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The Madoff Economy
By PAUL KRUGMAN
December 19, 2008
The revelation that Bernard Madoff - brilliant investor
(or so almost everyone thought), philanthropist, pillar
of the community - was a phony has shocked the world,
and understandably so. The scale of his alleged $50
billion Ponzi scheme is hard to comprehend.
Yet surely I'm not the only person to ask the obvious
question: How different, really, is Mr. Madoff's tale
from the story of the investment industry as a whole?
The financial services industry has claimed an ever-
growing share of the nation's income over the past
generation, making the people who run the industry
incredibly rich. Yet, at this point, it looks as if
much of the industry has been destroying value, not
creating it. And it's not just a matter of money: the
vast riches achieved by those who managed other
people's money have had a corrupting effect on our
society as a whole.
Let's start with those paychecks. Last year, the
average salary of employees in "securities, commodity
contracts, and investments" was more than four times
the average salary in the rest of the economy. Earning
a million dollars was nothing special, and even incomes
of $20 million or more were fairly common. The incomes
of the richest Americans have exploded over the past
generation, even as wages of ordinary workers have
stagnated; high pay on Wall Street was a major cause of
But surely those financial superstars must have been
earning their millions, right? No, not necessarily. The
pay system on Wall Street lavishly rewards the
appearance of profit, even if that appearance later
turns out to have been an illusion.
Consider the hypothetical example of a money manager
who leverages up his clients' money with lots of debt,
then invests the bulked-up total in high-yielding but
risky assets, such as dubious mortgage-backed
securities. For a while - say, as long as a housing
bubble continues to inflate - he (it's almost always a
he) will make big profits and receive big bonuses.
Then, when the bubble bursts and his investments turn
into toxic waste, his investors will lose big - but
he'll keep those bonuses.
O.K., maybe my example wasn't hypothetical after all.
So, how different is what Wall Street in general did
from the Madoff affair? Well, Mr. Madoff allegedly
skipped a few steps, simply stealing his clients' money
rather than collecting big fees while exposing
investors to risks they didn't understand. And while
Mr. Madoff was apparently a self-conscious fraud, many
people on Wall Street believed their own hype. Still,
the end result was the same (except for the house
arrest): the money managers got rich; the investors saw
their money disappear.
We're talking about a lot of money here. In recent
years the finance sector accounted for 8 percent of
America's G.D.P., up from less than 5 percent a
generation earlier. If that extra 3 percent was money
for nothing - and it probably was - we're talking about
$400 billion a year in waste, fraud and abuse.
But the costs of
the direct waste of dollars and cents.
At the crudest level, Wall Street's ill-gotten gains
corrupted and continue to corrupt politics, in a nicely
bipartisan way. From Bush administration officials like
Christopher Cox, chairman of the Securities and
Exchange Commission, who looked the other way as
evidence of financial fraud mounted, to Democrats who
still haven't closed the outrageous tax loophole that
benefits executives at hedge funds and private equity
firms (hello, Senator Schumer), politicians have walked
when money talked.
Meanwhile, how much has our nation's future been
damaged by the magnetic pull of quick personal wealth,
which for years has drawn many of our best and
brightest young people into investment banking, at the
expense of science, public service and just about everything else?
Most of all, the vast riches being earned - or maybe
that should be "earned" - in our bloated financial
industry undermined our sense of reality and degraded our judgment.
Think of the way almost everyone important missed the
warning signs of an impending crisis. How was that
possible? How, for example, could Alan Greenspan have
declared, just a few years ago, that "the financial
system as a whole has become more resilient" - thanks
to derivatives, no less? The answer, I believe, is that
there's an innate tendency on the part of even the
elite to idolize men who are making a lot of money, and
assume that they know what they're doing.
After all, that's why so many people trusted Mr. Madoff.
Now, as we survey the wreckage and try to understand
how things can have gone so wrong, so fast, the answer
is actually quite simple: What we're looking at now are
the consequences of a world gone Madoff.