Reading about Madorf and the filching of USD 33 billion in a pyramid scheme from his select group of customers makes for interesting reading. It draws the attention (yet again) to the dangers of having a lack of transparency in financial markets. As the Economist says, it was “Dumb money and dull diligence“.
What marks Mr Madoff’s case out, however, is the calibre of investor he suckered. It is not the first time that wealthy people have been swindled out of huge sums of money, nor will it be the last. But never have so many big financial institutionsâ€”the oxymoronic ‘smart money’â€”been so bilked by an individual. It is here that investors, as well as the authorities, should tighten the thumbscrews and demand more transparency.
This is the key lesson that should have been learnt from the current financial turmoil. There is always ‘dumb’ money out there – often even marketed as being smart. It always shows at the end of a economic cycle. What has been interesting this time around is how much of the ‘smart’ and supposedly well informed (at least that is what they charge for) providers of investment services have been getting done.
The reason is simple. The market relies on reasonably complete information being available to significiant sections of the market for it to function efficiently. It has said so in every course and book that I’ve ever read. The converse is also true. That having information restricted provides opportunities to those in the know. If the information is essentially not available, as in the case of this scheme, then it is likely to be a market scam.
Not even the best of regulators (and the SEC is not that) can be sure of stopping a determined fraudster. The authorities can, however, help investors make better judgments by requiring more disclosure from hedge funds and other high-fee asset managers. It would have been particularly useful to know how much of their clients’ money they were investing in inscrutable people and illiquid assetsâ€”even if, at the time, few investors may have cared.
The analogy to the ‘discussion’ of the Electoral Finance Act 2007 is much the same. A lot of the act was put in place to ensure that the known loopholes and problems in the Electoral Act 1993 were repaired or fixed. Many of these had been exploited by various parties and their supporters in the elections between 1996 and 2005 – mostly by National and Act.
In particular the whopping great big hole with using anonymous trusts to conceal the sources of finance involved in campaigning in the political arena. The purported anonymity of donors from recipients had all of the hallmarks of the fragility of the financial ‘chinese’ walls from the 1987 crash. This was a corruption scandal waiting to happen because of the lack of transparency about donors. Fortunately even the National party appears to realize this – it appears to be one area that they want to keep from the EFA.
However at present, we still have absolutely no ideas what they are planning on putting in to correct for the other flaws in the EA 1993. Based on recent experience of their autocratic, arrogant, and undemocratic behavior in the house, we will probably see some opaque, badly written, and badly thought through legislation pushed through under urgency.
But after all, this is the ‘smart’ money party – what else do you expect? They like low-transparent solutions – it is after all how you seperate the suckers from their assets like votes or money. Madoff would probably approve.