Paul Krugman: The Madoff Economy

The costs of "America's Ponzi Era":

The Madoff Economy, by Paul Krugman, Commentary, NY Times: The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.

Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?

The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s ... had a corrupting effect on our society as a whole.

Let’s start with those paychecks. ... The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence.

But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.

Consider the hypothetical example of a money manager who leverages up his clients’ money..., then invests the bulked-up total in high-yielding but risky assets... For a while — say, as long as a housing bubble continues to inflate — he (it’s almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he’ll keep those bonuses.

O.K., maybe my example wasn’t hypothetical after all.

So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. ... Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.

We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.

But the costs of America’s Ponzi era surely went beyond the direct waste of dollars and cents.

At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics... Meanwhile, how much has our nation’s future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else?

Most of all, the vast riches ... undermined our sense of reality and degraded our judgment. Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? ... The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.

After all, that’s why so many people trusted Mr. Madoff.

Now, as we survey the wreckage and try to understand how things can have gone so wrong, so fast, the answer is actually quite simple: What we’re looking at now are the consequences of a world gone Madoff.

Comments

[Winslow R.]

Krugman "What we’re looking at now are the consequences of a world gone Madoff."

Nice punchline but where is the punch. Redesign an optimal financial system. I like Krugman's ever expanding demand for fiscal policy, I'd like to see 1.5 - 2 trillion but where is his 'solution' on the monetary policy side? Is fiscal policy his only solution when we see time and again how corrupted our monetary policy system is?

[mick]

"...how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees..."

The theory of efficient markets coupled with self-interested Randian actors leads me to believe that insider trading, price fixing and Ponzi schemes are the rule in an unregulated market, not the exception. I think this is so obvious that i won't bother to explain it. Oh, hell, let me explain it: these schemes and ruses are the most efficient path to wealth, after all. they beat hard work and thinking!
i'm just an unshaven guy in pajamas who barely graduated high school. it should be easy to prove me wrong if i am indeed wrong about this. and my pet theory (if something so obvious can actually be called a "theory") pretty well blows away the Ayn Randian/pure, efficient markets approach to economics and finance.
So why do i not hear smart people like krugman and de long espousing this point? what am i missing? where is the constant, pointed debunking of unregulated market theory? where is the laughter and ridicule? where have all the good times gone? and where did my money go?

excuse me while i check my 401k account.
your turn.

[anon]

When your government, acting through its banking system and central bank promises to constantly debase the money you use as a medium of exchange and hopefully a store of value, indeed the smartest thing to do is to get as close to the action as possible. So it's no surprise that the best and brightest find their way to where easy money created out of thin air is there for the taking.

Of course, they'll kick back as much as necessary to the politicians that make it possible.

This type of banking system is perhaps the longest running scam in history and it shows no signs of abating.

[reason]

Brilliant article. But I agree with Winslow R. it needs some follow up. Not just on wall street, but the whole international financial system. The whole thing needs a rethink. I don't think PK has done the thinking yet. But he sure is a good thinker when he gets going.

[Daniel Barnes]

This is surely one of Krugman's best. Remember back when he was mocked for saying Enron would ultimately be more significant for America than Sept 11? Well, now here we are in Ponzi Nation.

[a]

What Krugman wrote is a tad bit obvious. Still, it is worth repeating: "The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing."

[calmo]

@Posted by: anon | Link to comment | December 19, 2008 at 12:07 AM,
So no need to think that this financial system (government, acting through its banking system and central bank) is any different from the UK's, or the Swiss or the US system 50 years ago?
So it's no surprise that the best and brightest find their way to where easy money created out of thin air is there for the taking. But they aren't the best and brightest, only the richest and only in the context of money do we think "smartest"...history does not tally these people in the same way that Forbes does.
This type of banking system is perhaps the longest running scam in history and it shows no signs of abating. We need to hear about the others, the comparables, to know what you are saying here. Is there a Buddhist Bank? How about non-European banking...any such animal?

I no sooner tell rdf that Krugman's writing is not witty then PK lays this ...egg:"...world gone Madoff". Ok, rdf, 'tis the Nobel that has affected him...anso onwards to the Nobel for Literature now? [No, this is not his best work and he is tired from all the Nobelling around.]
This is also pretty windy for Krugman, but here he could have been windier:Most of all, the vast riches ... undermined our sense of reality and degraded our judgment. by looking a little closer at those vehicles/instruments...the TV set mostly, but also the remnants of newspapers like NYT and WSJ, that for the most part, lionized these bandits. We sat on our fatasses expecting these 2 papers to be our guardians, but Watergate belongs to another era.
So, that might have comprised his skit at NYT, but he can afford it now...and he still might. He referred to Tanta once --he could meditate on her line: "We are all subprime now."

[reason]

calmo
where did you tell rdf that PK's writing is not witty? Compared to whom? I remember always telling the party joke, that as an economics student insomnia was never a threat. Pull out an economics text and deep sleep in 3 minutes flat.

says...

Heads should roll

Article: The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so.

America is collecting a good number of world-class "Scandalous Firsts”. This Ponzi Scheme, in the hands of an adept Wall Street phoney, is just the latest in a series of eye-poppers that we have suffered on financial markets -- down through both Replicant and Dem administrations. Where will it ever end?

We have a right to ask, “What next?”

Let’s hope the answer is more regulation. A Free Market is not a market where the law of the jungle applies. A free market is ordered, principled. It is where access is free to all comers and there is no dominating actor, in either Supply or Demand. It is free because the information circulating, upon which investment decisions are made, is truthful and honest.

What does that definition mean for the more obvious transgressor, financial markets? For that question, we must go to heart of the matter. Which is the culture of “bonus”. Despite the chaos in financial markets this year, the total amount of bonuses to be distributed in London will be worth 20B euros. Many of us have lost our shirts, but some others have feathered well their nest.

Doesn’t seem fair, does it. Because it isn’t fair.

Profit is the reward for risk. One bets one’s money on a market idea, something that will fulfil a supposed market need. And, right or wrong, either profit or loss results. Should that be the same when one does not bet one’s own money, but someone else’s? Enormous commissions should be earned on such “bets”? So much that one is childishly prompted to bet even more … and perhaps take a few short cuts?

Arbitraging is as old as finance itself. We did not invent arbitraging yesterday, not on Wall Street and not in the City of London. Clever minds have always been on the lookout for market price differentials. Much as economists have faith in the law of Supply and Demand, the law of one price simply does not exist in today’s world. So, arbitragers take advantage of even the most minuscule differences. One might say they are the Cleaning Ladies of World Financial Markets.

Does one need any particular expertise or education to arbitrage? Not really, just a keen eye. Much as gambling on horses or even sports events. It is akin to gambling, but has a more hallowed aspect since it is done by well-heeled investment banks … with paneled offices and plush leather chairs.

Does one need any particular knack to slice and dice mortgages, obtain by hook or crook triple-A ratings, then foist them on the world? Not really. Once again these Golden Nerds did it because nobody was watching. Like the kid in my senior year high school class who would steal chalk erasers to sell them to a school in another town; it is, comparatively, a form of delinquency with higher stakes in play. The SubPrime Mess is, most certainly, an abuse of confidence even if the joke was played on a gullible public and investors.

Which is why we have usury laws as well as a Truth in Lending law as well as laws that cover fraud in all its manifest forms? The laws are there, for the most part, they just need enforcement.

On the international scale, we need an agency that has both the credentials and the expertise to track down both fraud and tax evasion. It is estimated that more than half of ALL financial transactions pass through offshore establishments, thereby avoiding any and all national taxation. One must think, I submit, that the time has come for the Tobin Tax applied to such transactions. And since they are, for the most part, electronic, that should pose no great problem.

It is all a matter of policing. That is, the will of governments, by means of their various agencies, to police the market. Those agencies have failed their duty to us. Heads should roll and more competent people put in their place.

One just did, that of the SEC. Ben had better update his résumé …. (Princeton can certainly benefit from his well-honed experience of late. He can write another book on Depression Economics. An academic treatise on "What to do when the financial world is falling down about your ears". For dummies. Most engaging, that title.)

Adage: Whilst the cat's away, the mice will play.

[Lafayette]

mick: I think this is so obvious that i won't bother to explain it.

Hold it. No, it is by no means obvious.

The present circumstances indicate that such as happened. But, that regards only present circumstances. You are taking great license in proposing that finance markets, in general, are riven by fraud.

Have you any facts or just positing a sentiment?

[Lafayette]

The Prudent Man Rule

The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.

But of course they know what they are doing. Or, they wouldn't be there, in Corporate Offices, doing it.

That which has been lost in the shuffle over the past few decades on Wall Street (and often Main Street) is the once prevalent rule (first elaborated in 1830) called the Prudent Man rule from which we learn: The Prudent Man Rule directs trustees "to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.

We need, perhaps, to engrave that in stone and place it somewhere conspicuous on Wall Street. Speculation is NOT the norm in money management. It is the exception to the norm and therefore exacts far more prudence in terms of risk management. (Those who refuse to learn the lessons of history are condemned to repeat history's failures.)

And I submit further: The only way to curb Consummate Cupidity in business is to tax away its incentive. Meaning this: Confiscatory Taxation on all compensation above some threshold total amount.

[hari]

I've called IBs and Hedge Funds and now this Madoff economy, as part and parcel of a (religious) cabal for whom greed is everything. Because they're rewarded by their collegues for their great accumen of accumulating wealth without a sweat...and so on.

The world of finance has finally recognized American capitalism is a sham and nothing more. It's driven by immoral greed and reverence for wealth.

Paul would have been taken serious if he said that the hi fi sector was now defunct and required a total restructuring.

[gordon]

Lafayette, you might like to check out this article on international flows of "dirty money" by Baker and Nordin at Economists' Voice (based on a book by Baker). There is an FBI site which offers some stats. on white-collar crimes which should include some of those that mike mentions. There is also an outfit called the Association of Certified Fraud Examiners (US) which has a website (I've lost the URL, apparently) and publishes reports.

The whole issue of the economic cost of fraud seems very murky. Tax avoidance alone has generated a big literature and lots of different estimates. I remember getting involved in an argument on another blog some time ago about whether frauds which are discovered were aberrations in a predominantly honest world or were the tip of an iceberg - those seemed to be the two polar positions in that debate. I was arguing for "tip of an iceberg", but I don't remember that the debate had a resolution (most blog debates don't). Like mike, I suspect that there is a lot of fraud of various kinds, and that the economic costs (I guess predominantly opportunity costs) are large. But I don't know whether we have progressed much further in analysis than J.K.Galbraith's famous remarks about the "bezzle" made many years ago. The whole issue is a very interesting one.

[gordon]

And, Lafayette, we might consider that if fraud is substantial, where do the fraudsters (and gangsters) put their money? In banks. Why is everybody so amazingly anxious to bail out banks? Maybe "too big to fail" is a policy response to an offer that can't be refused...

[Man in Shanghai]

Guys, we are really getting closer in ideology...

[Mick Boyce]

hi Lafeyette

BCCI, Teapot dome, Enron and Arthur Anderson, Savings and Loan, Sumitomo, Worldcom, Matthew Piper, George Soros, Martha Stewart, Boesky, Milken, Leeson, Kerviel.

i'm sure i could find some more, but i'm not your research assistant. if you are proposing that unregulated markets do NOT invite scandal and cheating, then the burden of proof is certainly on you, Lafayette, not me.

my statement is basically this: unregulated markets invite foul play. it is one reason we have a government. to me, this is obvious on it's face. and hardly worth repeating.

[Massimo GIANNINI - M.G.]

Excellent. The economy has gone Mad-off!!! Eventually a Nobel Prize writes an inconvenient truth. But now you have to draw the consequences of this, and somebody's else, written truth about fraud and corruption economy: a) what is the point and macro arithmetic of a 600 Billions fiscal stimulus when Madoff with just a pen writes off about 10% of that "wealth"? b) What about progressive and financial transactions taxation? c) What about better allocation of now scarce resources to productive investments?
With these questions, I would like to wish you .

Merry Christmas and Happy New Year

[calmo]

You B right Shanghai Man. And this is a danger, yes? Wazzinit this very unison stupor that got us here in the first place? Don't we need some dissenting voices...like there might B one good banker still providing a service and extracting a modest fee for his work...and not providing for his extended family and favorite charities...and possibly a recreational cottage --nothing fancy...in the south of France...maybe a housekeeper if the weather is encouraging.
Ok, banks didn't always use to B this crummy. And we should not make the same mistake twice: paint everything the same color...it is a GOP characteristic: "You can't trust any politicians"...not a note from a decent publicly elected official. They almost deliberately do a bad job of governing just to persuade you that Government is Bad...only they are often self-thwarting...proving the point, but needing others (Dems) to articulate this...dang.
So Shanghai Man, beware the consolidating ideology. It is the bark of a dog...not a real voice.

*reason* I looked in the links for my criticism of rdf's note that PK was witty but incapable of speaking and thinking at the same time...ok, I know where it is now: the video where PK answers MT's question.

[BJ Feng]

We have a competitive and comparative advantage in finance. As I said in another thread, we are the only ones who can create dollars, the reserve currency of the world. Other countries like Russia need to hold our dollars because their currencies are nothing but paper, not real money like the dollar is.

Madoff was only one of many asset managers. He didn't ooperate a hedge fund, what he did I still am unclear on. It seems he was some sort of a broker-dealer/asset manager, his structure was unique which is why a lot of people refused to invest with him after doing due diligence. Even those who did invest with him thought something was fishy, they just assumed he was breaking the rules to benefit them. They didn't think he was breaking the rules to cheat them.

Yes I believe most hedge funds aren't worth their high fees, but then again, if it's your money, then you get to decide where to place it. And how are the fees hedge fund managers get any different than the benefits and wages paid out to unions? The hedge funds are able to convince people through actual performance while the unions use threats and intimidation through strikes, that's the difference.

Let me clarify, unions do and should have the right to strike just as hedge funds have the right to ask for whatever fees they think appropriate.

[Rebekah Jensen]

I read an article the other day in which the author observed that the prevailing thought in Florida is, "Wealth is everything. Once you lose your money you become a nobody." I think that pretty much summs up the way our culture has been trained to think over the last decade. I suspect that over the next few years we'll start to see a push towards believing that public service and working for the common good is the criteria that we should use when measuring one's character.

[Beezer]

"BCCI, Teapot dome, Enron and Arthur Anderson, Savings and Loan, Sumitomo, Worldcom, Matthew Piper, George Soros, Martha Stewart, Boesky, Milken, Leeson, Kerviel." Writes Boyce.

Hitler, Mussolini, Pol Pot, Mao, Stalin, Bin Laden (any of an endless list of Dictators the past 100 years). Governments too can produce horrors. The primary difference is free market ones take your money whereas government ones take your freedom, money and life.

The solution is not a sweeping one. It's actually contained in just this simple thread. And it has several very obvious parts. One is balance. If incomes become out of balance, it's a sign of something amiss. If certain freedoms begin to be compromised, such as free speech, or the right to move about freely, then it's a sign of something amiss.

Prudence is a good word, as well. Transparency is an essential. Fair rules fairly enforced is necessary.

Government, for better or worse, is the primary enforcement vehicle for protecting fairness and punishing crooks (those that are caught). Banks used to be the primary vehicle for protecting people's savings. But that was changed in 1999, and that imbalance still exists, by the way.

Let the new administration work on the obvious imbalances we've built up the past few decades. There are a lot of them.

But cupidity and hubris are never going to go away. And people, even real smart ones, will still fall for con artists (hence the artist designation). People will still adore wealth and power. That's not going away.

But it's times like these that remind us of the real truths. Truths that contain "balance," "prudence," "transparency," "honesty," and "fairness," not only in word but in practice.

[im1dc]

PK writes "Most of all, the vast riches ... undermined our sense of reality and degraded our judgment. Think of the way almost everyone important missed the warning signs of an impending crisis."

And Jack Bogle on Bloomberg TV this morning makes PK's case for him when he said of this financial crisis "I thought I had seen it all until this year."

JB missed all the warning signs too.

Bogle blamed this financial crisis on greed, most especially in the financial industry, but also on all Americans in all sectors.

He also said, again, "The old rules don't apply" to this crisis.

He implied that America needs to return to a cash only culture when he rolled out his story about saving $5 a week for 8 weeks from his job until he could afford to buy a bicycle for cash. He did not use credit then and no one did.

He neglected to say that was a different financial era.

PK also asks why most esteemed money managers missed it: "How was that possible? ... The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing."

John Bogle, one of the elite, falls into that category.

And something not said by either prophet, PK in his Editorial or Bogle in his interview, is that many now consider the next Bubble is in US Bonds.

[ken melvin]

I B inspired. Let's have a Global War on Tax Evaders (GWOTE), a real clear and present danger not one a made up one, using intelligence snifters - the whole sheebang.

[im1dc]

FYI

Oil is down 27% this week and this morning was as low as $33 a barrel.

The BOJ cut its key rate to 0.1% this morning.

The 10 yr US Bond Yields 2.09% this morning.

German Producer prices fell the most this year since records began in 1949.

There is a bit of good news. Fred Smith, CEO of FedEx, is taking a 20% pay cut but then he's dishing out aross the board 7% pay cuts to all salaried personnel and cut all contributions to employee 401K's to zero.

Don't think that Fred Smith has actually taken a hit in income. His salary represents only 10% or so of his annual haul of well north of $10 million.

He's a bad dog.

[im1dc]

Oh, I forgot to add Mutual Fund outflows are rising rapidly.

You do comprehend about the relationship between MF outflows and the price of equities?

[im1dc]

I also forgot to mention that Hedge Funds are essentially out of business and in redemption also exerting their selling pressure on equities.

And yet the market goes up? You got to wonder who is buying when the big players are selling, or if there is any real buying going on as opposed to sham trading?

Just asking the question given the recent revelations of extreme fraud on Wall Street and the total lack of Fed oversight.

[Ninja Zombie]

There is a problem waiting in the wings far worse than the Madoff scheme. It's a ponzi scheme worth over a trillion dollars. And unlike Madoff's scheme, this one is a pension fund rather than a hedge fund. When it collapses, ordinary Americans will be hurt.

Will the SEC do anything about social security?

[im1dc]

It is clear from the following that it is not Detroit's failure to make and sell good non Union cars, it is the global Depression causing people to not buy cars made by Union or non Union workers.

Yet, 43 sits manipulatively in the WH unwilling to timely support Detroit's Big Three request for emergency bridge loan without extorting bankruptcy filings from them.

This after ramming the $700 Billion Bailout through Congress to float Wall Street.

Someone ought to check if George W. Bush is actually an American Citizen. He certainly has not played on the American Team or supported American workers these past 8 yrs.

The difference imo is that Wall Street gave Republicans more campaign money while Detroit unions supported Democrats.

Toyota to suffer first full-year loss: reports

Dec 18 10:24 PM US/Eastern

"Japanese auto giant Toyota is likely to suffer its first-ever operating loss..."

"It would be Toyota's first operating loss since it began releasing earnings figures for the year to March 1941, the Nikkei business daily said."

BTW, for the Eco greens, the report on Toyota also says Prius sales are down 47%.

[mausa.nonia@gmail.com]

Two points:

---Ponzi Nation: to a lesser extent the real estate market did this too. Each time a house changed hands, the agents got their fee, taxes were paid and also land titles registry fees, plus the cost of cosmetic fixups and etc.

You might call it a Froth Economy. It is evaluated by volume, (whoopee huge GDP!), but paid out in weight.

I love the froth on latte as much as the next person, and I think financial froth is necessary for an agile economy, but what we have here is a cup full of froth with a half-inch of coffee lurking at the bottom.

--- "...there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money..."

...because, especially in a very unequal society, they are often the chief source of money. So a circle of two-faced people grows up around them. The inside face is sycophantic and approving, the outward face is defensive and aggressive.

One of the things I hate most about the increasing inequality in the US has been the mobilization of poor people in the fierce defense of the rich. Makes me nuts.

Noni

[anne]

"Will the SEC do anything about social security?"

No; the SEC will do nothing about Social Security because there is a massive and growing Social Security surplus and the system has reserves sufficient for decades and possibly indefinitely. The system is invested in Treasury bonds and completely secure, and suggesting that Social Security is a Ponzi scheme is a mean-spirited lie.

[im1dc]

Bush from the WH is outlining his Big Three bailout.

It appears it does not include forcing bankruptcy to get funds.

He is granting loans from TARP to Detroit for 3 months to March 31st giving them time to restructure.

He is requiring concessions including changing their retirement plans.

BTW, Bush is having difficulty speaking. He is hesitant, trips over his tongue, starts and stops inappropriately and stumbles over words.

His speech is indicative of Major Depression. He should be removed from office ASAP.

[Lafayette]

MB: i'm sure i could find some more, but i'm not your research assistant. if you are proposing that unregulated markets do NOT invite scandal and cheating, then the burden of proof is certainly on you, Lafayette, not me.

Your original comment was overreaching. Finance markets, in terms of total monetary value, are by and large fair. They are NOT dominated by fraud, as your comment implies – whether you mean manipulation, abuse of confidence or money laundering or whatever else.

Yes, the abuse of privileged information (insider information) and confidence, or outright fraud, does exist – and it is not insignificant. The subject has also presently great currency. But, if you wish to maintain that it is just the tip of the iceberg, as it seems you do, then I suggest you justify that remark. Which you cannot.

Because, in fact, we don’t know how much of all total transactions it constitutes. "It" meaning both tax avoidance and fraudulent financial operations.

But, as regards the former, in a very well done investigative report by a French TV station (yes, the French are getting around to British reporting astuteness), the “tax avoidance” was estimated at about 100B euros to the French government (a bit less than a tenth of its budget, I estimate). That is a significant amount. Certainly worth hiring a lot of investigative detection work to pry it loose.

The offshore centers based in the EU, last year, went through a major correction. The EU imposed upon them a regulation that all holdings in non-risk instruments (meaning equities) must pay a tax. Confidentiality is preserved by not identifying the individual’s name. So, the tax collected is a bulk sum transfer to the nation whose nationals employ these offshore banking services.

The trick now is bringing non-EU and non-US offshore centers under the same purview. To wit, I suggest also employing a Tobin Tax to assure a base tax is paid. And I am also sure the amounts paid will be minor percentages of the total offshore fund value, since most are kept in equity funds, which do not fall under the terms of the agreement. Still, why not tax equity capital gains?

Offshore Tax Paradise Nations are fairly well known. Even widely written about. If interested a seminal work was written “Guide Chambost des Paradis Fiscaux” by Edouard Chambost (unfortunately only in French, I think) who keeps it updated. A tax lawyer, he lives in Geneva, of all places …

We know what’s going on. Until now, there was no common will to tackle the problem. That hurdle may have been overcome. It WILL be on the G-20 agenda that Sarkozy forced lead-head to sign onto. It is a matter on the front burner, which BO&Co. will need to assume early in his tenure.

Lord knows we are at time when countries really need the tax monies that are going off to these centers called, in French, a Fiscal Paradise. Appropriate appellation, that.

[anne]

The problem that John Bogle began to write about in the 1980s and Paul Krugman is writing about now is simple to understand. Since August 1976 when investors were initially able to buy a stock index fund, the Vanguard Standard & Poors index has returned 10.02% after costs. Now, professional management investment costs such as the costs to investors who were placed by fund raisers with Bernard Madoff run about 3 percentage points in all. Such a cost is typical to low for hedge funds. But, to simply earn as much as the Vanguard stock index over a long period a manager would have had to make not 10.02% but about 13.02%. There are managers who have beaten the index by 30% and more over time, but this cannot happen for the market as a whole and most managers will not come close.

What we have then, year on year is an astonishing cost for professional investment management that as David Swensen of Yale has repeatedly pointed out will be a losing proposition for investors whether institutional or individual, wealthy or middle class.

[anne]

While the return on stock index investment since 1976 has been 10%, the return on long term investment grade bonds has been 8.14% after Vanguard costs since July 1973. Imagine then what professional management costs for bond investing that are typically 2 percentage points in all means in terms of a drain on investors accounts. Even with honest accounting, professional money management has been so exceedingly profitable for so long because it is so exceedingly costly with costs seemingly of no concern to most investors even when the costs are made clear which is problematic.

[anne]

As for a bubble in Treasury bond investing, no bubble is possible though losses for a time are always possible. The way to project bond returns in simply to look to current interest rates or yields. The yield on the Vanguard long term Treasury fund is 3.13%, with a duration of 11.2 years, which means expect a return of 3.13% over the coming 11.2 years. If such a return seem too low the long term investment grade fund prospect is for a return of 6.18% while the intermediate term investment grade prospect is 7.05%, which a duration of 5.1 years.

[swells]

Here's the deal as far as I can see it. The Enron guys, the Wall St. bankers, et al, are simply engaging in monkey see monkey do. If there is an exemplar of off the budget liabilites and ponzi style transfers from later investors to earlier, it is to be found in the operations of the US government.

How much debt has been transferred to future generations at this point? It's one thing if it's debt that was productively invested but it's really, really hard to see how Iraq expenditures fit that mold.

And yes, I know the social security trust fund has a lot of special treasuries in it. But all that backs up those treasuries is a promise to tax later.

[anne]

And yes, I know the Social Security trust fund has a lot of special Treasuries in it. But all that backs up those treasuries is a promise to tax later.

No; this is knowing nothing and distorting as much as possible. There is now a massive and growing Social Security surplus, but there are those who are beyond understanding or honestly describing that.

says...

The Social Security fund does not hold marketable securities, those "treasuries" are intragovernmental IOUs to be "repaid" with future tax revenues. The SS surplus has already been spent! There is no surplus.

[Ninja Zombie]

Anne: "The system is invested in Treasury bonds and completely secure, and suggesting that Social Security is a Ponzi scheme is a mean-spirited lie."

So if one branch of Madoff's hedge fund issued bonds to the other half, would that make it completely secure?

From wikipedia: "A Ponzi scheme is a fraudulent investment operation that involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profit from any real business."

That's exactly how Madoff's scheme worked and that is exactly how social security works.

The only big difference between SS and most other schemes is the method of getting new investors. Madoff used fraud. SS uses force.

says...

Prudence is the mother of all virtue.

The purpose of banking regulation in general is to promote prudent banks and reduce systemic risk. Sound banking regulation does not inhibit "creative" finance or reduce fraud and incompetence, but protects the system.

So I disagree with the Krugmeister. Its not a madoff world, its an imprudent one, and the solution of good old fashioned sound banking regulation has worked before.

says...

ninja zombie

Are you suggesting that the federal government NOT support old people, the handicapped, etc.?

Otherwise, what is your plan for funding a good social security system?

[evagrius]

Getting off the topic with Social Security- which is not a ponzi scheme but an embodiment of inter-generational obligation, something far different.
Those attacking Social Security should examine if they hold to any notion of gratefulness for their own lives to those who worked to make sure they had that life.
If they don't and therefore suscribe to the notion that they are fully responsible for their own education, nutrition, shelter, roads, etc; etc; then they are arguing for atomistic individualism.
They shouldn't, therefore, be upset at Madoff and his ilk when they, ( Madoff & co.) rip them off.

[Ninja Zombie]

blank name: "Are you suggesting that the federal government NOT support old people, the handicapped, etc.?"

The part of social security dedicated to supporting those who are totally disabled is a separate issue. That's just a federally run insurance plan. I have little objection to this, but this is a tiny fraction of social security.

We can easily keep this piece, and scrap the rest.

As for old people, I do indeed suggest that the taxpayers should not be obligated to support them.

[anne]

http://ebooks.adelaide.edu.au/d/dickens/charles/d54ld/chapter21.html

1855

Little Dorrit
By Charles Dickens

Mr Merdle’s Complaint

Upon that establishment of state, the Merdle establishment in Harley Street, Cavendish Square, there was the shadow of no more common wall than the fronts of other establishments of state on the opposite side of the street. Like unexceptionable Society, the opposing rows of houses in Harley Street were very grim with one another. Indeed, the mansions and their inhabitants were so much alike in that respect, that the people were often to be found drawn up on opposite sides of dinner–tables, in the shade of their own loftiness, staring at the other side of the way with the dullness of the houses.

Everybody knows how like the street the two dinner–rows of people who take their stand by the street will be. The expressionless uniform twenty houses, all to be knocked at and rung at in the same form, all approachable by the same dull steps, all fended off by the same pattern of railing, all with the same impracticable fire– escapes, the same inconvenient fixtures in their heads, and everything without exception to be taken at a high valuation—who has not dined with these? The house so drearily out of repair, the occasional bow–window, the stuccoed house, the newly–fronted house, the corner house with nothing but angular rooms, the house with the blinds always down, the house with the hatchment always up, the house where the collector has called for one quarter of an Idea, and found nobody at home—who has not dined with these? The house that nobody will take, and is to be had a bargain—who does not know her? The showy house that was taken for life by the disappointed gentleman, and which does not suit him at all—who is unacquainted with that haunted habitation?

Harley Street, Cavendish Square, was more than aware of Mr and Mrs Merdle. Intruders there were in Harley Street, of whom it was not aware; but Mr and Mrs Merdle it delighted to honour. Society was aware of Mr and Mrs Merdle. Society had said ‘Let us license them; let us know them.’

Mr Merdle was immensely rich; a man of prodigious enterprise; a Midas without the ears, who turned all he touched to gold. He was in everything good, from banking to building. He was in Parliament, of course. He was in the City, necessarily. He was Chairman of this, Trustee of that, President of the other. The weightiest of men had said to projectors, ‘Now, what name have you got? Have you got Merdle?’ And, the reply being in the negative, had said, ‘Then I won’t look at you.’

This great and fortunate man had provided that extensive bosom which required so much room to be unfeeling enough in, with a nest of crimson and gold some fifteen years before. It was not a bosom to repose upon, but it was a capital bosom to hang jewels upon. Mr Merdle wanted something to hang jewels upon, and he bought it for the purpose. Storr and Mortimer might have married on the same speculation.

Like all his other speculations, it was sound and successful. The jewels showed to the richest advantage. The bosom moving in Society with the jewels displayed upon it, attracted general admiration. Society approving, Mr Merdle was satisfied. He was the most disinterested of men,—did everything for Society, and got as little for himself out of all his gain and care, as a man might.

That is to say, it may be supposed that he got all he wanted, otherwise with unlimited wealth he would have got it. But his desire was to the utmost to satisfy Society (whatever that was), and take up all its drafts upon him for tribute. He did not shine in company; he had not very much to say for himself; he was a reserved man, with a broad, overhanging, watchful head, that particular kind of dull red colour in his cheeks which is rather stale than fresh, and a somewhat uneasy expression about his coat– cuffs, as if they were in his confidence, and had reasons for being anxious to hide his hands. In the little he said, he was a pleasant man enough; plain, emphatic about public and private confidence, and tenacious of the utmost deference being shown by every one, in all things, to Society. In this same Society (if that were it which came to his dinners, and to Mrs Merdle’s receptions and concerts), he hardly seemed to enjoy himself much, and was mostly to be found against walls and behind doors. Also when he went out to it, instead of its coming home to him, he seemed a little fatigued, and upon the whole rather more disposed for bed; but he was always cultivating it nevertheless, and always moving in it—and always laying out money on it with the greatest liberality.

Mrs Merdle’s first husband had been a colonel, under whose auspices the bosom had entered into competition with the snows of North America, and had come off at little disadvantage in point of whiteness, and at none in point of coldness. The colonel’s son was Mrs Merdle’s only child. He was of a chuckle–headed, high– shouldered make, with a general appearance of being, not so much a young man as a swelled boy. He had given so few signs of reason, that a by–word went among his companions that his brain had been frozen up in a mighty frost which prevailed at St john’s, New Brunswick, at the period of his birth there, and had never thawed from that hour. Another by–word represented him as having in his infancy, through the negligence of a nurse, fallen out of a high window on his head, which had been heard by responsible witnesses to crack. It is probable that both these representations were of ex post facto origin; the young gentleman (whose expressive name was Sparkler) being monomaniacal in offering marriage to all manner of undesirable young ladies, and in remarking of every successive young lady to whom he tendered a matrimonial proposal that she was ‘a doosed fine gal—well educated too—with no biggodd nonsense about her.’

A son–in–law with these limited talents, might have been a clog upon another man; but Mr Merdle did not want a son–in–law for himself; he wanted a son–in–law for Society. Mr Sparkler having been in the Guards, and being in the habit of frequenting all the races, and all the lounges, and all the parties, and being well known, Society was satisfied with its son–in–law. This happy result Mr Merdle would have considered well attained, though Mr Sparkler had been a more expensive article. And he did not get Mr Sparkler by any means cheap for Society, even as it was. There was a dinner giving in the Harley Street establishment, while Little Dorrit was stitching at her father’s new shirts by his side that night; and there were magnates from the Court and magnates from the City, magnates from the Commons and magnates from the Lords, magnates from the bench and magnates from the bar, Bishop magnates, Treasury magnates, Horse Guard magnates, Admiralty magnates,—all the magnates that keep us going, and sometimes trip us up.

‘I am told,’ said Bishop magnate to Horse Guards, ‘that Mr Merdle has made another enormous hit. They say a hundred thousand pounds.’

Horse Guards had heard two.

Treasury had heard three.

Bar, handling his persuasive double eye–glass, was by no means clear but that it might be four. It was one of those happy strokes of calculation and combination, the result of which it was difficult to estimate. It was one of those instances of a comprehensive grasp, associated with habitual luck and characteristic boldness, of which an age presented us but few. But here was Brother Bellows, who had been in the great Bank case, and who could probably tell us more. What did Brother Bellows put this new success at? ...

[anne]

http://krugman.blogs.nytimes.com/2008/12/19/madoffmerdle/

December 19, 2008

Madoff/Merdle
By Paul Krugman

I'm ashamed to admit that I've never read Little Dorritt, by Charles Dickens. But I guess I'll download it to my Kindle. A reader points out that the BBC is currently doing a dramatization, and that the character of Mr. Merdle, the fraudulent financier, bears a strong resemblance to Bernard Madoff.

[anne]

http://atbozzo.blogspot.com/2008/12/big-fraud-in-little-madison.html

December 15, 2008

Big Fraud in Little Madison
by Tom Bozzo

Earlier in the year I reviewed the investments held by the Madison Cultural Arts District's trust fund, which once had been intended to use stock market returns (and later alternative investment returns) to pay the Overture Center's construction debt and contribute to the Center's operations. I concluded that the fund was undercapitalized and needed to get cracking on fundraising. In September, the fund reached a point where it was to be liquidated to pay off the bulk of the construction debt, leaving the major donor and the city of Madison on the hook for the balance. We only recently, as lapsed Madison Symphony subscribers, received a fundraising letter.

An interesting detail is that when I'd reviewed the MCAD trust's assets, it held $17.9 million — just under 18 percent of its $100M portfolio of the time, in the Fairfield Sentry fund. (In early '06, they had an even greater exposure.) At the time, Fairfield Sentry was among the trust's high-flying investments, relatively speaking. I said "who knows" with respect to how Fairfield found its alpha.

Well now we know! Per Bloomberg, Fairfield Sentry was 100% invested in Bernard Madoff's mega-swindle! I hope they actually managed to liquidate their balance. If they did get out soon enough, then at least the MCAD trust may not have been the biggest of suckers in one respect.

Otherwise, big potential losers are Andrew Ang, Matthew Rhodes-Kropf, and Rui Zhao, whose April '08 NBER working paper concluded that funds-of-funds "on average, deserve their fees-on-fees." * At a minimum, they should delete the Madoff suckers and recalculate.

* http://www.nber.org/papers/w13944

[What is astonishing is finding professional money folks who simply cannot or will do the math year on year.]

[The Baron]

@Ninja Zombie,

No the real difference is that, when time for payout comes due, Madoff didn't have anything to give to the investors. Whereas the U.S. Gov't will just print more dollars to payout to SS recipients, if necessary.

SS, under its current structure absolutely requires one, or a combination of, the following:
1) Federal Budget surplus be run to both pay current accounts and payback the T-Bills being held by SS when incoming SS funds fall below obligations, (massive reduction in spending or increase in taxes or both)
2) Massive change in the structure of U.S. debt, not only will SS not be there to buy all the T-Bills the Feds want to issue, but there must be willing buyers, other than the Federal Gov't itself, to purchase all of that debt, (the SS trust has been backstopping the Federal deficit for decades. We will not have that luxury any more.)
3) Print as many dollars as necessary to meet Federal spending in excess of the ability to sell T-Bills. (Hello Zimbabwe)
4) Eliminate or reduce the liabilities and outflow from the SS trust.

If anne or anyone else has any other options, I would love to hear about them, but in the end, income must be equal to or exceed expenditure. If it doesn't, debt increases to the point that either no one is willing or able to further lend to you, or you can't afford to pay the interest on the accumulated debt, or you print money, if you have that luxury, but then what you print devalues what's already out there.

[anne]

http://delong.typepad.com/sdj/2008/12/hedge-fund-of-fund-returns.html

December 18, 2008

Hedge Fund-of-Fund Returns

How about it guys? How significant is -$50 billion? You say that "the total funds under management for funds-of-funds is $156 billion." And do you calculate arithmetic or geometric rates of return?

-- Brad DeLong

[anne]

Notice the Social Security monsters are about, having lost any chance of interfering with Social Security initially in 2006 and definitively in 2008. Worry not, these are Sendak monsters and Social Security is in massive and growing surplus and will be in surplus for decades at the least and is completely secure against monsters.

[evagrius]

"As for old people, I do indeed suggest that the taxpayers should not be obligated to support them."

I think I've read this somewhere before, perhaps as a quote from an enlightened 18th or 19th century pundit.

[anne]

http://www.nber.org/papers/w13944

April, 2008

Do Funds-of-Funds Deserve Their Fees-on-Fees?
By Andrew Ang, Matthew Rhodes-Kropf, Rui Zhao

---- Abstract -----

Since the after-fee returns of funds-of-funds are, on average, lower than hedge fund returns, it is easy to conclude that funds-of-funds do not add value compared to hedge funds. However, funds-of-funds should not be evaluated relative to hedge fund returns in publicly reported databases. Instead, the correct fund-of-funds benchmark is the set of direct hedge fund investments an investor could achieve on her own without recourse to funds-of-funds. We use asset allocation concepts to estimate characteristics of the fund-of-funds benchmark distribution. Since the benchmark characteristics are reasonable, we conclude that funds-of-funds, on average, deserve their fees-on-fees.

[Here then is the lunacy and worse of concluding that when stock index returns have been 10% since 1976, after Vanguard costs, costs beyond hedge fund costs, costs beyond 3 percentage points a year are fine for what are essentially index fund investors. After all, all hedge funds will wind up, as has been shown at Princeton, underperforming the market by about the cost of the funds.]

[ken melvin]

.. and remove all doubt.

[for the record]

We can debate the definition of 'surplus' but social security input will exceed output for years.

Growing annual deficits are projected to exhaust HI [medicare] reserves in 2019 and Social Security reserves in 2041.

A SUMMARY OF THE 2008 ANNUAL REPORTS
Social Security and Medicare Boards of Trustees

http://www.ssa.gov/OACT/TRSUM/index.html

[swells]

Ann, the surplus consists of special US treasuries. I stand by my assertion that the only thing that backs them is a promise to tax later. Please point out the flaw in what I said. Is it or is it not the case that those special US treasuries are backed only by taxation at some later date (or simply printing money which is another kind of invisible tax)?

[anne]

"We can debate the definition of 'surplus' but Social Security input will exceed output for years."

Get it? I get it. Them what do not get it are them what mean to destroy Social Security. No chance, no problem.

What matters here however is not Social Security, which was absurdly attacked, but what should be attacked which is a finance industry that has been harming investors with excessive fees for decades, even as mortgage lenders found a way more recently to do special harm by charging excessive fees.

[reason]

swells,
this is an old and much played semantic game, that is not particularly relevant to the issue at hand. Yes pay as you go social security systems imply some tax increases or benefit cuts in the future if either population growth or economic growth slow down. Anybody sensible accepts that. However, the general government deficit and balooning medical expenses are much bigger and more urgent problems. SS is not a Ponzi scheme and is not relevant to this thread. Lets move along now!

[anne]

Simply think of what it means to take gains collectively from stock and bond investors of 20% or 30% for decades. Imagine the value of the market from 10% yearly gains for 32 years or 8% for 35 years and imagine what giving away 20% to 30% of the gains has meant for the finance industry and for investors as a whole.

[Patrick]

Ninja Zombie: libertarian economics is completely flawed and here's a first hand account of why: I lost my job not long ago when the angel investor funding the small company (about 15 employees) I was working for lost his shirt (I assume he was leveraged up big time and got the mother of all margin calls). The company was actually doing quite well; costs under control, getting close to turning a profit, but when the margin call comes, it's gotta be answered.

So I find myself sans income with a wife and 2 year old to support. Luckily I live in Canada. Between EI, savings, and some belt tightening (we live every modestly anyway - no cable, no cellphones, one small car). I should emerge relative unscathed. Without EI, I would be in big trouble. The house would have to go in a firesale for sure, as would the car, and the retirement savings would get decimated as well.

So even if you don't care about the misery the job loss could inflict on me and my family without the welfare state, the lesson here is that the welfare state is actually GOOD for the economy. By helping people like me bridge hard times it avoids fueling the self-reinforcing downward spiral. In my case, it also protects future taxpayers by allowing me to keep my retirement savings.

My suggestion to you is to put down the Ron Paul manifesto and go get a copy of the General Theory. And get some compassion.

[Lafayette]

NZ: That's exactly how Madoff's scheme worked and that is exactly how social security works.

Your rebuttal is totally aberrant.

One cannot classify Social Security as a Ponzi Scheme because the beneficiaries are fully cognizant of the payment system. Furthermore, unlike a Ponzi scheme, which participants paid into originally, they will more than likely be around for the payback, which will be far, far less than what they input.

They come out thus winners not losers.

Confucius say: Engage mind before commenting in blog.

says...

The finance industry has been fleecing investors for CENTURIES. John Law was much wilder and more flavorful then Madoff. What do you expect?

[Eric Dewey, Portland, Oregon]

Good to see that the blinkers are coming off the eyes of the academic economists, who have seemed to truly believe that the system was set up to be fair.

Lafayette's points are well-made, and should not be disregarded - simply pointing out that fraud exists does not necessarily prove that it dominates the market.

However, Krugman's point is that there are serious ethical errors in the thinking of a majority of those who have been leading our capital markets, and that this has significant explanatory power when considering the current meltdown.

Reacting with passion is unavoidable, but it will probably not lead us out of this mess. I will do my best to model the calm projected by our newest leader, soon to be in the White House.

[Barkley Rosser]

says,

Well, that definitely proves you are not anne, who does have a healthy respect for actual economic data. She is probably wrong that the surplus is still rising, but it was through 2007, and, while we do not have the final numbers for 2008, its surplus almost certainly has only dropped a bit, if at all. This is the year the surplus was supposed to peak, at over $200 billion, a pretty healthy sum, and the only part of the US federal government that is in surplus.

People such as yourself who make arguments like yours are victims of hysterical propaganda. In more years than not out of the last decade, the system has done better than the so-called "low cost" scenario, which involves the surplus declining, but never getting to zero. So, the social security system would pay for itself forever without ever having to cash in those securities, and would continue to lend to the rest of the government forever. This year it is not going to beat that scenario, and may not for the next few years, but if it does not do so, it is also likely that the stock market will perform terribly and thus the privatization scenario favored by all those critics you take so seriously will also be garbage.

BTW, I have noticed several conservative commentators suggesting a "payroll tax cut" as a way to deal with our current situation. Curious that some of these are some of the same people trumpeting the alleged future insolvency of the social security system, which that tax pays for, and calling for its dissolution or privatization. Gag, hyporcrisy.

[im1dc]

#43 and his administration's extremism, corruption and stunning incompetence at every level and every day of these last 8 years has so bummed me out I picked a Theme Song to help me make it through to January 19th, 2009.

Let me share it with you. I hope it helps ease your angst as it helps relieve mine.

Bob Dylan - Things Have Changed

Link to Dylan Here

[Patrick]

swells: Taxes for grandma? So? Civility, compassion, and social stability are not negotiable, and so the welfare state should not be negotiable. Period. It's like arguing we should do without electricity or vaccines because our ancestors did. It's just stupid.

Income support for the old, universal health care, unemployment insurance were all invented by our grandparents generation (well, my grandparents generation anyway) - you know the same guys who fought off the Nazis and gave us the Universal Declaration of Human Rights - because of the absolute misery they lived through during the GD.

Interesting how this idiotic debates come up just as the living memory of the GD is, sadly, passing away.

says...

Barkley Rosser

What are you talking about?

If surplus means cash in the bank, gold in the vault, or treasury bonds that can be sold to the Chinese, then there is no surplus.

If surplus means more money coming in than being spent by the social security system, then there is a surplus.

There was just a misunderstanding of terms.

[im1dc]

A last minute Christmas present from George W. Bush to USA's homeowners

"Owners find themselves trapped underwater"

By Stephanie Armour, USA TODAY

..."Nearly one in seven homeowners is underwater, owing more on their mortgages than their homes are worth. That's about 12 million homeowners, nearly double the number underwater at the end of 2007, according to Moody's Economy.com. Most are homeowners who bought between late 2003 and 2007.

"Home prices are projected to drop on average another 10%, bringing to about 14.6 million the number of homeowners who will be underwater on their mortgages by fall 2009, says Mark Zandi, chief economist at Moody's Economy.com. By contrast, about 2.5 million homeowners had negative equity in their homes in 2006."

Article linked here

[im1dc]

A last minute Christmas present from George W. Bush to USA's homeowners

"Owners find themselves trapped underwater"

By Stephanie Armour, USA TODAY

..."Nearly one in seven homeowners is underwater, owing more on their mortgages than their homes are worth. That's about 12 million homeowners, nearly double the number underwater at the end of 2007, according to Moody's Economy.com. Most are homeowners who bought between late 2003 and 2007.

"Home prices are projected to drop on average another 10%, bringing to about 14.6 million the number of homeowners who will be underwater on their mortgages by fall 2009, says Mark Zandi, chief economist at Moody's Economy.com. By contrast, about 2.5 million homeowners had negative equity in their homes in 2006."

Article linked here

[anne]

No; the Social Security surplus is growing still and is slated to grow till about 2018 * and last till about 2042 though the last date keeps lengthening.

The year 2018 can easily be mixed with 2008, but the years are really not the same.

* http://krugman.blogs.nytimes.com/2008/03/28/about-the-social-security-trust-fund/

[Not Mark T]

Eat your own cooking: "Credit Suisse Group will pay senior executive bonuses with troublesome, illiquid assets, forcing employees to take on the risk that at least some of them put on the Swiss bank's books."
http://www.cnbc.com/id/28306986

[evagrius]

"However, Krugman's point is that there are serious ethical errors in the thinking of a majority of those who have been leading our capital markets, and that this has significant explanatory power when considering the current meltdown."

The major "ethical error" was in thinking that profits should always increase over time rather than be at a steady rate.

i.e; Greed/ avarice. Daffy Duck no bigger than an ant screaming "Mine, mine" as he hugs an oyster pearl bigger than himself.

[Ken]

evagrius wrote: "I think I've read this somewhere before, perhaps as a quote from an enlightened 18th or 19th century pundit."

Are you sure you are not thinking of Jonathan Swift's "A Modest Proposal"? If so, it was not about letting the elderly starve, but about feeding them using an abundant, readily-available source of protein.

[Ninja Zombie]

Lafayette: "One cannot classify Social Security as a Ponzi Scheme because the beneficiaries are fully cognizant of the payment system."

As I noted, the main difference between Madoff and SS is that Madoff used fraud, while SS uses force.

"Furthermore, unlike a Ponzi scheme, which participants paid into originally, they will more than likely be around for the payback, which will be far, far less than what they input."

A ponzi scheme is one in which payouts of current investors come from the payin of future investors. Social security meets this criteria.

Your hopes and dreams regarding the sustainability of your preferred Ponzi scheme do not change that fact.

says...

Most of all, the vast riches ... undermined our sense of reality and degraded our judgment. Think of the way almost everyone important missed the warning signs of an impending crisis

There are core philosophical "errors" which people tend to commit as a group - as a nation, race, religion etc.

These 'errors' are in that sense political. Iraq war. Torture. Housing bubble. In the case of Iraq, and torture, the group won, so they can get history to whitewash it. The consequences of the errors were borne by "outsiders". The winners do not have to acknowledge the cost or suffering of the losers (cf. Native Americans in Americas).

For the housing bubble, those who thought they were "in" the group, (the get rich quick, work is for losers type, pigmen, housing only goes up) now find they were losers. We see a quest for accountability now, only because the losers have the _possibility_ of holding the winners accountable. We see the winners (plutocrats, pigmen, Fed and the economists who supported these errors) trying to whitewash and cover-up the losses and calm down the losers because of the fear of accountability.

A people decide to commit an "error", fully conscious of the same, because they believe that _they_ don't have to pay the price. Nothing - truth, logic, appeal to honor, integrity or morals - is going to stop them.

says...

Ninja Zombie

How do you think old people should be provided for?

[kharris]

You've got the looks,
I've got the brains,
Let's make lots of money...

The Petshop Boys knew this was coming. So did Madonna, for that matter. And Cindy Lauper. Our pop culture, irritating as it may be at times, has offered a good indication of the direction we were taking for ever so long. All anybody had to do was listen.

[anne]

"A Ponzi scheme is one in which payouts of current investors come from the paying of future investors. Social Security meets this criteria."

Mean spirited rubbish.

[groucho]

"Think of the way almost everyone IMPORTANT missed the warning signs of an impending crisis. "

That says it all!!!

Everyone IMPORTANT missed it!

Paul Krugman, as one of the main scribblers who endorsed "printing our way out of our problems"(as you clearly endorsed both in Japan and the US)is to blame far more than Wall st including Madoff, since "scribblers" are always at the core of policymaking.

"The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly believed. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Soon or late, it is ideas, not vested interests, which are dangerous for good or evil."

- John Maynard Keynes

says...

"A Ponzi scheme is one in which payouts of current investors come from the paying of future investors. Social Security meets this criteria."

In that case, even the stock market is a Ponzi. If there are no future investors to pay-in to buy your stock, your stock has zero value when you try to sell and get your payout.

[Ninja Zombie]

Blank name asked: "How do you think old people should be provided for?"

My personal preference is to save money while young, and use it when you get old. You can do whatever you want.

I don't gain any happiness by forcing my choices on other people.

Anne: "Mean spirited rubbish."

I think you forgot to use the word "vile" 8 times in a row. Remember, no amount of logic, careful reasoning or empirical study can stand up to the word "vile" repeated 8 times.

[Patricia Shannon]

Lafayette says...

mick: I think this is so obvious that i won't bother to explain it.

Hold it. No, it is by no means obvious.

The present circumstances indicate that such as happened. But, that regards only present circumstances. You are taking great license in proposing that finance markets, in general, are riven by fraud.

Have you any facts or just positing a sentiment?

Lafayette says...

The Prudent Man Rule

The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.

But of course they know what they are doing. Or, they wouldn't be there, in Corporate Offices, doing it.

That which has been lost in the shuffle over the past few decades on Wall Street (and often Main Street) is the once prevalent rule (first elaborated in 1830) called the Prudent Man rule from which we learn:

The Prudent Man Rule directs trustees "to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.

We need, perhaps, to engrave that in stone and place it somewhere conspicuous on Wall Street. Speculation is NOT the norm in money management. It is the exception to the norm and therefore exacts far more prudence in terms of risk management. (Those who refuse to learn the lessons of history are condemned to repeat history's failures.)

And I submit further: The only way to curb Consummate Cupidity in business is to tax away its incentive. Meaning this: Confiscatory Taxation on all compensation above some threshold total amount.

If what Mick said wasn't true, nobody would need to posit The Prudent Man Rule, or "curb Consummate Cupidity in business is to tax away its incentive".

[anne]

Groucho:

Paul Krugman, as one of the main scribblers who endorsed "printing our way out of our problems"(as you clearly endorsed both in Japan and the US)is to blame far more than Wall St including Madoff, since "scribblers" are always at the core of policymaking.

[Please do explain what this means.]

[Ninja Zombie]

Blank name: "In that case, even the stock market is a Ponzi. If there are no future investors to pay-in to buy your stock, your stock has zero value when you try to sell and get your payout."

False.

Stock provides ownership of a fraction of a company. Even if you never sell the stock, this grants you the right to vote on directors, various minority shareholder rights (assuming you are a minority shareholder), a share in the dividends, a share in the corporate assets (in the event of liquidation) and several other rights.

I own several businesses which I'll probably never manage to sell. They are not valueless because they make me money (not much yet, but I'm working on that).

[flubber]

Since bubble investing depends on the "greater fool" coming along after you, and you getting out before the last one's left holding the bag, I thought Krugman was going to make the point that there isn't much difference between a Ponzi scheme and bubble investing. But he didn't, instead taking the easy way out and blaming the fraud.

When he says that "high pay" on Wall Street was a "major cause" of the divergence between the top 5% and the median worker, he's being a bit lazy. But all editorials are mostly worthless, and his are generally less worthless than the others, since he does sprinkle a few facts in there.

[anne]

"As I noted, the main difference between Madoff and Social Security is that Madoff used fraud, while Social Security uses force."

Similarly mean spirited rubbish, but of no consequence since Social Security is now completely protected from the monsters who would devour the system and us.

[anne]

When he says that "high pay" on Wall Street was a "major cause" of the divergence between the top 5% and the median worker, he's being a bit lazy.

[Care to explain the laziness, not to mention the meanness, since this is precisely so?]

says...

My personal preference is to save money while young, and use it when you get old.

How exactly do you "save"? What is your "savings"? Do you literally plan to hoard food, water or clothing? Or are you talking about holding promises from other people to provide those in future?

Will they honor those promises? Can you make them honor it, or do you assume an omnipotent power to make them honor those promises? If there is such an omnipotent power, why should it not grab those promises to its own benefit?

You should go back to school.

[Ninja Zombie]

Anne: "Similarly mean spirited rubbish,..."

If it's rubbish then state your case.

Or I guess you could just call anyone who disagrees with you a monster. Either way, same difference.

If you want to go the latter route, then fine:

U r a gayayayayay raaaaccist h0m0z go b@ck 2 azeroth u orc loving nigz!

(Verbiage borrowed from World of Warcraft. )

says...

Ninja Zombie

Thanks. That brings us back to Madoff. You know the argument. What if old people lose their money?

Even worse, what if poor people cannot save any money? Some poor SOB clocking 50K a year paying a mortgage and supporting the kids will not save any money. Unless the government forces him to. Actual poor people cannot save either. That is the majority of people today.

The Madoff Economy means I take mine, I steal yours, screw everybody else, its their problem. "You can do whatever you want".

Patrick made the insight. Do what works best for the group, for the economy. Leaving poor people and especially poor old people to fend for themselves will create far greater problems than taxation and government social services.

[Patricia Shannon]

Zombie is a leach. He has benefitted from the actions and taxes of those older than he, many of us w/o children. If he is in IT, he has benefitted from age-based discrimination. I bet he participated in it if he was in a position to do so. But he doesn't want to give anything back. Of course, he will think differently when he is old.

[Patricia Shannon]

Zombie, please let us know the names of your businesses. I, for one, want to avoid them.

[anne]

"As I noted, the main difference between Madoff and Social Security is that Madoff used fraud, while Social Security uses force."

These comments about Social Security are simply lies, lies meant to be destructive of the system and of people who rely on the system. Continuing on with such lies, simply shows with ever more clarity the monstrous intent. The need evidently being to destroy for the sake of destruction.

[Hal]

Has it occurred to anyone else that maybe the government should take Madoff and put him in charge of the Treasury? LOL the gov. runs so many ponzi schemes itself after all.

What was interesting to me with his arrest early in the week and the info of 50 billion gone was how the market reacted. I follow precious metals with the real time tracker, ExactPrice, and you could see people jumping ship out of hedge funds and into gold. The street is beginning to run red with fear and people are looking to something they can trust. And sadly it's becoming clear we can't trust people managing our money or the government who seems to be entwined with those crooks.

[Patricia Shannon]

I have always been a saver. I didn't make risky investments. I bought a modest house. In 1990, I had paid ahead four years on the principal of my house. I thought it would be paid off when I retired. I had about 5 months living expenses in my savings account, which is the longest I had ever been between jobs. I had a good start on a retirement fund in my IRA. Then the depression of 1990-1992 came, and I had to get a 2nd mortgage to live on. After being out of work more than a year and a half, I had to move twice in less than a year and a half to get work. I started having a harder time finding work, because of my age. In 2000, when a lot of IT workers were out of work after saving the economy of the world from the Y2K problem, the U.S. Congress greatly increased the number of H1-B visas issued to IT foreigners. Etc. I ended up losing my house and all my savings. I had to work as a waitress at Waffle House for four years, because I was "over-qualified" for a better-paying job. I was only able to get back into IT because older people started retiring (or giving up), and younger people got wise and stopped going into IT. (Note that the number of IT jobs has been dropping steadily since 2000).

I tell my story because I am not alone. Many people, in different industries, have had similar experiences. People who worked for years thinking they would have company pension plans have been laid off right before they were vested, or had their companies declare bankruptcy so they could terminate their pension plans, although they had money for giant executive pay.

You might be sure it won't happen to you. That doesn't mean it won't.

[Ninja Zombie]

Mr Blanky: " What if old people lose their money? Even worse, what if poor people cannot save any money?"

The able bodied/able minded can continue to work. If necessary, I'd support providing them with physically undemanding jobs in return for supporting their material needs (a bed in a government dorm, 3 square meals a day, etc).

If you want to transfer wealth to the poor, argue for that. Don't try to hide it in a gigantic, uneconomical ponzi scheme.

"The Madoff Economy means I take mine, I steal yours, screw everybody else, its their problem."

Indeed, that's why I oppose the Madoff/FDR/Bush/Obama economy.

says...

Mr Blanky here. Exactly, nobody wants to literally kick people to the curb. Even the Evil Ninja Zombie!

I think social security works pretty well. For me, its not about transferring wealth. Its about a system that works best for the group, for the economy, for the nation. And taking care of people.

[S Brennan]

Money attracts the best and the brightest.

Sometimes, sometimes not...

Money attracts the criminal element.

Always true.

Money attracts the sociopaths of the world.

Almost always true. Because of what our society attaches to money, it gives sociopaths all of what they seek.

The elaborate justifications for this high pay have been many. Almost all have been shown in time to be completely false.

Quoting from a book that is lost to me.

"Any businessman will tell you, if your choice is between being a producer of goods and a middle man who takes a percentage, the sure bet is with the percentage. No start-up costs, no production cost, the lowest overhead in the chain to market, your labor is largely unskilled and what skills you need are plentiful"

Q] So why are those who do the least for given society, take the lowest risk, take home the highest pay?

A] Because they have been able through their agents in the media, to convince enough people that they contribute more to society than any other group...and the more they are given, the more they can perpetrate this myth.

A fair tax system addresses unforeseen imbalances that profit those who through whatever means are in the right place at the right time with the right amount of capitol.

Factoid for those who sore elbows patting themselves on the back:

If Bill Gates had been born 20 years earlier...or later, no one would have heard of his name. He came from one of Seattle's wealthiest families and he was able to capitalize on an singular event. Few college dropouts had 100,000 to throw around back then, fewer still had access to large amounts of capitol at the age of 20. Consider, Microsoft [outside of a (previously used) silencing agreement] has never come up wit a single innovation.

[Patricia Shannon]

And how long will it be before we hear news of gold fraud.

I remember some years ago a friend who invested in gold. He eagerly followed the price of gold, and was quite pleased. Then I read of a supposed gold trader, who was selling gold, which was supposedly stored in a safe place. Guess what. There was no gold. I wondered about my friend's gold. Sure enough, enough, it was with the fraudulent company. My friend is a decent person, trying to provide for his retirement.

[kthomas]

This is a very disappointing article. Not that I necessarily disagree with Prof Krugman (Peace Be Upon Him), but he does not need to add any more fuel to this fire.

As for NinjaZombie, I sense the development of a wicked troll in him. Please post in a less incendiary fashion, or be 86'd. What the hell does this mean? "Indeed, that's why I oppose the Madoff/FDR/Bush/Obama economy." GROW UP.

[Patricia Shannon]

S Brennan
I thought your comment was so good I posted it in my own blog.

[Patricia Shannon]

http://www.mcclatchydc.com/256/story/57980.html

Posted on Wednesday, December 17, 2008
Food broker accuses California company of racketeering

By Denny Walsh | Sacramento Bee

Randall Lee Rahal, a New Jersey sales broker, leveled a startling allegation with a guilty plea in Sacramento federal court Tuesday, telling the judge that SK Foods L.P., one of the nation's largest processors of tomato-based products, has been run as a "racketeering enterprise" since 2004.

Rahal admitted that he used SK money to bribe purchasing managers whose list of employers reads like a who's who of food industry giants. In return, he related, the managers bought SK products at inflated prices and supplied SK with competitors' bidding and proprietary information.

He also admitted conspiring with SK to defraud some of its customers by supplying inferior and mislabeled products.

The charges against Rahal are the first to emerge from a nationwide probe of food pricing by federal prosecutors, FBI and IRS agents, and antitrust investigators. The inquiry was sparked by reports of collusion among farmers, processors and retailers that may be helping drive the price of groceries to all-time highs.

Read the complete story at sacbee.com