Wednesday, November 11, 2009

Cuffy Meigs, Meet Bernie Madoff

One of the biggest myth's perpetuated by populist politicians and their mouthpieces in the media, is that Wall Street, or the financial profession, is not regulated. It is in this wild jungle, we are told, that vampire financiers hatch their Machiavellian schemes to suck the blood of the common man.

What they forget is that the financial profession is among the most heavily regulated industries in the economy. The banking system has been essentially nationalized since the inception of the Federal Reserve and money itself, which used to be a commodity freely chosen by market participants, is literally created by the government. Besides the Federal Reserve, federal and state government agencies employ legions of regulators to oversee mountains of byzantine regulations and conduct field investigations.

In reality, it is this cozy relationship between major financial institutions and the Federal Reserve, born from the legal and regulatory framework enacted by the government, that has led to the notoriously politicized bail outs of recent history. On a free market, any business would stand or fall by virtue of its ability to earn profits or not. In the current system, a system that has been unjustly and absurdly characterized as a system of "laissez-faire", it is pull peddling and backdoor corporate "cronyism" that determines who gets bailed out and who does not. It is the Federal Reserve board, itself subject to political pressure, that determines the level of credit expansion through its manipulation of the currency and thus the relative intensity of the boom-bust cycle.

One small and tragically comical example is the recent Madoff case in which it was revealed that Bernie Madoff had run a multi-billion dollar Ponzi scheme for decades.

A recent investigation conducted by the SEC Inspector General, H. David Kotz, shows that the government watchdog, the SEC, had been warned for years about Madoff and had botched the investigation every time.
The New York Times reports:
The new exhibits consist of 6,157 pages of interviews, letters, e-mail messages, telephone records and other background material gathered during Mr. Kotz's 10-month investigation of how the commission handled, and mishandled, numerous tips and warnings it received about Mr. Madoff over the years. His full report,released last month, found the agency had received six substantive complaints since 1992 -- and botched the investigation of every one of them. He found no evidence of any bribery, collusion or deliberate sabotage of those investigations.
The SEC had investigated Madoff so much, he was sure he was going to be caught.
In the interview, Mr. Madoff said that the young investigators who pestered him over incidentals like e-mail messages should have just checked basics like his account with Wall Street's central clearinghouse and his dealings with the firms that were supposedly handling his trades.

''If you're looking at a Ponzi scheme, it's the first thing you do,'' he said.
The most comical instance of the SEC's bungling was revealed by the Wall Street Journal when a belligerent Cuffy Meigs like character, William Ostrow, showed up:
One of those failures occurred during a 2006 examination when senior compliance examiner William Ostrow and another examiner visited the Madoff office over a period of two months...

"Madoff indicated that Ostrow was an 'obnoxious guy' and noted that Mr. Ostrow wore an SEC jacket with the word 'enforcement' emblazoned across the back," the account of the interview says. "Madoff … stated that this jacket 'caused an uproar' " in the office.
Madoff was able to use his reputation in the business as politically connected to intimidate the SEC inspectors, especially with claims that he was "dear friends" or had "recently lunched" with agency heads like Arthur Levitt and Mary Schapiro.
The paperwork gathered from the agency's files also tell a tale of unseasoned, poorly managed people who were uncertain about what to do and unwilling to ask for help. In numerous instances, employees would share their doubts about Mr. Madoff in notes or e-mail messages, but then never take steps to press for more information.
Sadly, such regulatory agencies usurp the function of proper due diligence or of industry self-regulatory agencies as investors rely on the tacit imprimatur given by this vast regulatory apparatus. In other words, a rational investor could reasonably say: "if Madoff has been in business for 30 years under the supervision of the SEC et al., how could he possibly be a fraud?". Now we know the answer.

Ask yourself: does the Madoff fiasco represents an instance of a lack of regulation?

4 comments:

Burke said...

You write,

"Second, through various legal precedents, it failed to legally define property in such a way as to effectively outlaw the practice known as fractional reserve banking, i.e., legally distinguish between a deposit and a loan contract."

Wouldn't this be a violation of the rights of those who choose to practice fractional reserve banking and of those who choose to deal with them?

What business does the govt have telling people what they should use as money and how they should bank as long as everyone knows what is going on?

Doug Reich said...

Burke,

See my post:

http://dougreich.blogspot.com/2010/02/boom-bust-part-3.html

where I discuss FRB in depth

thanks - Doug

Anonymous said...

Madoff was arrested Dec 11, 2008. Schapiro was appointed as head of the SEC on Jan 20, 2009.

Please explain how Madoff was able to use claims of having "lunched with SEC head Schapiro" as a way of subverting SEC investigations at a time when she was not heading the SEC.

Doug Reich said...

Schapiro was chairman of the CFTC in the 90s and then CEO of the NASD in the 2000s which became FINRA. So she was a prominent regulator throughout that time albeit not as SEC chairman. Presumably, it was in this capacity that the article refers to her as an "agency head." if I'm not mistaken, madoff himself was head of the nasd at one point! I ask: Not enough regulation?