Thursday, 18 December 2008

Greed, dishonesty and complacency - the recipe for any financial bubble

The Madoff $50 billion pyramid scheme has a parallel with our own domestically generated swindle – the UK housing market. All scams need three crucial elements; greed, dishonesty and complacency.


Madoff had a deep understanding of that old adage that “nothing succeeds like success”. His above market returns attracted banks, hedge funds and wealthy individuals to hand over their cash. Greed had blinded them, and left them unable to ask the obvious question; how could Madoff consistently outperform other hedge funds.

Likewise, rising house prices encouraged a cycle of greed and speculation. As prices increased, greed trumped caution. People bought into the lie that house prices could keep on rising forever. When something looks too good to be true, invariably that is exactly what it is. Greed debilitates good judgment.


It takes more than greed to spin a scam. All scams need a murky core of deception. Madoff played out this role in this most recent outrage. He took the investors money, misled them about returns, and falsified the books.

The UK housing market does not have a single individual that provided this catalytic role. Instead, a shadowy confederation of bankers, estate agents, and TV property rampers supplied the deceitful lubricant that oiled the UK housing bubble. They provided the cash, talked up the market and spin the lies that deluded people into thinking that property was essentially a riskless investment.

However, greed and dishonesty is never quite enough to sustain a ponzi scheme. The third leg of this tripod is complacency.


Since financial scams are as old as capitalism, society has a long history of legislating against ponzi schemes. In the US, the Securities and Exchange Commission was supposed to oversee Madoff’s operation. It failed lamentably. Here in the UK, responsibility for overseeing the housing market is a little more diffuse. However, the FSA should have kept a much closer eye on our banking system. Estate agents, with their self-serving investment advice, remain largely unregulated. Their dishonest “house prices never fall” sales patter has yet to be adequately challenged.

At the root of this regulatory failure is complacency. Although there was compelling circumstantial evidence that something wasn’t quite right with Madoff, regulators didn’t bother to investigate him. Again, there is a close parallel with the UK housing bubble. Regulators only had to look at mortgage spreads or housing price growth and see that something was going badly wrong and that a crash was imminent. Despite the accumulating evidence of an upcoming crisis, complacency always seemed to win over concern. The bubble grew, feeding on greed and dishonesty until it could grow no more.

The true return

This year will go down as the great moment of reckoning after years of greed, dishonesty and complacency. Madoff was exposed only after the entire hedge fund industry was devastated by the credit crunch. It was the same sudden evaporation of liquidity that destroyed our housing bubble. Now, at last, the true return is being calculated. The financial reckoning from both ponzi schemes will be horrific.


Anonymous said...

British economy sinks like a stone
By Jean Shaoul
18 December 2008

Have fun!!!


Anonymous said...

In the aftermath of the Japanese crash and interest rates there going to zero, there was a rash of corruption exposed. I see no reason why this won't be the case in the west. This $50bn fraud is not the last, I'd be willing to bet.

Chris said...

"It failed lamentably." -- I don't mean to nit pick and I am not sure I quite understand the British system just yet but in the case of the SEC not investigating Madoff, I would like to say that the SEC failed deliberately. He was a friend of some of the SEC investigators. The Republicans put in people at the top, ie Christopher Cox, who had no intention of looking seriously at his (or anyone with a large enough bank account's) books. The SEC was designed by the Bush administration to fail.

The free market will always regulate itself don't you know?

Anonymous said...

Madoff was reported to the SEC in 1999 - Clinton's time, not Bush's. For all we yet know his fraud could stretch back to Reagan's or even Carter's time.

P.S. There are four crucial elements; greed, dishonesty, complacency and cheap money.

Anonymous said...

Correction: "He'd been in business since 1960". Delete "Carter", insert "Kennedy".

Anonymous said...

Don't forget leverage, as an essential ingredient of a scum-crisis. Financial derivatives have enhanced leverage.

Anonymous said...

On corruption: The psychological dimensions of this merit careful consideration.

In Australia psychologists have talked about "organisational psychopaths"; the New Scientist a couple of years ago picked up on some US work in an article called 'Snakes in Suits" which emphasised how present business culture tends to forward a near-psychopathic type because of its drive, self-belief, and utter disregard for any human dimension which does not serve its goals.

In other words, the utter self-concern of the narcissist, the sociopath - lacking all empathy - actually serves the target-oriented, money-reward business, unethical culture which is now deeply rooted.

Think about this:

Do you know someone who is utterly charming, oozes self-confidence, easily persuades others, and yet behind the scenes is a liar, a schemer, driven beyond normal measure?

Do you know someone who lies easily and persuasively, even recklessly, to secure a deal?

Do you know someone who systematically takes credit for the achievements of others while effortlessly passing blame for error to his or her PA and other colleagues?

Do you know someone who seems to be Teflon-coated when it comes to pining blame on them?

If you do, think egotistical all-powerful bank CEO/ think super-successful City fraudster / think Madoff - and think a large number of the types who have pushed themselves to the top in the current poorly regulated, largely unethical banking and commercial environment.

Oh, and where else are these people? Pushing themselves to the top in talk-don't-do public sector positions where "quality" and "box-ticking" have substituted for principle and hard work.

For more read on Malignant Narcissism/ Narcissistic Personality Disorder/Snakes in Suits/ Organisational psychopaths.

B. in C.

Nick von Mises said...

I think there's three reasons why Madoff got away with it as long as he did:

1. Ponzi schemes collapse because redemptions hit critical mass. That usually happens in a bust. In a boom people are still throwing money into it.

2. This would've been easily stopped if the fund of fund managers had done their due diligence. Those who did advised their clients away.

3. He ran his own brokerage so the broker confirms were not independent.

The free market DOES deal with scams like this. The idiots who fall for them lose their money and the idiot fiduciaries who place it get sued and lose business. I suspect it lasted as long as it did because of the placebo effect of trusting the regulators rather than your own due diligence.

More regulation will make this scheme more common, not less.

Electro-Kevin said...
This comment has been removed by the author.
Electro-Kevin said...

There was the herd mentality driving it too.

Not wanting to be left behind is the most powerful of forces.

The subliminal and overt media messaging 'property is good ... lots of property is better ...' has been relentless and difficult to resist because it inculcates feelings of inferiority in those not on the bandwagon.

At times the elements of this boom dovetailed so well that I thought it had to be a Nu Lab conspiracy (it had to be by design, surely ?) but it wasn't.

It was just part of the new meme - a post religionist revolution; the obsession with self-image and worship at the alter of Bling. Cometh the hour, cometh the man - and he did. Tony Blair - the perfect man heading the perfect government at the height of our avarice and ignorance.

I recently visited a manor house which had been untouched by the modern world - worn stone floors and servants bells in the kitchen. The three old ladies living there (now in their 90s)living simply but surrounded by shelves stacked high with literature - not a TV in sight. So very verrry English. So very unlike me. One of them lost her husband in the Second World War. They stayed put, living simply as they had learned to do in those years of austerity.

Never mind. I'm sure that soon some speculator will be able to rip the 'property' out and partition it all up to maximise 'potential' - all done 'sympathetically' I'm sure.

Mark Wadsworth said...

What NVM says.

Actually, the Madoff story is not like UK housing, not in the slightest. The total net losses from Madoff are actually minimal - don't forget that earlier people were overpaid on fictitious returns (I wonder whether they'll have to repay that?) and later people lost their money.

So all it was, was a giant random transfer from one group of gullible rich people to another, a bit like a betting shop for rich people.

The cost to 'the economy' of Madoff's scheme is unmeasurably small, compared to the £4 trillion Ponzi scheme that was the UK housing market (of which half was bubble element), which is now dragging everything else down with it.

Disclaimer - I sold to rent and made oodles of cash by not believing this crap about "prices only go up".

Anonymous said...

This year will go down as the great moment of reckoning

Reckoning? Bah. We're still in the point-fingers-and-blame-your-neighbors phase. And I doubt we'll ever get out of it.