There are far more losers in the Bernie Madoff Affair than just those wealthy individuals, banks and hedge funds whose money he apparently squandered. His scam threatens to damage the entire investment business.
Every day, it seems, a new scandal bursts into public view. The collapse of Bear Stearns, Fannie Mae, Freddie Mac, AIG and Lehman Brothers were scandals, all with strikingly similar story lines in which executives took huge risks, reaped huge bonuses and wipe out their shareholders while becoming incredibly wealthy. Add to that list Merrill Lynch and Citigroup, both of whom needed huge amounts of government funds to survive. Morgan Stanley too. Huge commercial banks behaved no better.
None of these may have been criminal enterprises in the way that Madoff’s wealth to poverty management business was. But viewed from afar—say, from a Izaak Walton hall in Des Moines, Iowa—they send the same message: Wall Street is not just a high-stakes gambling hall. It’s a rigged gambling hall, where the investor always loses and the operators take all the gains. Turning Lehman into a huge real estate speculation factory might not have been a Ponzi scheme—we’ll emphasise “might” there, because it’s at least arguable that a business plan built on ever skyrocketing real estate prices bears a family resemblance to the schemes of Mr Ponzi and Mr Madoff—but the effects on investors were the same: they were wiped out. What’s worse, when the game falls apart, the operators on Wall Street have had their businesses rescued by the government.
Phony earnings built on a real estate bubble, incompetent regulators, wrongheaded government policies, the epic failure of economists, directors unable to protect shareholder interests, arrogance run rampant—it’s not just a few bad apples spoiling the lot here. Increasingly, this looks like a rotten orchard that may, at best, have a few good apples still on the branches. An ancient tragic playwright wouldn’t hesitate to say that the mighty are being brought low for the sins of greed and hubris.
We’re a bit less imaginative so instead we say that what we’ve seen is a systematic breakdown. Nearly attempt to check the kind behaviour that lead to these scandals—moral, traditional, reputational, corporate governance, market efficiency, regulatory, you name it—proved almost entirely ineffective. And now Madoff—a classic insider, trusted by the most sophisticated, a man who was a member of all the right clubs, had a long standing reputation on Wall Street, once ran a fracking stock exchange—provides evidence that far more than just errors of judgment were involved. He shows, at least, that the shepherds of the economy have long since departed from out shores. Those carrying the crooks in their paws are as likely to be wolves or our fellow sheep.
The stage is set for the worst crisis of investor confidence since the Great Depression. This comes on top of a still weakened sense of confidence that followed the last round of accounting scandals and the dot com crash. None of the reforms adopted in the wake of that catastrophe seems to have mattered on bit. What confidence can an investor take that anything can be done.
At least when the dot com bubble burst, Americans still had some confidence in our politicians. That too is gone. From Chicago to New York, we’ve uncovered shocking behaviour in the state houses. The serial bailouts—all passed by politicians against the preferences of the voters—have alienated voters who are convinced that the politicians have chosen sides and it isn’t with ordinary investors.
Capital markets cannot function healthily without trust. That once crucial factor is now more challenged than at any time in our life.
In past times, it might have made sense to say we need radical reforms or new programs and regulations. But we’ve already had those and it didn’t work. More phony solutions will only further damage investor confidence and our markets. There are times that are so dark that it is tempting to light a match. But if there’s a funny smell in the air, maybe another spark isn’t such a good idea. Maybe we should just get ready for some time spent cursing the darkness.