$50 Billion Fundamentalist Free Fall

In the latest news flash that has Wall Street reeling, Bernard Madoff, arguably the most dominant figure at the NASDAQ Exchange, was arrested on one count of Security Fraud by an FBI team investigating the affair. The Securities and Exchange Commission has launched its own investigation, and further charges seem inevitable.

The numbers involved are staggering. His company’s value, estimated at some $50 billion is now, by his own admission, based on “one big lie.” (Recall that Enron was valued at $63.7 billion when it went belly-up).

That lie is the oldest one on the books, one enabled and exacerbated by a paper-money-and-credit system such as ours. It was, in the word of the day, a “Ponzi scheme”…

You know how they go: initial investors receive large and remarkably consistent returns, thereby creating “buzz” (Madoff’s firm provided 8-9% on your money, every year, regardless of so-called market conditions). Later investors provide the cash payouts for these initial investors… and for everybody else. It’s also called a “pyramid scheme,” and so long as the base of the pyramid is larger than the tip, the system is, if not quite secure, then stable at least. When numbers of new investors decrease, as is inevitable in a finite universe, the seismic shocks ensue.

What triggered this now is the overwhelming feeling of crisis on Wall Street and throughout the country. Simply put, a number of Madoff’s investors needed their money (even the very wealthy are feeling pinched in this downturn), and he was confronted with the impossibility of meeting the looming demand for a $7 billion payout.

Some weeks ago, I wrote a short history of John Law, purveyor of the first such Ponzi scheme in France. His story sounds eerily familiar this week. More maddening still is that these men are not evil; they seem quite likeable and decent, in fact.

What is worrisome about them is rather their blind faith in markets and the possibility of continually positive returns on investment. They believe what they want to believe. And let’s be clear: so do their investors. They promise something close to winning the lottery, with lower rates of return but many more winners. Indeed, early on, everybody is a winner. And this exuberance creates the illusion that market values—much like internet values, and real estate values, and hedge fund values, and on and on—will continually rise.

It is an imaginary world without gravity, without downturn, without pain, and most distressing of all, without responsibility. This has been the world of the current administration as well.

It was less than four year ago, in the January 2005 State of the Union address, that President Bush proposed permitting US citizens to invest their own Social Security funds in the stock market, in order to take advantage of the higher returns available there.

Resistance to the idea was two-fold. First, Social Security is itself another Ponzi scheme; no one has “their own money” to invest. “My” money will be paid into the system when I retire by taxpayers who are still working then. So the proposal actually hinged on a misrepresentation of the way the system works.

And let us be clear about another worrisome device used to sell this idea: US taxpayers used to receive a report on their yearly earnings and Social Security payments once each decade. In Bush’s first term, the federal government began issuing a yearly report, thereby underwriting the illusion that the recipient personally had some sort of Social Security “account” that he or she could “manage.” It isn’t quite like that anymore than Madoff’s investors’ money was simply theirs, available to them whenever they needed it.

The second worry was more predictable and more timely. The idea was just too risky. The Bush proposal hinged on his limitless confidence in the stock market’s ability to rise. The fundamental rule of capital—that higher risks generate higher returns as well as higher losses—was replaced by a blind faith in the US economy’s ability to grow without limit. It traded on the reckless language of infinity, and of faith.

As I have emphasized in a number of columns over the past four months, the capitalist system hinges on the future and the long view, and it relies entirely on trust. We now live in an environment where it has become painfully clear that banks do not even trust other banks to tell them the truth about their real financial situation. And if they do not trust one another, they do not trust individual loan applicants either. No one trusts anyone enough to lend them money these days. And no one trusts the so-called experts to tell them the truth about value, about the future, or much of anything else. When the director of a major exchange can say “it’s all just one big lie,” then we are indeed living in a quavering new world.

The challenges facing the new administration are enormous, and go far beyond the desperate practicalities of figuring out how best to spend the staggering sums of money we are throwing around. No, it is virtually a cultural matter now, a matter of finding some way to shift the corporate culture of the nation and the economic habits of the people. How to reorient our thinking to the long view and to the future? And how to restore the realization that truth-telling, honesty and responsibility really do matter to the project of our common survival?

Ironically, this has happened in the season when It’s Wonderful Life seems to run on a loop on the TV. The film offers a harrowing picture of a future in which craven corporate greed, shameless dishonesty, and the general anti-humanism of the slumlord constitute the reigning political philosophy. The Madoff scandal makes very clear just how fragile is the romantic image of a duty-bound George Bailey, and suggests the disturbing possibility that we now live in a time when the Potters of the world reign supreme.