"And lack of oversight is precisely how our trillion-dollar Ponzi scheme was allowed to grow."
In a way, when Bernard Madoff was arrested two weeks ago on suspicion of running the biggest Ponzi scheme in U.S. history, it was the perfect coda for the far-from-perfect crash of 2008.
The collapse of Madoff’s hedge fund – which led to an estimated $50 billion in losses among his investors – has bankrupted or severely damaged hundreds of wealthy investors and a number of charitable institutions that put their faith in him.
Even though Madoff has been arrested in connection with one of the biggest financial crimes ever reported, wealth has its privileges. Instead of immediately being tossed into jail – like, say, a bandit at a 7-Eleven – Madoff has been allowed to stay in his $7 million penthouse apartment on New York’s tony Upper East Side. (That’s only one of his digs. His mansions in Long Island and Florida are reportedly worth more than $20 million).
As one Internet comic put it: “Nothing says ‘what you did is flat-out wrong’ like being stuck in a 10,000-square-foot apartment with just your butler and your maid.”
But before getting too upset about the details of his “house arrest,” think about this: Is Madoff unique? Was his scheme really – as it’s alleged to be – the biggest pyramid scheme in U.S. history? A CNN poll last week reveals that three out of four Americans believe that Madoff’s behavior is common among financial advisers and institutions. And they may have a point.
After all, what’s the difference between Madoff and most of the investment banks on Wall Street? Hasn’t Wall Street been running the world’s biggest Ponzi scheme for the past several years? And hasn’t Wall Street’s Ponzi scheme done much more damage than Madoff could ever aspire to?
I’m not being flip here. The Wall Street scheme of writing mortgages with the riskiest terms possible, bundling them up with safe mortgages, getting them a good stamp of approval from a friendly ratings agency (insert Standard & Poor’s or Moody’s), and then selling them to unsuspecting investors abroad has all the hallmarks of a multitrillion-dollar Ponzi scheme.
Some commentators have recently taken to blaming the small fry for our troubles. They blame the economic crisis on government programs to help the poor buy homes or on individuals who refinanced their homes with risky mortgages to buy SUVs and flat-screen TVs.
There’s an element of truth to some of that criticism, but picking on the small fry does nothing to explain the immense financial debacle that now faces us. The reason this is a multitrillion-dollar worldwide crisis instead of a multibillion-dollar home crisis is the Ponzi-like investment derivatives that were peddled by Wall Street’s leading investment banks.
The difference between Madoff and the Wall Street investment banks is that instead of arresting the perpetrators and throwing them into jail – or even confining them to Madoffian house arrest – we have spent hundreds of billions of taxpayer dollars to keep them afloat. We have allowed many of the Wall Street firms to keep the expensive array of salaries, bonuses and perks that benefit the architects and purveyors of the mortgage scheme.
As was reported last week, the financial firms that are getting federal bailouts paid their 600 top executives nearly $1.6 billion last year – an average of $2.5 million apiece, though some individuals made more than $50 million. That’s a lot more than you can get running a small-time con.
In the new year, there will undoubtedly be further arrests on Wall Street and more high-flying bankers being pushed into house arrest in their uptown penthouses or their mansions in the Hamptons. But even if a handful of perpetrators go to jail, that may not be enough to rectify the Ponzi scheme. Instead, what is needed is an overhaul of Wall Street, from top to bottom.
We’ve had an opportunity to do so over the past year, when the nation’s biggest financial firms began coming cap in hand to the federal government, seeking bailouts.
We could have required that the people who were responsible for this debacle be fired, demoted or stripped of much of their salary. We could have done more to ensure that the banks that were given money to revive the frozen credit market actually loaned the money out instead of hoarding it in their coffers. But the Bush administration declined to take such steps.
When other nations, like Sweden and England, bailed out their financial institutions, they demanded seats on the boards so they could oversee how the money was spent. This, too, is something the administration refused to do.
Wall Street, of course, would never have been able to accomplish what it did without the purposefully lax attitude among the “watchdogs” at the Federal Reserve, Securities and Exchange Commission, Treasury Department and Congress.
Over the past decade, Washington has steadily stripped away regulations that were designed to prevent such financial shenanigans – including some that were written during the Great Depression, by people who knew firsthand what could happen when the financial system was not sufficiently reined in.
The Crash of 1929 was preceded by an explosion of unregulated investment houses that essentially placed bets on the direction of various investments. During the New Deal, the Roosevelt administration outlawed those speculative investments. But those regulations were lifted eight years ago, laying the groundwork for the bubble in derivatives.
“There has been all kinds of excessive deregulation and incompetence,” said Dan Seiver, an economist at San Diego State University.
After Madoff’s arrest came the news that SEC officials had known for several years that there was reason to be suspicious about his investments. At least with Madoff there’s the excuse that his niece was romantically involved with an SEC official.
But how do you explain the actions of one of the senior regulators at the Office of Thrift Supervision, who allegedly looked the other way as troubled banks submitted fraudulently inflated financial sheets? How do you account for the fact that stock-fraud prosecutions dropped from 537 during the last year of the Clinton administration to 133 last year – the lowest number since 1991? Have our regulators just been lax? Or have they become complicit?
The Obama administration will undoubtedly try to draft new regulations to make sure this type of crisis does not occur in the future. But the most important thing is to put more effort into enforcing existing regulations – with more manpower and a different attitude at the SEC, among other places.
“It’s not a question of regulation. In fact, I hope there’s not too much new regulation, which is what sometimes happens in this type of atmosphere,” said Jim Welsh, head of Welsh Money Management in Carlsbad. “But we need more oversight. Regulation doesn’t mean much if there’s not oversight or enforcement.”
And lack of oversight is precisely how our trillion-dollar Ponzi scheme was allowed to grow.