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Washington Examiner


Could a New Federal Agency Catch The Next Madoff?

March 31, 2010

By Nicole Gelinas

In his bill to fix financial regulations, Sen. Chris Dodd would task a new agency, the Financial Stability Oversight Council, to “respond to emerging threats to the stability of the United States financial markets.” But regulators had a decade to ferret out investment manager Bernard Madoff’s blatant fraud -- and failed. A bureaucracy created to expose subtler dangers will fail, too.

The Securities and Exchange Commission has a straightforward mandate: to protect investors. Yet it missed multiple opportunities to protect investors from Madoff before he stole $65 billion. (Madoff confessed his Ponzi scheme in December 2008.)

Harry Markopolos, a Boston-based quantitative analyst, learned about Madoff early on from his colleagues at an investment firm. They wanted him to find Madoff’s secret -- and replicate it. Markopolos learned, though, that the secret was fraud.

“With a math problem, there is only one correct answer,” Markopolos relates in his new book, “No One Would Listen.” Madoff’s strategy “couldn’t produce the returns Madoff was delivering. His basket of stocks had to have a reasonable mathematical correlation to the exchange on which the stocks were traded, and they did not.”

Less wonky evidence piled up. Madoff’s method required him to buy tens of billions of dollars of financial instruments regularly -- but dealers in those securities never did business with him.

Starting in 2000, Markopolos brought his findings to the SEC. He submitted a 2005 report under the following title: “The World’s Largest Hedge Fund Is a Fraud.” Markopolos listed 26 “red flags,” from the mathematical to the mundane.

Why didn’t the SEC act? Turf warfare: Markopolos brought his initial findings to the Boston office. But Madoff was in New York -- and the New York office didn’t want Boston’s scraps. Too many lawyers: “they were expecting me to provide legal proof.” And personalities: Meaghan Cheung, one of Markopolos’ SEC contacts, “didn’t like me,” he writes.

It’s hard to get any entrenched bureaucracy to fight conventional wisdom. Big organizations decide things by committee and don’t like dissent. Officials’ real mandate is to preserve themselves.

Madoff was powerful, and there wouldn’t be much of a reward for a midlevel government official who fought that power and lost. “Bernie Madoff was the ultimate insider; I was the bothersome outsider,” Markopolos concludes.

Even as the SEC couldn’t do its job, it bred investor complacency. Markopolos doesn’t mince words with money managers who put their clients’ money with Madoff. “A marginally competent fund manager should have said thank you very much, Mr. Madoff, but no thanks, and run as fast as possible in the other direction,” he writes.

But those managers easily dismissed any skepticism. “Investors around the world believed that [the SEC] offered them a great level of protection and that their money was safe. ... The SEC seal of approval was misleading and actually very dangerous.” The SEC helped disarm some investors of an invaluable tool: disbelief.

The SEC didn’t prevent Madoff -- and Dodd’s Financial Stability Oversight Council cannot prevent the next financial crisis. A future Markopolos could present the FSOC with evidence pointing to a burgeoning bubble -- but the agency will ignore it if it’s the minority opinion. Just as the SEC dismissed Markopolos, insiders long dismissed early housing-bubble naysayers as kooky, dumb or constitutional complainers.

Meanwhile, market participants will figure that the FSOC is on the job -- and discount their own doubts.

Washington would do better to improve existing bureaucracies.

Politicians can do that only by acknowledging the limits of regulation. Regulators cannot predict the abstract future. Instead, they should enforce concrete rules in the present -- like borrowing limits and requirements to disclose trade information -- to lessen the effect of inevitable future crises.

Original Source:



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