Friday, December 19, 2008

The Madoff Economy

There are 33 days until Jan. 20, 2009.


The Madoff Economy



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

that divergence.


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 America's Ponzi era surely went beyond

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.



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