Bernard Madoff: Scapegoat of an Economic Crisis
Throughout human history punishments have been meted out to people who are not guilty or only partially guilty. Actions that can invoke punitive action from the authorities include treason, fraud, crime, breach of trust, etc. Famous examples from recent centuries include Galileo Galilei, Charles Darwin, Bertrand Russell, etc, who were ostracized and punished for expressing their sincere beliefs and thoughts. Galileo, for example was threatened with torture for openly expressing his views on the cosmos, which contradicted the conventional Christian view of the universe. Darwin was condemned and treated with contempt by the Church for proposing the theory of evolution that linked all living matter in earth, including humans. In the case of Bertrand Russell, he was imprisoned as a ‘conscientious objector’, for expressing his opposition to British participation in the First World War. These are typical examples of people being wrongfully punished, when they were guilty of no crime or fraud or misdoing. It would be highly improper to associate Bernard Madoff with the aforementioned luminaries, for he was truly guilty of carrying out the biggest financial fraud in modern history. At the same time, it would be simplistic to classify him a victim of comtemporary judicial system. The truth, in fact, is somewhere between these two extremes. It would be fair to say that Madoff was a key participant in the unregulated global capitalist system that led to the present economic turmoil. This essay will argue that the onset of the latest episode of economic depression is not entirely due to individuals such as Madoff, but rather due to fundamental flaws within the capitalist financial system.
Before we try to understand the real reasons behind the economic crisis, a brief look at the fraud committed by Bernard Madoff is warranted. The investment scandal perpetrated by Bernard Madoff is the largest financial fraud in the history of capitalism. It is believed that Madoff’s secretive investment advice firm caused a loss of nearly $65 billions for the 4,000 odd investors who trusted his firm with their wealth. The investors consisted of several celebrities as well as people from middle and lower classes, thereby making the loss more acute for the latter group. For example, Madoff’s ponzi investment scheme showed investors double digit annual returns on their investments, when in truth the money went straight to Madoff’s business bank account with Chase Manhattan Bank. Whenever an investor would request a redemption, Madoff’s firm would pay using funds from new investors, the excess being sent straight to the Chase Manhattan account. The trouble started when this vicious spiral of new infusions and redemptions went out of control. (The Washington Times, 2009, p. A12)
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As much as it is a case of individual indiscretion, there is a broader systemic failure behind the Madoff Scandal. A key example of this is the general failure of regulatory bodies and corporate governance agencies in the United States. Specifically, the Securities and Exchange Commission (SEC), which is an agency of the Federal government that is entrusted with the task of regulating the financial markets is one of the chief culprits behind this failure. The SEC had brushed aside several warning signals in the years leading up to 2008, either due to the incompetency of their auditing staff or due to collusion with the fraudsters. Ever since Madoff started his ponzi investment scheme two decades ago, there have been independent reports that questioned the sustained high earnings of Madoff’s investments, in spite of the market downturn. It was only in 2008 that the truth about the firm’s fabricated accounting practices came to light, following which Bernard Madoff was duly tried and convicted for 150 years in prison. (Parles, et. Al, 2009, p.39)
The market crash of 2008 and the onset of recession since have not lacked precedents. In fact, the story of unregulated capitalism is one of cyclical booms and busts. Even as early as the 1920s, the inherent flaw in this system was blatantly exposed by the Great Depression. In the years leading up to the stock market collapse of 1929, the then President Calvin Coolidge had deregulated the corporate environment, thereby eliminating the necessary checks and balances required for accountability. This led to a free climb in stock prices purely based on financial speculation, i.e. the quoted stock prices were much higher than actual values. At the same time there was a large disparity in income distribution between the top and bottom quintiles of the population. All these factors culminated in initiating the period of great economic distress, retrospectively termed as the Great Depression. One realizes that all of the aforementioned factors of the Great Depression, namely corporate greed, financial deregulation and disparity in income distribution are all contributing factors to the present crisis as well. It then begs the question, why haven’t the authorities learned lessons from the past and attempted to rectify it (Culp & Niskanen, 2003). This just goes on to show that stringent regulations and controls over the financial markets would have thwarted frauds such as the one perpetrated by Bernard Madoff.
The greed of money that led Madoff to resort to unethical accounting practices is not a unique event. In fact, the very basis of corporate America seems to be greed and unsustainable profits. As the case of the collapse of Lehman Brothers clearly illustrates, the unrealistic ambition of CEOs of large corporations is a major factor. For example, Henry Fuld, the Lehman Brothers CEO who took his company to bankruptcy, had earned $350 million as compensation in the three years before the collapse. This figure is comparable to the money earned by Henry Ford, the founder of the Ford Motor Company in the three years leading up to the Great Depression. The deregulated economic environment of the Coolidge years is quite similar to the right-wing economic policies implemented by the Bush Administration during its eight year tenure. (The Washington Times, 2009, p. A12) The Madoff Scandal then looks like a case of history repeating itself. In this context, it is incorrect to place the entire blame on Bernard Madoff and the fraud that he carried out.
The responsibility for the crisis lies primarily with such institutions as the SEC, the Federal Reserve and other government agencies. In the case of Federal Reserve, its policy to encourage trading in complex financial products such as derivatives had played a major role in the economic crisis. The policies framed by the Federal Reserve had indirectly contributed to income disparities in American society, which proved to be a key factor. For example, in economies where income and wealth are unevenly distributed, the supply-demand equilibrium is threatened. In the years leading up to the present crisis, the middle and lower classes which form the majority of the population, found themselves with inadequate disposable income to buy products and commodities. In other words, the supply overshoots the demand thereby leading to a state of economic instability. During the first few years of this millennium the gap between the affluent and the middle class got wider. During the second term of the Bush Presidency the top 1 percent of the population owned more wealth than the bottom 90 percent of the population put together – an unbelievable fact. In the same period, the top CEOs of major financial institutions were drawing more than $39 billion in bonuses alone. These imbalances led to an unstable economic climate, which ultimately precipitated the market crash and recession (Daily Record, 2009, p.9). Considering this, it would be imprudent to make people like Bernard Madoff the sole culprit.
It is indeed remarkable that in spite of several episodes of recession in the last sixty years, the American legislatures have not been suitably amended to mitigate future recessions. Even under the new leadership of President Obama, no major changes have been made to change the policy framework. In fact, judging by the remedial measures taken so far, it seems that the present stimulus and bailout packages offered by President Obama does not measure up to the New Deal initiatives taken by President Franklin Roosevelt in the aftermath of the Great Depression. In this scenario, singling out Bernard Madoff and his ponzi investment scheme for the present economic turmoil is quite inaccurate. (Rothschild, 2009)
It should be noted that the economic recessions are not unpreventable. The leading economists of our time, Joseph Stiglitz and Paul Krugman, both Nobel Prize winners in the field of economics, have unequivocally expressed their support for the nationalization of banks, which they believe would enforce greater controls on the financial system. But their voice of reason and prudence was drowned out by the more influential corporate media commentators and lobbyists. The problem is compounded by the prejudices held by a majority of Congressmen and Senators against the notion of ‘nationalization’. The very term, according to most of them, betrays the key founding principle upon which the American nation is built, namely that of unfettered capitalism. Furthermore, the collapse of Lehman Brothers and the Madoff Scandal were not an one-off events; several other major banks such as Meryll Lynch and Citibank were also on the verge of bankruptcy. This should have convinced the policy makers about the systemic failure of the financial system in America – something which piecemeal solutions like financial bailouts will fail to address. But the political and corporate opposition to the measure is so vocal that President Obama had to settle for the next best plan, namely, infusion of taxpayer money to support privately owned banks (Rothschild, 2009).