The Madoff Problem
Bernard Madoff will plead guilty, sparing the nation the soap opera drama of a trial. But while the Madoff story has gotten a lot of coverage, I think the broader Madoff problem in the economy has gotten very little attention. A complicated modern economy operates largely on issues of branding and trust. You don’t personally verify what’s in the can labeled “Diet Coke,” you assume that the Coca Cola company puts more value on maintaining its brand and the consistency of its product than it would put on the possibility of earning fifty cents by selling you a bum can of soda. People assume that a well-regarded investment manager isn’t ripping his clients off. But Madoff was ripping his clients off. And it seems that Allen Stanford is also a fraud.
I think a typical agent with bounded rationality and the capacity for heuristic reasoning needs to rethink a lot of things in light of these events. For one thing, where there are two crooks there are likely to be more. For another thing, the regulatory agencies charged with monitoring such matters don’t seem to have done a very good job. For a third thing, the financial press doesn’t seem capable of breaking major news stories. And for a fourth thing, it’s generally the case that where there are illegal scams, there’s other behavior that, while not necessarily rising to the level of a criminal fraud, is also basically a scam.
Under the circumstances, is it so surprising that banks are having trouble raising private capital? That nobody wants to invest in anything other than T-bills and FDIC insured accounts? Part of what’s changed is the business outlook, sure. And part of what’s changed is people’s attitude toward risk. But in addition to becoming more risk-averse, I think people have lost confidence that the brands and institutions governing the financial system actually work. Beyond stimulus, beyond bank rescue plans, I think this is another factor the world is going to have to address to get to recovery. In part, that’ll be the responsibility of the Obama administration and the congress. In part, it’ll be the responsibility of foreign governments. But in part it’s the responsibility, I think, of big players in the “real” (i.e., non-financial) economy who have a strong interest in ensuring that some new, credible financial institutions come into being or that existing credible ones grow in size and prominence.
32 Responses to “The Madoff Problem”
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March 11th, 2009 at 9:18 am
But in part it’s the responsibility, I think, of big players in the “real” (i.e., non-financial) economy…
Which, of course, means throwing everything at the war against unions.
March 11th, 2009 at 9:21 am
Re Matthew’s comment “it’s the responsibility, I think, of big players in the “real” (i.e., non-financial) economy who have a strong interest in ensuring that some new, credible financial institutions come into being ”
—————-
Well, yes. Con Artists do have to come up with new cons once the rubes wise up to the old ones.
March 11th, 2009 at 9:23 am
Although the Big Con known as the Democratic Party has had some pretty long legs.
As Barnum said, there’s one born every minute.
March 11th, 2009 at 9:47 am
I kind of love that when the abyss winks back at Matt, he hurries to his computer to raise an imperious finger and ask for more legislation.
Time to take the credit system back to basics and start marking the heads of the debtors.
March 11th, 2009 at 9:51 am
every post on this subject–and indeed every post on the current meltdown of the economic system, should include the 2003 photo of republican legislators and republican regulators gleefully posing with a chainsaws and loppers as the “cut red tape”, i.e. gut the regulations that held some of this stuff at bay.
http://2.bp.blogspot.com/_pMscxxELHEg/SSj9kLPDgvI/AAAAAAAAD1U/b7uNjYr5p-w/s320/chainsaw.png
March 11th, 2009 at 9:51 am
For a third thing, the financial press doesn’t seem capable of breaking major news stories.
Well, let’s make a distinction between CNBC and the FT and the news section of the WSJ. You should read them more. I’m not saying they are perfect, but still there is a lot of good there.
March 11th, 2009 at 9:55 am
Re Don Williams
There was an article in the Jerusalem Post a few days ago which claimed that the amount of money stolen by Mr. Madoff was considerably less then the 50 billion figure being bandied about. Of course, even 15 – 20 billion is a pretty good scam.
March 11th, 2009 at 9:56 am
What really gets me is that these guys were running Ponzi schemes. Complex financial fraud this isn’t. You could solve all this with stricter auditing requirements, right?
March 11th, 2009 at 9:56 am
I wonder how far this Madoff-induced loss of trust extends. I for one was never at risk of being caught up in a Madoff scheme or a Sanford scheme — my potatoes are far too small. Also, I don’t think the kind of trust that Madoff or Sanford relied on — which often involved an actual network of people vouching for his veracity and reliability — is the same as the trust I have in my Diet Coke. I’m sure there’s an element of “tsk, tsk, ain’t it a moral shame?” in the public response to Madoff/Sanford etc, but there’s also a lot of “Lord, what these rich folks will get up to! Can youj believe it?” — class struggle humor and pornography, in a way.
March 11th, 2009 at 9:57 am
I agree completely with Matt here, and indeed, he hasn’t gone far enough. The tail-chasing debate over “nationalizing” the debtor banks would be elucidated by criminal prosecutions: some of these banks’ activities, both in their strategies for managing debt via swaps and in marketing them to investors, arguably constituted fraud. If some banks’ boards can’t muster a quorum because too many executives and directors are in jail, then those banks have to go into receivership.
Or is that “socialist” thinking?
March 11th, 2009 at 10:08 am
I’m not shocked this sort of thing happens in the US, we run our schools like an experiment in social Darwinism. Violence, on an ever escalating scale, was always going to be the result of this. Allowing the strong to brutalize the weak has the effect of creating terrorism in all environments. When it’s condoned and even applauded by those in charge, that violence loses it’s narrow focus on individuals and spreads to an institution and all it’s members in general.
I don’t get this in Denmark, though. Are there schools really that shitty?
March 11th, 2009 at 10:09 am
Wrong place, argh
March 11th, 2009 at 10:10 am
How do you credibly claim to be different from Bernard Madoff? Exactly what evidence can you show that you aren’t like him, which is different from the “evidence” he showed that he wasn’t doing what he, in fact, was doing?
March 11th, 2009 at 10:23 am
Chris: For one, Matt’s not, uh, selling anything. He’s paid to write his opinions, which he certainly is factually doing, and we’re reading them for free.
Madoff, on the other hand, was clearly not actually investing money in the things he said he was investing in, which could have been easily verified had anyone bothered to.
March 11th, 2009 at 10:49 am
I’m perpetually confused by the libertarian morons who advocate on behalf of financial darwinism. They make ludicrous arguments that financial systems are basically self-organizing and even without oversight, it’s in everyone’s best interest for them to function honestly and so they will.
Anyone who’s actually studied evolution knows that un-governed systems don’t work that way. They don’t proceed to optimal outcomes–not even close. I mean, just look at the fire ecology of Australia. It’s perfectly stable over the long haul, but in the short run it swings through spectacularly destructive extremes. Or heck, Chimpanzees. They’d be a lot better off as a group if they weren’t so incredibly violent, but it still never happens.
Anyway, it’s just stupid to posit that Wall Street will be self-policing because it’s in Wall Street’s best interest to effectively police itself. Aside from the empirical evidence that Wall Street never does this effectively (and, in fact, does this least effectively in times when we’re pouring more and more national resources into it as we did in the 1980’s to the present), there’s no theoretical reason to believe this. And, in fact, the Darwinism that libertarians hew to suggests it should NOT happen. It’s survival of the fittest, not the best. Big distinction.
March 11th, 2009 at 11:29 am
in addition to becoming more risk-averse, I think people have lost confidence that the brands and institutions governing the financial system actually work.
Ding, ding ding, give this man a prize.
You might add to your list of the reasons why the (deserved) loss of cedibility of the Bond rating agencies.
March 11th, 2009 at 11:30 am
I would argue that the problem is way bigger than Madoff.
I see a failure of the democracy experiment. Our system of government is unable to “promote the common welfare”. Instead we get the triumph of special interests on a regular basis. Wall Street gets to use public money to play casino games, take the winnings and leave us with the losses. AIPAC gets to make the US a tool of Israel. Insurance companies get to charge us for a service they then regularly deny, and at higher cost than a public system.
It is also a failure of the leadership class. The most competent people are truely a “me” generation. Lawyers scheme with each other to generate billable hours, doctors perform unnecessary procedures, politicians become K Street whores. We have Supreme Court justices like Scalia and senators like Schumer or Gramm. A total mess.
It appears to originate with the “greed is good” credo. Maybe the beginning of the end was the SCOTUS decision in Buckley v. Valeo. If money is deemed equivalent to speech, then this is apparently what we get.
And unfortunately, it seems that we deserve it.
March 11th, 2009 at 11:47 am
The old propaganda was that protestant countries succeeded in becoming prosperous because their capitalists cultivated virtue and deferred reward. Their schools prepared leaders for service and self-abnegation, not self-advancement.
That was the drill — maybe people didn’t follow it, but it was the official ethos. Well, that’s over with. Then we had an experiment in running things strictly on the basis of individualistic self-interest, Mario Puzo-style. T he results have been what one could have predicted.
March 11th, 2009 at 12:17 pm
Don’t you read Reason magazine, Matt? The market polices itself. Ayn Rand said no company would ever lie, cheat, or steal because it conveys no long-term benefits to that company, and of course the motives of agents are always aligned with those of companies, and short-term objectives are always aligned with long-term objectives, and people are always rational. So…no regulation.
You’re not suggesting you’ve detected a flaw in all of this, as Alan Greenspan recently did, are you? Next you’ll probably explain how free markets are actually government inventions or something. Collectivist! Hiss.
March 11th, 2009 at 12:38 pm
There is no financial press in this country, just a marketing mechanism for selling risk to people who really couldn’t afford it. These shills are now reduced to yelling at people for being stupid enough to buy what they were selling, and complaining about Jon Stewart.
March 11th, 2009 at 12:56 pm
Mmmm … trust. Like being able to believe an information source is capable of identifying a geographic location correctly to within 500 miles or giving enough of a damn to correct an error after it’s been pointed out dozens of times? Maybe if Matt had badmouthed an “allied” centrist policy outfit in the post it would have been cleaned up by now.
March 11th, 2009 at 12:58 pm
c’mon matt, this post is valuable and your reasoning is correct, but you don’t need to show off that harvard vocabulary
March 11th, 2009 at 1:26 pm
And tort law, baby! C’mon, release the trial lawyers – one or two little changes in procedure and you won’t be able to recognize the corpses that used to be these guys.
March 11th, 2009 at 1:31 pm
c’mon matt, this post is valuable and your reasoning is correct, but you don’t need to show off that harvard vocabulary
I’m just confused about how someone who can deploy the word “heuristic” correctly can mess up “your” and “you’re” as often as Matt does.
That said, I think he hit the nail on the head.
March 11th, 2009 at 3:39 pm
I find it interesting that Madoff and Stanford were both big Democratic Party contributors. 88% of Madoff’s and 78% of Stanford’s contributions went to Democrats
http://www.opensecrets.org/news/2008/12/madoff-and-company-spent-nearl.html
http://www.opensecrets.org/news/2009/02/obama-ney-and-delay-also-among.html
Big money, too
March 11th, 2009 at 3:40 pm
People assume that a well-regarded investment manager isn’t ripping his clients off. But Madoff was ripping his clients off.
Au contraire. The people who invested with Madoff knew that his returns were too good to be true, but kept with him because they assumed he was an insider trader whose reputation meant he wouldn’t get caught, rather than an old-school Ponzi schemer who cooked the books.
Now, Daniel Davies suggests that the crunch is basically a “work-to-rule” by the people in the global financial system: that’s to say, a moratorium on the the turning-blind-eyes and corner-cutting (and nod-and-wink dealing) that is a tacit part of greasing the wheels.
March 11th, 2009 at 3:54 pm
@#14: Sorry, I wasn’t aiming that remark specifically at Matt. I meant, how does a generic investment manager type convince his customers that he’s different from Madoff? If you are a broker and want to convince your customers that you are not Madoff, how do you do it? You can’t point to your ratings – everyone knows the raters are crooked bastards who rate you whatever you bribed them to rate you. Your books look the same cooked as uncooked (except to a thoroughly qualified auditor who spends weeks on the problem, and even then, the answer is only as good as the *worse* of the auditor’s competence and honesty). Even the SEC isn’t reliable because of political pressures on it.
That’s the kind of institutional trust that has broken down, and I don’t really see how you rebuild it.
March 11th, 2009 at 5:42 pm
“The government has asked the district court to issue an order authorizing the forfeiture of up to $170 billion from the fraud” – Today’s NY Times story.
That’s the latest number the government is looking to reclaim from Madoff. Wee bit more than the Jerusalem Post number above.
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