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  • Human Networks and Single Points of Failure

    Posted by Jonathan on December 18th, 2008 (All posts by )

    Ronald Cass’s column about Bernard Madoff is insightful:

    The sense of common heritage, of community, also makes it less seemly to ask hard questions. Pressing a fellow parishioner or club member for hard information is like demanding receipts from your aunt — it just doesn’t feel right. Hucksters know that, they play on it, and they count on our trust to make their confidence games work.
     
    The level of affinity and of trust may be especially high among Jews. The Holocaust and generations of anti-Semitic laws and practices around the world made reliance on other Jews, and care for them, a survival instinct. As a result, Jews are often an easy target both for fund-raising appeals and fraud. But affinity plays a role in many groups, making members more trusting of appeals within the group.

    “Affinity groups” (to use modern marketing-speak) may be particularly vulnerable to fraud because trust works both ways. Group members tend to be more trusting of other group members than of outsiders, and this caution toward outsiders protects the group. But it also means that group members tend to let down their guard against other group members. This is OK most of the time because the extra caution about outsiders keeps predators at bay, and business people who gain admittance to the group are more likely to be trustworthy than outsiders are. However, a sociopath who penetrates the group’s defenses may wreak havoc — the single-point-of-failure problem.

    This is an inherent weakness of high-value and high-trust organizations, and of any high-stakes situation where trustworthiness is defined as passing one test or as passing a series of tests once. More-competent security and intelligence agencies minimize this problem by encouraging employees to be vigilant about security, by compartmentalizing, by testing employees frequently and by creating internal departments whose job is to maintain the security of the organization. (Less-competent security agencies like the TSA do dumb things like creating a “trusted flier” program.) Competent business organizations use audits and other internal controls to minimize theft of money and physical valuables, and contracts to deter theft of intellectual property. Yet even the CIA and FBI are compromised from time to time, occasionally with disastrous results. A country club or other affinity group with wealthy members — Cass, citing Tocqueville, points out that the USA as a society is particularly rich with such organizations — may be as attractive to thieves and con-men as the CIA is to foreign spies. Yet most such organizations and their members are lax about security and by nature encourage trust rather than suspicion.

    Cass is right that this is a problem that won’t be solved by passing laws. Nor would it be solved by the adoption by clubs and religious and civic organizations of stringent security measures. Such organizations, if they become security-minded, tend to create single points of failure. And unlike security agencies they have little control over the behavior of their members. And people who join clubs and other social networks are not usually doing so in order to work toward a common business or national-security agenda that might justify putting up with rigorous security measures, but rather because they want and need to trust people in their communities. The only response that makes sense is for individuals to be more careful about security in their personal and financial affairs, and to diversify their investments along all dimensions. Your social network may remain vulnerable no matter what you do, but you can greatly reduce your risk by not creating single points of failure in your own affairs. Compartmentalize your assets. Don’t put all of your eggs into one basket.

    (via Tom Smith)

    UPDATE: The game-theory angle.

     

    12 Responses to “Human Networks and Single Points of Failure”

    1. Shannon Love Says:

      The same thing happens in politics.

      I think this is why so many people had trouble believing that Bill Ayers was such an extremist. He had wormed his way into networks and institutions that people trusted. People assumed that Ayer’s had been vetted and found to have reformed. They just couldn’t believe an unrepentant Maoist terrorist could be knocking around Chicago politics or be a prominent member of America’s education establishment because they assume that someone would have called him out if he was still a murderous extremist.

      Similarly, people have trouble believing that politicians they like are corrupt because they assume that the party and media will have vetted them.

    2. ElamBend Says:

      Time and and again through my work in real estate, I have seen people put up with bad service, bad advice, and plain chicanery simply because they preferred to deal with someone within their own affinity group (in my case, specific ethnic groups), even when the services provided by ‘outsiders’ came from nationally recognized brands (like banks or mortgage groups).

    3. renminbi Says:

      It is good to trust people,but it is better no to.

    4. renminbi Says:

      …not to.

    5. wordsmith96 Says:

      Ronald Reagan is quoted as saying about the Soviets, “Trust but verify.” I agree.

    6. david foster Says:

      An excellent point about trust networks/affinity groups. Also, people should understand that an individual’s skill as a salesperson is not likely to highly correlated with his investing prowess.

    7. Ron Coleman Says:

      In the long run we would not expect this generalization to be true unless the actual payoff were not higher by working within affinity groups. In fact the generalization is far too broad — in general, and contrary to the assertion here, especially as applied to Jews, who are demographically among the most, not the least, sophisticated consumers and investors. I speak from practical experience of course as a professional service provider actively involved in and part of this community.

      While as in any network people are more likely to start with those they know and have an affinity for when seeking providers of goods and services, there is virtually no substitution within this subculture of tangible value for intangible. Or have you heard about the Jews?

      Furthermore, Cass does not seem to acknowledge that the phenomenon of trust within an affinity group is double-edged. Betrayal of that trust carries a substantial non-economic, i.e., social cost. There is no question, however, that once someone decides he is willing to bear the risk of incurring that cost — or irrationally convinces himself that he is so smart (or have you heard about the Jews?) that there is no such risk — there is an opportunity for short term exploitation.

    8. Robert Schwartz Says:

      I know two members of the Palm Beach Country Club who were never contacted by the Madoff gang. They both had the reputation of being truculent. Madoff clearly wanted to avoid the sort of people who might start asking questions.

    9. Jay Manifold Says:

      Instalanche in progress …

    10. Anonymous Jew-Hating Moron at IP Address 24.126.107.51 Says:

      “The Holocaust and generations of anti-Semitic laws and practices around the world made reliance on other Jews, and care for them, a survival instinct. As a result, Jews are often an easy target both for fund-raising appeals and fraud.”
      That’s precisely right, blame the Nazis and anti-semenites that wealthy Juice are not content with 11% one could expect from passive management of index funds.
      No, the YHVH’s chosen own pets deserve better, but it has to be done on the hush-hush and through a Special Connection. Bernie Madoff knew that very well.

      Oh well, there’s always hiring season for Wal-Mart greeters.

    11. newton Says:

      I’ve seen the same kind of fraud committed among other groups – Evangelical Christians and Baptists, for example. I even heard about a scam managed by a dentist and his wife (especially the wife) in the NY/NJ/CT area years ago. I’m sure it happens in every ethnic and religious group out there – and even among groups that have nothing to do with religion or ethnicity, but are people “trusted by the community.”

      In all cases, those who invested on it trusted them because they “knew” them personally or as an acquaintance, all of them were defrauded spectacularly by the scammers, and all of them were seriously punished by the authorities – jailed, their properties confiscated, or made to pay hefty fines for compensation, however modest the amounts stolen.

      It is easy for people to fall for scammers when they’re “closer to home”, so to speak.

    12. Kurt Brouwer Says:

      There is one simple remedy for a Madoff type scandal — having an independent custodian. Madoff & Co. acted as their own custodian so they could produce statements that purported to show how much a given client had. Now, of course, it turns out those statements were false.

      If you use an investment advisor, just make sure the assets are in an account at Charles Schwab & Co. or TD Ameritrade or Fidelity etc. The custodian holds the assets and values them each month and gives you a statement. The investment adviser makes investment decisions, but does not hold the assets. In this arrangement, which is common in the industry, you avoid any possibility of a Madoff type fraud.