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Thread: The SEC Makes Wall Street More Fraudulent

  1. #1
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    The SEC Makes Wall Street More Fraudulent

    The mainstream reaction to the Bernard Madoff scandal was inevitable. Whenever a government regulatory agency proves itself to be incredibly incompetent or corrupt, the respectable media swoop in to declare that the "free market" has failed and the agency in question obviously needs more money and power.

    Whether it's the Department of Education's failure to produce kids who can read, the FBI's accusations against innocent people in high-profile cases, or the FDA cracking down on tomatoes, the answer is always the same: proponents of bigger government argue that yes, mistakes were made, but the solution of course is to shovel more taxpayer money into the agencies in question.

    In the private sector, when a firm fails, it ceases operations. The opposite happens in government. There is literally nothing a government agency could do that would make the talking heads on the Sunday shows ask, "Should we just abolish this agency? Is it doing more harm than good?" It's not just Fannie Mae and Freddie Mac: throughout history, virtually every agency created by the federal government has been deemed too important to fail. (I vaguely remember some Republicans in the mid-1990s holding a press conference and declaring that the Department of Commerce was done, and that voters could "stick a fork in it." I guess they found it was still pink inside.)

    Madoff's Ponzi Scheme

    The pattern plays out perfectly with the SEC and the Madoff bombshell. Suppose a few years ago, I told a group of MBAs to imagine the worst screwup that the SEC could possibly perform, something so monumentally incompetent that members of Congress might openly question whether the agency should continue. I think that at least half of the class would have come up with something far less outrageous than what has happened in fact.

    Everyone who reads the headlines knows that Bernard Madoff is accused of running a massive Ponzi scheme that, for over a decade, has ripped off investors to the tune of $50 billion. But those who dig a bit deeper learn that Harry Markopolos, who used to work for a Madoff rival, has been writing the SEC since at least May 1999, urging them to put a stop to Madoff's Ponzi scheme. (Markopolos examined the options markets that Madoff told investors he used to hedge his positions and yield his steady stream of dividends, and Markopolos concluded that Madoff's results were impossible.) Incredibly, the SEC apparently had evidence in front of its face sixteen years ago (in relation to another case) that Madoff was a crook.
    Yet it gets worse. As the Wall Street Journal and others dig into the story, they find that Madoff's family had close ties to the SEC. His sons, brother, and niece, for example, worked with or advised financial regulators on certain matters—no doubt telling them the best way to protect investors from fraud.

    But the pièce de résistance is that Madoff wasn't caught; his own sons turned him in after he came to them and admitted what he'd done. (Let's assume they are telling the truth and didn't realize what their father was up to all along.) And even Madoff's confession was not because of a visit from the ghost of Christmas future. No, Madoff's scheme simply ran out of gas, because of large redemption claims that his clients filed, due to the collapse of the financial markets. Had it not been for the bursting of the credit bubble, Madoff would likely still be bilking new investors — and advising the SEC.

    Laissez-Faire Ideology to Blame?

    Even though George Bush has presided over the most interventionist government since FDR's New Deal, he somehow has a reputation for being a free marketeer. (It's funny that his political opponents take him at his word when it comes to economic rhetoric, yet they don't universally refer to Bush as a lover of world democracy and peace.) Naturally, the Madoff Ponzi scheme is blamed on the Bush administration's failure to adequately fund and staff the beleaguered SEC. "Bush thinks markets are self-regulating, and look what happened!"

    This is complete balderdash. The SEC under George Bush has the biggest budget and the most personnel in its history. The charts below show the annual budgets and "full-time-equivalent" staff for the SEC by fiscal year. These numbers were obtained from the annual SEC reports archived here. (Note that there might be a slight discontinuity in the budget series in the year 2003, when the report format changed.)







    It's even more interesting to break down the growth rates in budget and staff by presidential administration. For the following table, I have assumed that an incoming president doesn't really influence the SEC's operations for that (partial) fiscal year. For example, Ronald Reagan won the election in November 1980, and was sworn in the following January 1981. To gauge how much he increased the SEC budget and staff, I look at the annualized growth from FY 1981 (which ran through September 1981) to FY 1989. However, I also ran the numbers going from FY 1980 through FY 1988 etc., and it doesn't really affect the results.

    (click here for table: http://www.mises.org/story/3273)

    As the table shows, clearly the person who hated the free-wheeling market most was the first President Bush, followed up by his son. And especially when we consider the high inflation rate, it's obvious that Jimmy Carter was a laissez-faire ideologue. Bill Clinton, in contrast, had the same attitude towards speculators as Ronald Reagan.

    Naturally we can quibble with these conclusions. Maybe Bill Clinton's numbers would have been a lot higher had Newt Gingrich remained a history professor. Maybe George W. Bush used the Enron scandal to beef up the SEC's budget, while he gave orders behind the scenes to use the cash for pizza and beer rather than enforcement.

    But whatever the excuse, it just proves my point: it is foolish to give the task of ensuring financial integrity to DC politicians. The SEC was supposedly retooled after the Enron fiasco in order to do its job. And it failed miserably. Some heads may roll and budgets balloon, but if history is any guide, there will be another huge financial fraud within another decade.

    Conclusion

    The SEC clearly botched its alleged job in the case of the Madoff Ponzi scheme. Taxpayers are certainly entitled to ask, "What exactly are we getting for our (now) $900 million per year?"

    It is not simply that the SEC failed to help. On the contrary, the SEC is actively harmful. For one thing, its implicit blessing of Madoff probably reassured some investors; surely the SEC would have shut him down if his returns were bogus! Beyond that, the SEC has been horrible during the financial crisis. In the summer it engaged in a phony ban on "naked" short selling that was already illegal, and then a few months later it banned short selling outright on hundreds of financial stocks, a move that paralyzed that particular sector even more. And lately, they've decided to launch a witch hunt on Mark Cuban—those 3,000+ employees have to do something.

    Democrats should not take away from the Madoff scandal the lesson that Republicans cannot be trusted to regulate financial markets. Even if it were true that Democrats would run it more honorably and competently, eventually another Republican will win the White House.

    Rather than pitting each party against the other, it is wiser to conclude that Washington politicians and bureaucrats will never put the average taxpayer or investor's interests above those of billionaire financiers. The SEC should be abolished, and investors should rely on private-sector watchdog groups to spot swindlers.


    Robert Murphy runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, and the Human Action Study Guide. Comment on the blog.
    http://www.mises.org/story/3273

    -Jon (bringing more Mises.org discussion)
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  2. #2
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    Ron Paul Madoff "Irrelevant SEC + Congress + Moral Hazard + US Gov't Ponzi Schemes"

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  3. #3

    Harry Markopolos

    There are numerous threads discussing forum member's dissatisfaction regarding corporate bail-outs, the stimulus package and plenty of discussion regarding small v. large government. One subject I found little discussion and interests me relates to Harry Markopolos and what he represents.

    Markopolos was a whistle blower who figured out a decade ago that Madoff was a fraud. Over many years, he provided individuals with the SEC with information that should have triggered an investigation of Madoff. Yet, there was a clear failure in regulation that resulted in over a hundred billion dollars of lost wealth. Regulation of business is contra to the ideologue of the majority of posters in this forum who believe in laissez-fair / free market economics. Perhaps that is why there is virtually no discussion of Harry Markopolos who in my opinion should be hailed a hero or at the very least, one of the good guys in todays ocean of greedy bankers, investors, hedge fund managers, mortgage brokers, investment bankers, CEOs and their ilk.

    If you read this article and do a bit more research about some of the names discussed, you'll find that there was a total failure of the SEC and the with the job that they were tasked to perform:

    http://www.foxbusiness.com/story/mar...mony-rips-sec/

    In my opinion, the head of the SEC should have been someone like a Harry Markopolos. And, that need for regulation of the banking industry and Wall Street is highlighted by this case. But, that is a subject not to garner a lot of attention on this forum. So, I'm putting in my two cents here because I find the subject worthwhile.

    Testimony and time-line of events and recommendations regarding the SEC:

    http://www.house.gov/apps/list/heari...olos020409.pdf


    Dan (posts here, the only place where he's been mentioned before)
    HFM

    As long as there exists people with religion and a belief in God, there will never be a Libertarian state.

  4. #4
    The SEC provides a sort of illusion of safety for investors. Mr Markopolos was a single private citizen that did something that an entire government bureaucracy couldn't. That is a fact that should make people, that push more regulation, stop and think.

    People act as if though without government regulation, Wall Street would be 90% Madoffs. Who would invest if they thought there was a 90% chance of being ripped off? Just like Skooly said that without government regulation, insurers would never pay up. It's ridiculous.

    If I were to devise a scheme for regulation, it would be based on independent private agencies that have a profit motive for busting frauds.

    Saying that the failure in the execution of regulation, should be more regulation is just insane. It's like saying that in order to make everybody who doesn't currently wear seatbelts wear them, you're going to force car manufacturers to install two sets of seatbelts.
    Last edited by Jesse; 03-13-2009 at 06:34 PM.

  5. #5
    Quote Originally Posted by Jesse View Post
    If I were to devise a scheme for regulation, it would be based on independent private agencies that have a profit motive for busting frauds.
    Privatization. If there were one word to be treated as gospel, the solution to all problems, the meaning of life and the salvation of humanity according to the Cato Institute, it is privatization.

    It is not the job of private enterprise to legislate, enforce or adjudicate the crime of fraud. Private agencies have no authority to regulate or punish those who commit fraud. Madoff would never be convicted and incarcerated by a private agency. Nor should any private agency wield the power to investigate a citizen for the purpose of conviction and incarceration.

    Dan (recognizes private Wall Street companies like Goldman Sacks worked by staying away from Madoff and the difference between market action from regulation and enforcement)
    HFM

    As long as there exists people with religion and a belief in God, there will never be a Libertarian state.

  6. #6
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    Quote Originally Posted by hfm View Post
    Markopolos was a whistle blower who figured out a decade ago that Madoff was a fraud. Over many years, he provided individuals with the SEC with information that should have triggered an investigation of Madoff. Yet, there was a clear failure in regulation that resulted in over a hundred billion dollars of lost wealth. Regulation of business is contra to the ideologue of the majority of posters in this forum who believe in laissez-fair / free market economics.
    You have provided a great example of why regulation doesn't work and when people put their trust in the government they get a false sense of security. Those are the very conditions which allow a person like Madoff to do what he did. In a true free market, it would have never been able to occur because people would be far more vigilant.

    Fannie Mae and Freddie Mac were also under direct government oversight and direct government regulation. Result, another massive failure that would have never happened with sound money of real value and a true free market.

    I think the biggest misconception many people have is that we had a free market in the banking and investment industry and that's what has failed. That couldn't be further from the truth, but that's certainly what those responsible for this mess would like you to believe so they can gain even more power and control and make the likelihood of repeating these events even greater.

    That's the biggest problem with government, they are incentivized to fail because when they do they convince the mob the answer is to give them more power and money! That's just insane.

    Steve (thanks Dan for a perfect illustration of the failure of government regulation)
    Last edited by Mr. Raceboy; 03-13-2009 at 07:54 PM.
    Sic Semper Evello Mortem Tyrannis.

  7. #7
    Quote Originally Posted by hfm View Post
    Privatization. If there were one word to be treated as gospel, the solution to all problems, the meaning of life and the salvation of humanity according to the Cato Institute, it is privatization.

    It is not the job of private enterprise to legislate, enforce or adjudicate the crime of fraud. Private agencies have no authority to regulate or punish those who commit fraud. Madoff would never be convicted and incarcerated by a private agency. Nor should any private agency wield the power to investigate a citizen for the purpose of conviction and incarceration.

    Dan (recognizes private Wall Street companies like Goldman Sacks worked by staying away from Madoff and the difference between market action from regulation and enforcement)
    Come on now.... THIS is what you're you're going to counter with? Of course fraud can only be prosecuted and punished by the government, after all, they have the monopoly on force.

    Investigation and exposing of frauds could certainly be accomplished by various trusted independent private agencies. You have to shift outside of your normal paradigm here. In a world where companies don't have an agency like the SEC to provide them a sense of legitimacy, the companies themselves would have provide this legitimacy. Most likely they'd allow well known and trusted agencies to have access to their books. I haven't put a lot of thought into this, but it seems pretty logical to me.

  8. #8
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    Quote Originally Posted by Jesse View Post
    Come on now.... THIS is what you're you're going to counter with? Of course fraud can only be prosecuted and punished by the government, after all, they have the monopoly on force.

    Investigation and exposing of frauds could certainly be accomplished by various trusted independent private agencies. You have to shift outside of your normal paradigm here. In a world where companies don't have an agency like the SEC to provide them a sense of legitimacy, the companies themselves would have provide this legitimacy. Most likely they'd allow well known and trusted agencies to have access to their books. I haven't put a lot of thought into this, but it seems pretty logical to me.
    I think Dan missed the point of this entire thread.
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  9. #9
    Quote Originally Posted by Mr. Raceboy View Post
    You have provided a great example of why regulation doesn't work and when people put their trust in the government they get a false sense of security. Those are the very conditions which allow a person like Madoff to do what he did. In a true free market, it would have never been able to occur because people would be far more vigilant.

    Fannie Mae and Freddie Mac were also under direct government oversight and direct government regulation. Result, another massive failure that would have never happened with sound money of real value and a true free market.

    I think the biggest misconception many people have is that we had a free market in the banking and investment industry and that's what has failed. That couldn't be further from the truth, but that's certainly what those responsible for this mess would like you to believe so they can gain even more power and control and make the likelihood of repeating these events even greater.

    That's the biggest problem with government, they are incentivized to fail because when they do they convince the mob the answer is to give them more power and money! That's just insane.

    Steve (thanks Dan for a perfect illustration of the failure of government regulation)
    What an incredibly strained and twisted analysis. The fact that regulation failed does not mean this would never have happened if there were a free market with no regulation nor was Madoff trying to make us think we have a free market so that he can gain more power and control to do this again. And, there is no government conspiracy that hopes that a new Ponzi scheme will develop so that government will become more powerful.

    The experiences from this failure should be learned from and used to fix the SEC regulatory agency.

    Dan (thinks a free market, the illusory home of privatization, will arise when there are no taxes - never)
    HFM

    As long as there exists people with religion and a belief in God, there will never be a Libertarian state.

  10. #10
    a
    Quote Originally Posted by Jesse View Post
    Investigation and exposing of frauds could certainly be accomplished by various trusted independent private agencies. You have to shift outside of your normal paradigm here. In a world where companies don't have an agency like the SEC to provide them a sense of legitimacy, the companies themselves would have provide this legitimacy. Most likely they'd allow well known and trusted agencies to have access to their books. I haven't put a lot of thought into this, but it seems pretty logical to me.
    You're right. Private agencies or individuals (like Markopolos) can investigate and expose frauds. The failure took place in this case when the SEC did not review the tip properly and failed to independently investigate.

    I am not saying there is no place for private investigation. I can see how my statement "[n]or should any private agency wield the power to investigate a citizen for the purpose of conviction and incarceration" could be interpreted that way. What I am saying is that the SEC must conduct its own independent investigations. Tips resulting from investigations by private agencies or individuals should be reviewed by the SEC. And, I am saying enforcement of wrong doing is a public not a private matter.

    As for the idea of access to books and provision of legitimacy, you may note from review of materials that I linked that Madoff acted under a veil of secrecy where financial transactions were hidden. Madoff was well known and trusted despite his lack of transparency and nondisclosure. He needed no private agency to go through his books to show investors his legitimacy in order commit his fraud.
    HFM

    As long as there exists people with religion and a belief in God, there will never be a Libertarian state.

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