Now that the whole horrible truth has come to light, I have no more reason to
conceal my true identity. I am Bernard Madoff.
Well, not really. But I wish I were. Few Americans have done more to punish
stupidity, pretension and complacency than Madoff, whose apparent US$50 billion
swindle calls to mind the caper by Mephistopheles in the second part of
Goethe's Faust. The fictional devil persuaded the emperor to issue paper
money against buried treasured yet to be discovered.
This month, I cited Benedict XVI's 1985 essay on morality and economics, in
which the future pope warned that the decline of
ethics "can actually cause the laws of the market to collapse". (See
Benedict XVI is magnificently right, Asia Times Online, December 9,
2008). In counterpoint to that message from our sponsor, satanic laughter
pealed through the marketplace on December 12, when Madoff's apparent misdeeds
came to light. That was just the sort of thing for which God summoned the devil
into being, as the Lord explained to Mephistopheles in the prologue to Faust,
for man seeks unconditional rest and needs a provocateur as companion. Mephisto
is an Old Testament devil, drawn from the Book of Job, who is part of the
Madoff, 70, a former Nasdaq chairman, was arrested by federal prosecutors last
week in relation to what he reportedly told his sons was a long-running Ponzi
scheme - that is one in which investors are paid high returns from money paid
in by subsequent investors.
Most gratifying is the fleecing of the rich and famous - director Steven
Spielberg, producer Jeffrey Katzenberg, and even actress Uma Thurman's
financier boyfriend Arpad Busson got stung, along with a list of supposedly
savvy investment firms. The man deserves a medal. Deplorable, to be sure, is
the ruin of hundreds of families who entrusted Madoff with their life savings,
not to mention charities and school endowments. Call them collateral damage. I
have never been squeamish about killing civilians when urgent military
objectives are at stake. We give medals all the time to people who cause
innocent death in war. Tough on them if they can't take a joke, as the
artillery likes to say about friendly-fire casualties.
The very rich believe what F Scott Fitzgerald said about them, that "the very
rich are different from you and me". Serried ranks of lawyers, accountants and
financial advisors surround them and keep them from harm. Madoff proved
otherwise, making a few of them into paupers and humiliating a very large
number of them. Not because of what they do, but because of who they are, the
very wealthy consider themselves above the fate of ordinary people. They know
the right people, they join the right clubs, and they have access to the right
advice. Sometimes it takes a national catastrophe to teach them otherwise. The
slaughter of the subalterns in World War I destroyed the flower of the English
gentry, and the Russian revolution left counts driving taxicabs in Paris. There
was no recuperation from such punishment.
Madoff has given Americans a lesson in humility that is cheap and painless by
comparison. America's elite - the people characterized as "one-trick wizards"
who lived off leverage (see
Obama's one-trick wizards, Asia Times Online, November 25, 2008) - turn
up as a self-satisfied, feckless gang of incompetents who could not spot the
wolf within their own sheepfold.
After the fact, it is obvious that it was physically impossible for Madoff to
produce the returns he reported. "While Mr Madoff's stated strategy was valid,
it would have been impossible to execute with the amount of money he was
managing ... Mr Madoff's firm couldn't have bought and sold the options he
claimed because those totals would have outstripped total trading volume those
days," according to the The Wall Street Journal on December 16. Nonetheless,
his wealthy dupes believed that he could spin straw into gold year-in,
If that sounds deluded, what shall we say about hedge-fund investing for the
masses, who believed that American home prices would double every 10 years, as
the National Association of Realtors continues to claim in television
advertisements? Perhaps they should call themselves Sur-realtors. Madoff
offered small change compared to Mom and Pop America, who put 10% down on a
home that appreciated 10% each year, for an annualized return on capital of
Americans luxuriated in a trillion dollars a year of capital inflows. The aging
savers of Europe and Japan viewed American markets (and American brick and
mortar) as a source of returns in a moribund world, while the newly prosperous
savers of China and the emerging world saw America as a safe haven. The world
threw money at Americans, and Americans threw the money into a housing bubble.
The idea was absurd that Americans could fund their collective retirement by
bidding up the price of each others' houses and then cash out at the same
moment. But it was no more absurd than Madoff's claim to make a steady 10%-15%
by trading illiquid stock options.
There weren't a tenth the number of stock options traded to carry out Madoff's
putative strategy, as anyone with a complete set of fingers, let alone a pocket
calculator, could determine without great difficulty. For that matter, there
weren't enough families to keep the home price-bubble going. Americans are
retiring faster than they are forming families, and aging Americans whose
children have left the home ("empty nesters" ) typically sell large homes and
buy smaller ones. A very crude comparison below shows Americans aged 25-50,
when they are most likely to raise children and buy larger homes, against those
aged over 50, who are more likely to sell large homes.
Prospective home buyers and home sellers in the US.
Demographers have been warning for 10 years of a home price collapse in
America's suburbs. Whistleblowers first warned the American authorities about
Madoff's machinations in 1999. There is no way to make either case less
embarrassing than it is. Among defenders of the market mechanism, there is a
half-hearted effort to blame the collapse of the American housing market on the
machinations of Democrats and the government-sponsored housing lenders, Fannie
Mae and Freddie Mac.
It was disappointing to see the usually astute Michael Novak resort to this
fairy-tale in the January 2009 issue of First Things. Novak is an estimable
political philosopher - I have cited his work in the past - but he vastly
overestimates the extent to which "the political system helped create this
mess" by mandating low-quality loans. Novak simply doesn't know the details of
the mortgage market; he repeats, inaccurately, what he has heard from
Republican apologists in Washington. He attributes part of the problem to the
fact that "some too brilliant Wall Streeters got the clever idea of buying
Fannie Mae mortgages and packaging them to sell in large bundles". In fact,
this bundling began in the mid-1980s and helped finance the quarter-century
economic boom inaugurated by president Ronald Reagan.
The problem, rather, was that the investment banks began packaging low-quality
"subprime" mortgages with high credit risk, and the credit rating agencies
knowingly represented dicey packages as default-proof triple-A credits. The
bankers knew they were cheating, as much as did Madoff, and the ratings
agencies knew they were selling their soul for revenues, as an unnamed official
stated in an e-mail made public by a US congressional committee. They got away
with this because the childless dystopias of Europe and Japan needed
investments in places where families still were formed, and were willing to
ship their money to the American subprime market without asking too many
questions, just like Madoff's investors.
There were underlying causes, but the human factor that should have sent up
alarm bells simply was not present - not at the Securities and Exchange
Commission in the case of Madoff, nor at the Federal Reserve in the case of the
banks. The American public got greedy and lazy, and is getting what it
deserved. It is comforting that America's elite also is getting what it
deserved, thanks in part to Madoff, who ensured that a representative sampling
of the very rich learned that Scott Fitzgerald was wrong.
The Federal Reserve's strategy for economic revival reduces to trying to put
air back into the bubble, by forcing mortgages rates so low that Americans will
return to punting on houses. That goes against common sense, for Americans who
have lost their nest egg in the housing market will not soon return, and
against demographics. "When the Baby Boomers were young, families with children
made up more than half of households ... The Boomers themselves are becoming
empty-nesters, and many have voiced a preference for urban living. By 2025, the
US will contain as many single-person households as families with children,"
wrote Christopher Leinberger in the March 2008 Atlantic Monthly, citing
academic research that predicted a 40% surplus of large-lot single-family homes
Like Mephistopheles' invention of paper money, the Federal Reserve's ballooning
balance sheet will not restart the American economy. In Goethe's play, the
emperor distributes paper money and finds that his courtiers use it to drink,
gamble, or otherwise dissipate more than they otherwise would have. He
complains (in lines 6150-54, Walter Arndt's translation):
I hoped for
pluck and zest for ventures new;
I should have known you, and what each would do;
For all new bloom of wealth, it's plain to see
That each remains just what he used to be.
economy will remain in the monetary equivalent of an iron lung until Americans
show "pluck and zest for ventures new", or what John Maynard Keynes called
"animal spirits". There is no more trend to ride. Wealth now will require
sweat, brains and guts.