More Failure of Imagination
A propos of yesterday’s post, I came across a blog post the other day about the Madoff scandal which I found quite interesting. Madoff, as anyone not living under a rock for the last few months knows, was the famed investor whose ponzi scheme milked America’s rich and famous out of nearly fifty billion dollars. The fact that this scheme went undetected for so long (despite the efforts of some to sound the alarm) and was only uncovered when his own sons turned him in, is, to put it mildly, a rather bad screw up for the S.E.C. In fact, as Robert Murphy notes, if you had asked people beforehand to come up with a situation where the S.E.C. screwed up so badly that it would be abolished, they probably would not have come up with something nearly as bad as the Madoff scandal. And yet, the response to these failures at the S.E.C. will undoubtedly be for it to be given more money, more power, and an even greater mandate to root out scams in the investment world.
No doubt for some the problem here is not so much a failure of government as a failure of Republican administrations. If the S.E.C. wasn’t doing its job, it must be because Bush gutted the agency, or filled it with ideological hacks who refused to enforce the law.
Of course, under Bush the S.E.C.’s budget more than doubled, but assuming the above is right, it does raise a rather interesting question. If having the government do something (say, regulatory oversight) only works when you have committed, capable people at the helm, and if Republican administrations are liable to fill the relevant positions ideological hacks, then isn’t that a fairly compelling argument for not putting the government in charge of things? I mean, like or not, if history is any guide Republicans are going to be in charge around half of the time, right? Would you want nice, liberal Dr. Jekyll managing your retirement, or health care, or making sure you don’t get ripped off, if you knew that he spent half his time as that right-winger Mr. Hyde? I know I wouldn’t.
When I made this argument on another site recently, he responded by saying that “half a loaf was better than none” and that even if government enforcement was going to be screwed up at least half the time, in the absence of government oversight, there would be no one to keep people from getting ripped off by financial scams.
Now Madoff’s scam was what’s called a Ponzi scheme, named after the investment scam perpetrated by Charles Ponzi in 1920. Ponzi was operating prior to the creation of the S.E.C., so it should not be surprising that his scheme went on longer and bilked investors out of far more money than Bernie Madoff was able to do.
Except, of course, that that isn’t true. Unlike Madoff, who managed to get $50 billion out of investors over the course of nearly a decade, Ponzi’s scheme was uncovered after six months and even in inflation adjusted terms he stole far less money than Mr. Madoff. Nor did the scheme run aground because, like all such schemes much, Ponzi eventually ran out of investors. His scheme could have and would have gone on much longer except for the fact that, on July 26, 1920, the Boston Globe began a series of articles asking questions about the validity of his system. These questions raised suspicions among investors, who began to ask questions of their own, which quickly brought down the whole house of cards.
Which brings me to the blog post I mentioned at the beginning of this entry (forgotten about that, hadn’t you?). It begins thus:
Ray Pellecchia is right: if Harry Markopolos had taken all of his evidence about Bernie Madoff and put it on a blog, instead of submitting it to the SEC, there’s a good chance that would have been the end of Madoff right there.
Comments are closed.
To me this is probably the best thing about the blogosphere. If one person spent a week trafficking various high-profile financial blogs leaving comments with this type of evidence or started a blog, it seems likely that that would have been enough to start the snow ball.
Let’s not plug imagination as an unmitigated good, though. After all, Madoff was very imaginative.
Ray Pellecchia is right: if Harry Markopolos had taken all of his evidence about Bernie Madoff and put it on a blog, instead of submitting it to the SEC, there’s a good chance that would have been the end of Madoff right there.
Mostly likely not.
There is a saying that if I owe the bank a $1000 and can’t pay, I have a problem. If I owe the bank $100,000,000 and I can’t pay, the bank has a problem. Certainly there is a relationship between regulation and moral hazard. No one denies it. It is still the case, to put in economics giberish, that there are significant negative externalities in the cases of large defaults.
And yes, Cox’s leadership of the SEC has been abysmal. It is still preferable though to having people play with billions outside any oversight. Additionally, Madoff was found out because people were taking redemptions; the rest was an attempt to keep his sons out of jail.
Ideally, yes, the government would be in charge of far less. Subsidiarity demands we reject much of the current Democratic agenda, and much of the previous Republican agenda.
Then when the government IS in charge of something, there would be a much higher expectation of excellence and a much greater level of oversight and transparency.
This is a little off the mark. The issue is not how much funding the regulator gets; the idea is the underlying regulatory philosophy. In the US and the UK, they went very much for light-touch regulation. It was a philosophy that self-interest would make financial firms police themselves. This was not the case. As Willem Buiter brilliantly put it: ““Self-regulation stands in relation to regulation the way self-importance stands in relation to importance.”
The “blind eye” philosophy was all about maintaining the competitive advantages of financial centers like New York and London, and in the US, you had the added problem of a true belief in the inerrancy of markets by policymakers; at least the Brits were more cynical.
MM makes a valuable point. In the wake of Enron, the Bush Administration did propose needed staffing increases from 2002- 2005. Chairmen Leavitt, Pitt and Donaldson also were attentive to responding to the employee moral and turnover issued that plagued the agency in those years.
Chris Cox represented a change of course. Staffing levels declined, morale started heading downward again and employees were ordered to regulate and investigate with a light touch, needing their superior’s permission to engage in any aggressive investigation.
S.E.C. should be given more money, more power, and an even greater mandate to root out scams in the investment world as well as competent leadership committed to the agency’s mission. The CFTC should also be merged into the SEC.
Abolishing the SEC because of Madoff would be like abolishing the Police Department because of a crime spree.
The problem with these sorts of thought experiments is that it’s simply false to assume that our current socioeconomic structures can be easily split into, on the one hand, the Government, and on the other hand, the Market. If large-scale government entities simply ceased to exist, they would be replaced, not by a bevy of small business entrepreneurs (those fairies that haunt the dreams of neoliberals) but by already existing enormous corporations which secure their dominance as much (or more) by lobbying money and the legislative protection purchased by it than by their sensitivity to the Market.
When one actually looks at how entangled big corporations are with the government in this country, how impossible *in reality* any appeal to “the Market” is, one quits taking these hopelessly abstract thought-experiments seriously.
wj,
I’m not sure I grasp the nature of your objection. Is it just that the chances of free market policies being enacted are quite slim? If so, then I agree with you. But to the extent that the problem with corporations is that they capture government regulators and have them shape regulation for their own benefit, rather than for the common good, this would seem to be a rather strong argument against having such regulation in the first place.
The chances of free market policies being enacted are quite slim, for the reason that, at the state, national, and international level, there simply is *no such thing* as a free market to begin with. It’s a bogeyman, a unicorn, a golden mountain!
The purpose of corporations is obviously not to serve the common good. It is to make money for its shareholders. Consequently, corporations use their considerable financial power to lobby senators and representative to pass legislation that is favorable to their business interests. It’s not that corporations *shouldn’t* be regulated, it’s that they really *can’t* be regulated; they tell Congress within what bounds they’ll accept regulation, and Congress capitulates. That’s the way the game works.
It’s not that corporations *shouldn’t* be regulated, it’s that they really *can’t* be regulated; they tell Congress within what bounds they’ll accept regulation, and Congress capitulates. That’s the way the game works.
It sounds like what you’re offering here is not an argument for or against any particular economic or regulatory scheme as it is a counsel of despair. Corporations make government dance to whatever tune they wish, and we are powerless to stop or even restrain their ability to do so.
One thing which would help would be radical campaign finance reform and radical changes in lobbying regulations and oversight, neither of which will ever happen, since it’s in the interests of both current political parties that the game continues. But this is no reason for despair, unless one thinks that living under an oligarchy is reason to despair. It is a reason to be skeptical of politics, perhaps, but nothing more.