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Lessons Bernie Madoff Taught Us
Oversight, due diligence, common sense — these critical elements were all missing.
John C. Coffee, a law professor at Columbia University Law School, has suggested changing a few rules for investment managers to separate temptation from fate. For example, Bernard Madoff legally acted as custodian for the securities he allegedly bought and sold. In a column on CNN Coffee suggests that those roles be separated. Not a bad idea, but I doubt it would have made one whit of a difference: The regulators gave a pass to Madoff because he was a pillar of the community. If they didn’t notice that his assets and well-publicized trading strategy would have dwarfed the options exchanges, how hard would it be for Madoff or others like him to create straw custodians? He outsmarted high-powered consultants who robotically handed over unconscionable fortunes to one person with no verifiable investment process or risk controls. Who needs due diligence when the initials on the black box are BM? Or AIG?
Bernie was the dream catcher to the rich just as option ARMS were catnip to guileless homeowners. He had a mathematically rigorous system for investing — the split strike, a sure thing, no big deal for the computer geeks in the land of financial Shangri-La. Mortgage brokers had a sure thing for the unlucky chumps who were short on cash.
What piece of regulation could really stand in the way of a $50 billion Ponzi scheme when the free markets had declared all risk dead — from mortgages to stocks to credit cards? Only sky-jumping seemed risky over the last few years, unless a Ph.D. could have come up with a way to bundle the jumps and sell them piecemeal, one altitude at a time.
Still, even in the age of risk-free investing this $50 billion sum is unlike any other number that has sauntered across the financial pages. Until now the numbers and players have been typecast bureaucrats, politicians, and financiers — all foils in a financial horror flick. But this number, $50 billion, has a face and a personality. It’s Palm Beach and Hollywood. It’s mostly Jewish and filled with many, many charities. Fifty billion dollars — about 50 times the price JPMorgan paid for the mortally wounded Bear Stearns, a firm that once employed 15,500 people. Fifty billion dollars! Nearly the same size as the securities portfolio Barclay’s snatched from Lehman Brothers after it stumbled into bankruptcy. Bernie lost $50 billion.
For better or worse, Bernie Madoff is likely to become enshrined as the symbol of the current morass, the Great Gatsby of the new millennium who fed on our desire to achieve, be safe, and continue endlessly into the future. Hubris was his currency and the zeitgeist his multiplier.
Wall Street sold with religious fervor its belief in the death of risk to itself, to gullible regulators, 401(k) investors and families seeking bigger and better homes. It was packaged as the ultimate American dream. When everyone awoke and peeled away the layers from the carefully wrapped box all they found inside was the tight-lipped face of Bernie Madoff.
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Nancy Miller is a financial writer living in New York City. She blogs at nancefinance.wordpress.com
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15 Comments
1. seven:We also need to regulate Nigerian scams. I see illegal scams will always be with us. Where were his prospectuses?
Jan 2, 2009 - 6:43 am 2. Jay:Ms. Miller alludes to the risk models used to justify the leveraging. The Black-Scholes model is easily falsified by simple and not so simple statistical analysis of stock rates of return. The B-S model and its extension are at the heart of the options pricing models.
Jan 2, 2009 - 7:39 am 3. simone:The value at risk VAR models are not calibrated from data. The whole tech enterprise was theoretical plus simulations.
The finance and economics professors who claimed that the models were based on sound science should be tried for grand theft. The irony is that the professor did not get rich the way the Wall Street tycoons did.
The lesson is clear the richer the crook the more they can steal.
Jan 2, 2009 - 8:12 am 4. David Thomson:A scam artist like Bernard Madoff is a secondary concern when looking at the big picture. Honest and well meaning men like George W. Bush and Barack Obama are far more dangerous. I do not doubt the sincerity of those who advocate Keynesian economic policies. And yet, they are a greater threat to our financial well being. The current talk in Washington, DC regarding the need for “economic stimulus” is very worrisome. Let’s keep our priorities straight.
Jan 2, 2009 - 9:48 am 5. Ann:More regulation isn’t going to do any good if you can’t get the regulators to regulate, or if the regulators have their own vested interest in what to regulate, or if someone else has a vested interest (think Barnie Frank and Chris Dodd) in preventing the regulators from regulating.
Goes back to the old saw: You can’t negotiate with a liar.
What on EARTH difference is it going to make to put words on paper in long, numbered lists when there is a high percentage of people in the bureaucracies who will actively oppose the implementation of those words?
Are we really still this naive, that we are having this conversation about more regulation as though “more regulation” will matter? Until and unless someone (in the electorate or in power) has the will and opportunity to REMOVE the manipulators, the incompetents and the liars, all of the understanding and “concern” in the world about regulations doesn’t matter one bit.
Jan 2, 2009 - 10:16 am 6. lydia:We also learn it doesn’t work out real well when we think our financial guru is making us all these great returns by insider trading instead of running a Ponzi scheme.
Jan 2, 2009 - 10:28 am 7. Horace Wells:The whole system we have is great. The one wrench in the works is that it attempts to harness the sins of greed and avarice to create wealth and plenty for all. Like all compromises it cuts both ways. So lets be honest cynics for once and stop all this fake piety of trying to merge some redneck cracker version of religion into capitalism and politics. Nobody with any integrity is buying any of the GOP holy roller crap anymore. Ditto with Obama and his clergy pals.
Jan 2, 2009 - 11:00 pm 8. Alan W.:Ms. Miller makes a very subtle point. I.e. everyone loves capitalism when the market is going up. You would have thought we would have learned from the tech bubble, which wasn’t so long ago, that “irrational exuberance” is just that; irrational. The real estate bubble, following on the heels of the tech bubble, has, once again, made us face the ugly reality that if something seems to good to be true it isn’t. That applies to tulips, Florida real estate, a dot com that produces nothing but an IPO, 2 bedroom Capes on 1/5 of an acre selling for $500,000, and consistent 15% returns even in a bear market.
Clearly, Barney Frank, Chris Dodd, et. al have a lot to answer for, but will they ever be questioned? However, the larger point is you can’t regulate the human capacity for greed and stupidity.
Jan 5, 2009 - 7:37 pm 9. Jonathan R:Regulation will not be a panacea. But more — or more importantly — better regulation can be a big help.
Yes, Ponzi schemes will always be with us, but we can hope to catch them before they have so many victims. As Ms. Miller points out, oversight was lacking.
A major goal should be to keep large institutions (AIG, Lehman, etc.) from threatening the system as a whole. A clearinghouse would be a big step in that direction. Futures blow-ups have occurred (e.g. Amarinth, Soc. Gen., Barings, Refco, and others) without creating systemic risk. They did not create paralysis or create systemic risk. The investment banks fought the idea of centralized clearing for CDS and other swaps tooth and nail because the over-the-counter system provided larger margins by creating opacity and barriers to entry. Users of these instruments strongly prefer a clearing system but lack the market (or political) power to force it. This kind of infrastructure is a public good and will only occur if imposed on industry by government.
Regulation will be far from perfect. Markets are imperfect too. And they operate better with adult supervision.
Jan 6, 2009 - 7:13 am 10. JulieW:Greed Greed Greed is what caused this mess.How a guy like Madoff can get away with this for so long is incredible. Is this the tip of another iceberg?
Jan 6, 2009 - 9:19 am 11. Ron H:Am I the only one feeling somewhat gleeful over the Madoff rip-off. I mean, it was only a monthor so ago that America’s elite and intellectuals were chastising us rural folks about being dumb knuckle-draggers not even nqualified to vote. Well, just how truly smart were all these “elite” to fall for the oldest scam in the book? You can bet that it was not blue-collar Americans that got fleeced by this guy. First and foremost, they (rural folks) are simply so much smarter than the upper crust. Eat cake you snobs in Palm Beach and Manhatten!
Jan 8, 2009 - 11:41 am 12. Janet Davis:Nancy Miller has really hit the nail on the head. Great article. Great insights.
Janet Davis
Jan 9, 2009 - 7:34 am 13. ZP:Well, there it is, folks. Any way you slice it, it comes out pure greed. A man’s reach again exceeding his grasp. Or what’s an investment for?
Feb 2, 2009 - 10:04 am 14. Revi:Well, we should remember what they say: If it seems too good to be true, it probably is.
Feb 3, 2009 - 1:37 pm 15. HM:If you watched the SEC testifying on how they investigated Bernie Madoff in 2006 and found nothing wrong, I don’t think you’ll ever feel safe investing in Wall Street again.
Feb 5, 2009 - 6:27 pm