Crisis Updates

What Wall Street knew (and didn’t say) about Madoff’s scam… The great Ponzi credit scheme of the 21 st century… The lessons from 1933… Why Congress are more pimps than whores…

** Yet more reason to avoid the shills on Wall Street…

The evidence is mounting that many on the Street we’re in on Bernie Madoff’s ruse.

It’s always struck me as odd that major financial institutions were ‘taken’ by such a paper-thin fraud.

Is it really plausible that the likes of HSBC, RBS, Santander, BNP Paribas and Nomura – all of whom were caught with their pants down by Madoff’s scam – didn’t ask any questions about how he was producing such stable and high returns?

According to financial strategist Paul Kedrosky:

They had to know that Madoff’s "split-strike conversion" option strategy was muck, utterly unlikely to produce the kinds of glassy-eyed stable returns seen by investors. It was obvious to anyone with reasonable option-trading competence, as you can see in this quote from a 2001 article in MAR/Hedge:

Skeptics who express a mixture of amazement, fascination and curiosity about the program wonder, first, about the relative complete lack of volatility in the reported monthly returns… In addition, experts ask why no one has been able to duplicate similar returns using the strategy.

So if the big institutions that poured money into Madoff’s scheme knew that his explanation for his gains was baloney, why did they keep investing?

The answer is simple.

They were making money and didn’t care how they made it. Nor did they care if their involvement in a scam lent legitimacy to it and therefore helped ensnare others.

As Kedrosky puts it:

[Far] from assuming Madoff was clean, in other words, they likely assumed that Madoff was running a different game than he talked publicly. Perhaps by piggy-backing on his securities firm’s order flow he was front-running trades, or maybe he was using bid-ask spreads from market-making in some clever way that was, ahem, not entirely above board. But smart investors didn’t care. They didn’t care as long as Madoff kept posting solid numbers with low volatility.

So what if he wasn’t doing what he said he was? They figured that wasn’t possible anyway. In their raging cynicism they were happy to go along with the con, so long as it goosed their own returns.

The irony, of course, is that Madoff’s scam was for more simple than that. It was a straightforward Ponzi scheme that eventually took down even the so-called pros.

** The West’s addiction to Ponzi credit…

Of course, Madoff and his willingly duped Wall Street pros weren’t the only ones dependent on Ponzi finance.

As The Daily Telegraph ’s Ambrose Evans-Pritchard points out, the twin blasts of fiscal and monetary stimulus by the US government in the face of the current crisis buys time, "but it does not solve the deeper problem, which is that a West addicted to Ponzi credit has put off the day of reckoning with ever more extreme monetary policy with each downturn, stealing prosperity from the future."

Evans-Pritchard is right. Spending ever vaster sums of taxpayers’ money to ‘fix’ the economy may avert some of the more catastrophic results of the bursting of the 2001-2007 credit bubble, but it’s not a get-out-of-jail-free card. And it doesn’t solve our addiction to credit.

** The lesson from 1933…

So, where are we now?

Well, according to Evans-Pritchard, we’re still far closer to 1931 then we are to 1933 – the second and far more gruesome leg of the Great Depression.

The banking system is in tatters. But massive fiscal support from Uncle Sam is keeping it on life support. Ditto the US car industry.

Unemployment is rising at a truly frightening rate. The US is losing 500,000 jobs a month. And the rest of the world isn’t far behind; Brazil shed 650,000 in December and the Chinese have lost 10 million jobs as a result of the credit crunch.

And the US economy is shrinking fast. It’s currently contracting at an annual rate of 6%. (In 1931, it was contracting only slightly faster at an annual rate of 6.4%.)

This is all very bad news indeed. But Evans-Pritchard makes the point that we are not in as bad shape yet as we were in 1933, when the country was close to open revolt and complete societal breakdown.

And this, you might say, is cause for hope…

But what keeps me up at night is that in 1931 – the middle of the Great Depression – the world seemed a benign place compared to how it seemed two years later in 1933, when the country was being stalked by armed revolt and the machinery of capitalism had all but ground to a halt.

When FDR took over the presidency, the New York Stock Exchange and the Chicago Board of Trade had shut up shop; armed mobs had gathered in many of the Prairie cities; and 25,000 angry and starving war veterans were camped out on Capitol Hill.

In other words, it’s good that society is holding together thus far… but we know it can fall apart in a just a few short of financial and economic crisis.

** More pimps than whores…

And finally…

A great piece by George Mason University economics chairman Don Bordreaux in the Pittsburgh Tribune-Review on why members of Congress have been greatly slandered by claims that they are whores.

According to Bordreaux, they are far closer to pimps.

Real whores, after all, personally supply the services their customers seek. Prostitutes do not steal; their customers pay them voluntarily. And their customers pay only with money belonging to these customers.

In contrast, members of Congress routinely truck and barter with other people’s property.

Consider, for example, agricultural subsidies. Each year a handful of farmers and agribusinesses receive billions of taxpayer dollars. These are dollars that government forcibly takes from the pockets of taxpayers and then transfers to farmers.

The customers, in this case, are the farmers and agribusinesses. The suppliers of the services performed for these customers are taxpayers, for it’s the taxpayers who possess the ultimate asset — money — that farmers and agribusinesses lust after. And the intermediaries who oblige the suppliers to satisfy the base lusts of the customers are politicians. Just as pimps facilitate their customers’ access to prostitutes’ assets, politicians facilitate their customers’ access to taxpayers’ assets…

Also like the ladies under pimps’ power, taxpayers who resist being exploited risk serious consequences to their persons and pocketbooks. Uncle Sam doesn’t treat kindly taxpayers who try to avoid the obligations that he assigns to them. Government is a great deal more powerful, and often nastier, than is the typical taxpayer. Practically speaking, the taxpayer has little choice but to perform as government demands.

So to call politicians "whores" is to unduly insult women who either choose or who are forced into the profession of prostitution. These women aggress against no one; like all other respectable human beings, they do their best to get by as well as they can without violating other people’s rights.

The real villains in the prostitution arena are those pimps who coerce women into satisfying the lusts of strangers. Such pimps pocket most of the gains earned by the toil and risks involuntarily imposed upon the prostitutes they control. No one thinks this arrangement is fair or justified. No one gives pimps the title of "Honorable." Decent people don’t care what pimps think or suppose that pimps have any special insights into what is good or bad for the women under their command. Decent people don’t pretend that pimps act chiefly for the benefit of their prostitutes. Decent people believe that pimps should be in prison.