, was how their leaders and members were stuck in an inescapable conflict of interest. Members of the House tried to buy time for failing rural banks, then proposed raising PDIC coverage for depositors that included their own members in banks due to collapse, and then faced innumerable questions about whether a Monetary Board with a member married to a mortal enemy of the Nograles, could be expected to deliberate objectively on loaning money to the PDIC.

These are just some examples of why too many people all too closely intertwined make for bad laws, dysfunctional institutions, and a public left holding the bag when the poop hits the fan. Harry Truman used to say the buck stops here, pointing to the presidential desk. But where, in our country, does the buck actually stop?

Manuel L. Quezon III.

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