Tuesday, January 6, 2009

Interesting Look at the Financial Meltdown

I saw this article sitting on the kitchen table the other day and then set about to find it on the internets.

It is fascinating to see how badly the whole financial system was set up that a guy, Harry Markopolos, could spend 9 years specifically detailing how Madoff's company could not be anything other than a Ponzi Scheme, and be basically ignored by the regulatory bodies whose job it was to investigate exactly those issues.

His argument went something along the lines of:

  • Madoff claims to be handling roughly $50 billion in securities.

  • The markets in which he claims to be involved are smaller than that.

  • If he actually did put $50 billion into the market, we would see those trades somewhere.

  • We don't see them, so he can't have invested the amount of money he claims.

The response seemed to be of the form, "yeah, we'll look into it." Turns out Markopolos was right, and nobody is quite sure where that $50 billion went.

The real meat of the column, however, is how the Madoff scandal (and the financial crash in general) was caused not so much by greed, but by a breathtakingly stupid system. Evie would be proud.

Take a look at the article for a better explanation, but the basic problem was that the people running the SEC were using it as a stepping stone to get a job at the same places they were supposed to be regulating. So if Bob the SEC Director of Enforcement was really hard on, you know, criminals who conned people, when he went to them asking for a job, they would probably roll their eyes at "Bob the Buzzkill." On the other hand, if he turned a blind eye, or, even better, actively helped them steal more money, come hiring day, he would be "Bob, the cool guy who got us all those strippers and booze," a much more qualified candidate.

It seems like the solution will come in the form of a system which does not reward and encourage the exact opposite of what it is intended to achieve. How to do that, especially in the face of an established system which, until recently, was doing quite well for itself is an exercise left to the reader.