The psychology of scams

For a most interesting discussion of scams and why people continue to fall for them, is found in Stephen Greenspan, Why We Keep Falling for Financial Scams, Wall St. J., Jan. 3, 2009.

Here are a few excerpts:

Financial scams are just one of the many forms of human gullibility -- along with war (the Trojan Horse), politics (WMDs in Iraq), relationships (sexual seduction), pathological science (cold fusion) and medical fads. Although gullibility has long been of interest in works of fiction (Othello, Pinocchio), religious documents (Adam and Eve, Samson) and folk tales ("The Emperor's New Clothes," "Little Red Riding Hood"), it has been almost completely ignored by social scientists. * * *

A Ponzi scheme is a fraud in which invested money is pocketed by the schemer and investors who wish to redeem their money are actually paid out of proceeds from new investors. As long as new investments are expanding at a healthy rate, the schemer is able to keep the fraud going. Once investments begin to contract, as through a run on the company, the house of cards quickly collapses. * * *

The basic mechanism explaining the success of Ponzi schemes is the tendency of humans to model their actions -- especially when dealing with matters they don't fully understand -- on the behavior of other humans. This mechanism has been termed "irrational exuberance" * * *

A form of investment fraud that has structural similarities to a Ponzi scheme is an inheritance scam, in which a purported heir to a huge fortune is asking for a short-term investment in order to clear up some legal difficulties involving the inheritance. In return for this short-term investment, the investor is promised enormous returns. The best-known modern version of this fraud involves use of the Internet, and is known as a "419 scam," so named because that is the penal code number covering the scam in Nigeria, the country from which many of these Internet messages originate. The 419 scam differs from a Ponzi scheme in that there is no social pressure brought by having friends who are getting rich. Instead, the only social pressure comes from an unknown correspondent, who undoubtedly is using an alias. Thus, in a 419 scam, other factors, such as psychopathology or extreme naïvete, likely explain the gullible behavior. * * *

There are four factors in my explanatory model, which can be used to understand acts of gullibility, but also other forms of what I term "foolish action." A foolish (or stupid) act is one in which someone goes ahead with a socially or physically risky behavior in spite of danger signs or unresolved questions. Gullibility is a sub-type of foolish action, which might be termed "induced-social." It is induced because it always occurs in the presence of pressure or deception by other people.

The four factors are situation, cognition, personality and emotion.

Special thanks to Joel Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.