Geoffrey Morton-Haworth_

Lesson Learned from Madoff's Ponzi Scheme

The short answer on trust is “the deeper you see the more you trust”.

As the UK TV series “Hustle” points out, “you cannot con an honest man”. Gamblers need to believe in a system that can beat the odds, and people wanted to believe Madoff was doing something slightly extraordinary to explain his exceptional returns. As long as they were beneficiaries, his investors preferred not to ask hard questions.

Madoff is surely only very small fry, just a cheap crook “caught swimming naked as the tide goes out”, as Warren Buffett puts it so delightfully. I can’t see why so many commentators treat him with a sort of grudging respect. The scale of deliberate deception is much greater than this and our culpability, or lack of “collective mindfulness”, is far more profound.

For instance, Fareed Zakaria’s GPS programme on CNN (December 28, 2008 - English slightly edited) hosted this frank discussion between pundits:

Hernando De Soto, President, Institute for Liberty and Democracy:
From a Third World point of view, the interesting thing is that, as trust breaks down in Western societies, like the United States, banks have stopped lending to each other because nobody really knows who owns what assets and what liabilities. You are starting to find out that the real economy has a lot more to do with trust than with the so-called fundamentals.

We have lost track. And we’ve lost track, because instead of having universal documentation as to who owns what — which is what international cooperation would give us — today, most of the paper in the world is untraceable.

Jagdish Bhagwati, Professor of Economics, Columbia University:
In each of these financial crises, the new instruments and changes have usually gone way beyond comprehension, and that is really at the heart of financial innovation.

Hernando De Soto:
It is about transparency.

Jagdish Bhagwati:
The downside is really important. When we say we must regulate, the regulators must first understand what has to be regulated.

Joseph Stiglitz, Nobel Prize-Winning Economist, Columbia University:
I think the point that Jagdish made is exactly right, that much of the innovation that we have had in the financial sector in the last two decades has been of negative value. It has been creating complexity. It is not a question of disclosure. You could disclose these documents, but nobody — the buyer, the seller, the regulators — can understand them. And it was done deliberately. It was done deliberately so people could not understand what was going on.

Hernando De Soto:
The reason you are in paralysis, the reason you are collapsing, is because you no longer know who’s got whose hand in whose pockets. You have to make a distinction. And remember that financing is there at the service of production, in combination, and is not center stage.

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Sadly, because we did not challenge things we did not understand, we have become collectively liable for the consequences of the deception. We have failed in our responsibility to be truthful to ourselves and to demand the same standards of honesty in others.