What made Madoff dangerous was too much — not too little — regulation

by Kurt Schulzke on December 17, 2008

Market pundits are already whining — wrongly — that the Madoff scam proves that markets need more regulation.  Here, for example is Tim Rutten, writing today in the LA Times:

The lesson is one that becomes clearer with each excruciating turn of the Wall Street screw. The long, bipartisan experiment with financial deregulation has failed utterly. The argument that a return to rigorous oversight will somehow stifle Wall Street’s “creativity” is no longer convincing. Whatever its theoretical costs, regulation is dramatically cheaper than intervention. And absolutist insistence on the superiority of “individual choice” and “free markets” now is exposed as so much vacant rhetoric.

Any system that permits a scam artist like Madoff to deceive not just widows and orphans but also sophisticated investors, like Fairfield Greenwich Group’s Walter Noel and Hollywood’s Jeffrey Katzenberg, isn’t a market at all; it’s a shooting gallery. We need, moreover, to re-regulate our securities markets because, if we don’t, foreign investors — like the European banks Madoff conned — simply will walk away from Wall Street, an exodus that will fatally undermine America’s position in the globalized financial system.

Not.  The Europeans having been leaving and staying away from U.S. markets, roughly since 2002, because of too much, not too little regulation.

The simple fact is that we have in the United States the most sophisticated, costly, smothered-‘n-covered system of financial regulation on the planet.  It is stifling.  Consider, for example, that the SEC’s draconian private offering rules that literally ban Americans with “too little” assets and income from ever participating in the upside potential of private equity deals.  The system that produced Maddoff was over-, not under-regulated.

No system of regulation — except an outright ban on financial products (think Sharia law) — will save investors who expect to be protected from the Madoffs of the world by regulators.  The regulatory error here was one of inducing reliance on an overly-burdensome regulatory framework that can never protect all of the world’s investors all the time no matter how many rules we make or how many regulators we assign to the task.

The incessant drumbeat for lower risk (through tighter regulation) would, if heeded, have the effect of lowering returns and locking in place the socio-economic structure.  Translated: If you are lower class today, you always will be.  That was the essence of Soviet Russia.  It is a philosophy that has no place in the United States.

If we want to prevent another 2008 financial debacle, teach America’s children, teens and adults that risk can lead in two directions: high profit or high loss.  Teach them to think and critically analyze what they are told by experts who are supposed to know.  We don’t need more regulators or regulation.  We need better, smarter students, parents, educators and schools.  We need a populace that acts with diligence and seriousness and takes ownership of its own destiny.  Rutten writes:

Madoff’s fund purportedly relied on a complex trading strategy, executed according to a supposedly proprietary algorithm. The truth about Wall Street, however, isn’t that dissimilar from what writer William Goldman once said about Hollywood — when it comes to what works or doesn’t work, nobody knows anything. When it comes to finance and investing, nobody is that much smarter than all the other smart guys.

So why do people insist on believing otherwise? That brings us back to Newton. Con men fatten not so much on their own talent for deceit as on their victims’ penchant for self-deception. Sadly, the world’s Bernie Madoffs will be with us for as long as some people believe that good fortune has inexplicably handed them an exemption from the laws of gravity — that, for them, what goes up must not necessarily come down.

Quite so.  And this is precisely why no amount of regulation except a Sharia-like elimination of financial markets can save some Americans, no matter how much money or education they have.