We know that the mice got at the financial system in the past few years–even if most of us still don't understand how. Bernie Madoff is only shocking because he was the single most brazen mouse.
Madoff wasn't one of the big financiers on Wall Street. Although he was at one point chairman of the Nasdaq stock exchange, he remained a relatively obscure figure, known best to initiates and financial middlemen (doubtless how he wanted it). Yet he sucked in $50bn—more than twice the amount of deposits taken by Northern Rock, a bank deemed too big to fail. He was able to do so mainly because the cats slumbered. The so-called professionals who took fees for managing our money failed to keep an eye out. And worse, the Securities and Exchange Commission (SEC), which oversaw Madoff's activities, was fast asleep.
For years, the SEC warned the public about what it called "affinity fraud": where fraudsters preyed on social networks, exactly as Madoff did on the wealthy Jewish community in Florida. There is a long document on the SEC's website detailing the telltale signs of such frauds. Yet when Wall Streeters came forward with warnings about Madoff, the biggest affinity fraudster of all, the SEC did nothing. We know this thanks to a bookish Boston accountant, Harry Markopolos, who tried for a decade to convince the powers that Madoff was a con artist. In 2005, he even sent the agency a paper starkly entitled: "Why the world's biggest hedge fund is a fraud." This set out in painfully accurate detail the scam that Madoff was perpetrating, its scale (even in 2005 Markopolos believed it to be worth "up to $50bn") and the impossibility that his "system" could deliver the enormous returns it promised. Moreover, he named Wall Street bigwigs who would not do business with Madoff and were willing to tell the regulator why. A simple phone call to a few of these sources was all it would have taken.
So why did the SEC do nothing? Apparently, the agency's guidelines laid down that it only investigated scams that were uncovered by an inside whistleblower. It was too hard to work out whether tip-offs from outsiders were prompted by an ulterior motive: perhaps commercial rivalry or another investor hoping to profit from a "short" trade. Markopolos did not work for Madoff, so his report went in the bin.
No wonder we are now in the phase where, in John Kenneth Galbraith's telling phrase, money is being "watched with a narrow, suspicious eye." If the SEC didn't investigate Madoff, despite all the steers to do so, what else didn't it look into?
Beware of zombies
Governments around the world are rushing forward with stimulus packages, promising to intervene and protect "strategic industries" such as carmakers. There's no truck for the idea that the economy needs purging after a boom. After all, wasn't it Herbert Hoover's treasury secretary, Andrew Mellon, who last prescribed such a purgative? "Liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate," he recommended. And look where that led—to the great depression.
Or did it? It's often forgotten that Hoover ignored Mellon and intervened relentlessly, running up what was then a record US peacetime deficit. And Roosevelt pressed ahead with Hoover's interventionist policies. The result was depressed business investment and what economic historians have called "a depression within a depression." Similarly, Japan withheld the purgative in the 1990s, preferring to keep banks and companies on life support. It was too difficult to break the Japanese social contract of lifelong employment. So-called "zombie" companies came to dominate parts of the economy, holding back employment and productivity. This delayed the recovery.
We seem no more willing now than then to apply the purgative: to encourage consumers to spend less and save more. Instead we cut consumption taxes, try to put floors under house prices and bail out failing industries. Bailing out Detroit or Jaguar may seem the lesser of two evils. But these zombies, once created, will come back to haunt us in the long run.
The commanding depths
It is a great shame that Tony Blair repealed clause four of the Labour party's excellent 1918 constitution. For this landmark reform has created a mighty mental block. It has deterred his successor's government from administering one policy that might stop the country's failing banks from trashing the economy in the present crisis: nationalise the suckers! At the moment we have the worst of all worlds. The state wants the banks to admit their losses (to "liquidate," to paraphrase the great Mellon) so they can start lending again. After all, it's only when the losses are out in the open that things will start moving. Yet while crippled institutions remain half in and half out of the public sector their executives have every incentive to do neither. They spin things out in the hope that conditions will recover and they won't ever have to admit the extent of their folly. But the economy won't wait. Time to seize the commanding depths.
