Why could Madolff get away with what he did despite a whistleblower? Why do people use so many derivatives despite their (known) dangers? In short, why has the economy gotten so far out of hand? It's a phenomenon best described by the fable, "the Emperor's New Clothes."
A pair of well-dressed, fast-talking "promoters" offered to make new clothes for the Emperor, in front of the full court. Since he liked the way they presented themselves, the emperor agreed. They promised to make him the best clothes in the world.
But there was a catch: One "weaver" said that such good cl... could only be seen by people worthy of their positions. The other agreed: "This will separate the men from the boys." (It always helps to have more than one promoter, to reinforce each other.)
The emperor disrobed, and the two promoters went through the motions of "weaving" their clothes, flattering the man on this or that feature, with the court ooh-ing and aah-ing in tandem, a process known as "anchoring." Finally, the weavers pronounced the job done, and asked the court, "Aren't these great clothes?' And the court agreed, even though the promoters really hadn't done a thing.
Heralds proclaimed the emperor's new style of dress, along with the above-mentioned caveat. And as he went among them, the people agreed that the emperor was very richly dressed, having been "prepped" beforehand. Except for a child who didn't care what others thought of him, and said, "Mommy, why isn't the emperor wearing clothes?"
The truth sometimes comes from the mouth of babes. At least it did this time.
So why did the SEC fail to catch Madoff when Harry Markoupolous went to them? The woman in charge of the New York office was a "career" employee with limited financial experience. She didn't want to admit that this was above her. So she went through an elaborate charade of inquiring of and about Maddoff, and then pronouncing him clean. ("We checked, but we didn't find anything") even though she didn't know where to look.
Regarding derivat... Warren Buffett said that "certain big-name CEOs (or former CEOs) at major financial insitutions were simply incapable of managing a business with huge, complex book of derivatives." (he included himself in that category). Most CEOs aren't that honest, and will try to pretend that have more "clothes" in this matter than they actually do, for the same reason as the emperor and his court.