Friday, December 19, 2008

Lack of honesty at root of financial crisis

Editorial - Arab News
Thursday 18th December, 2008

The $50 billion investment fraud to which the respected New York financier and former NASDAQ Chairman Bernard L. Madoff has allegedly confessed, may prove to be the paradigm for all that has gone wrong with the international financial system.

It points up the greed, incompetence and woeful wishful thinking that have all combined to produce economic meltdown and plunge the world into recession.

Most staggering is the stupidity of both regulators and professional investors in failing to spot that for at least a decade, at the heart of his hedge fund operations, Madoff was running a pyramid scheme. This relied on new investment funds to pay out market-beating returns to existing investors. Madoff’s refusal to explain his fund management strategy and his dubious employment of an out-of-town hick accountant ought to have rung loud alarm bells. The Securities and Exchange Commission ought to have checked out the business as a matter of course, especially after a few wise individuals had reported their concerns to it. But they did not.

Top flight international banks, as well as professional investment managers, including some of the most prestigious fellow hedge funds ought, as a very basic operational procedure, to have conducted elementary due diligence on the Madoff fund before giving it a cent. But they did not. What, therefore, does this say about the quality of regulators and highly-paid investment professionals to whom has been entrusted the oversight and care of trillions of dollars, which very often come from the agglomerated pensions of millions of little people? What indeed does this say about the culture and morality of the international financial markets and the people who have run them? The answer unfortunately is not very much.

Current economic problems may rightly be ascribed to a lack of liquidity and of market confidence, but the root cause has been a fundamental lack of honesty of which Madoff is just one, albeit outstanding example. Indeed what actually is market confidence? Until now it has not in reality been a confidence that the markets were well run with participants of the highest probity. Rather it was confidence that the whole merry-go-round of inflated values, frenzied trading in everything from commodities to spurious “Special Investment Vehicles” underpinned by ever-more ballooning credit, would carry on spinning.

That banks, companies and investment funds no longer trust each other with their remaining cash, perhaps evidences the fact that many of them know just how badly they themselves have behaved in the mad markets that crashed this summer. Madoff’s rotten pyramid of phony value could, therefore, be seen as not far removed from what has happened throughout the financial markets. There is no viable alternative to capitalism for the allocation of funds to produce increased value and prosperity. But there are certainly far better ways in which bankers, regulators and investment professionals can conduct themselves. Complaints that over-regulation will damage the markets should be ignored. We are where we are because what regulation that did exist failed to keep the markets honest.

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