Not A Bug But A Feature

This Bernard Madoff Ponzi scheme is really kind of incredible, if only because we haven't seen such a con on a high level like this in so many years. In fact, probably not since Charles Ponzi, the original scam artist. Maybe in the future they will be called Madoff schemes. As Anonymous Liberal notes, this is a tragedy for the federal government as well, because there will be billions lost in expected capital gains tax revenue as a result of the crime. All these investor losses will be deductible, as well as rebates of past capital gains that they've paid, and the cost to the Feds could rival the amounts talked about in the auto industry rescue.

Now, I think there's a reason this will wind up to be such a massive loss for those involved, and that's because this is not separate from the current financial crisis, but part and parcel of it. Because in this era of trusting the market, in believing in magical men who make money appear in everyone's numbered back account, the SEC didn't come close to investigating the scheme.

Bloomberg reported yesterday that since Madoff registered the investment arm with the Securities and Exchange Commission in 2006, that agency hadn't got around to looking at the business's books. The SEC usually tries to go through the books of newly registered firms in their first year.

"If the SEC didn't come in and inspect (the Madoff hedge fund), then they have a hell of a lot to answer for," one expert told the Associated Press.

But the problem doesn't appear to have started in 2006.

As early as 1999, an executive in the securities industry had urged the SEC to probe Madoff, on the basis of the remarkably steady returns that his investment business seemed to provide. The executive, Harry Markopolos, argued that Madoff must be generating those returns by "front-running" -- that is, using the brokerage arm of his company to illegally provide information to the investment arm.

The SEC said in a statement that it had conducted two investigations into the brokerage arm -- not the investment arm -- of Madoff's company, in 2005 and 2007. The first, begun in response to allegations of front-running, found three violations of rules requiring brokers to obtain the best possible price for customer orders. That investigation appears to have led to Madoff agreeing to register with the SEC the following year, giving the agency access to far more information than it previously had. But the 2007 probe, conducted after Madoff registered, found no evidence of anything improper.

Investment firms were as off-limits under Clinton as they were under Bush. In fact, as long as everyone made money, regulators weren't much exercised to investigate. This is the same root cause that led us to the crisis. Nobody checked the derivatives, nobody checked the CDOs and the credit default swaps, and nobody checked out Bernie Madoff. In good times, these bullets could be dodged. Not so now.

This is why you can't base an economy on pushing paper and inventing sums of money to trade, dependent almost entirely on greed.