Madoff's Ponzi scheme

Is this thing fascinating, or what?

John Hinderaker at Powerline:

Experts who are highly paid to invest money, and whose careers depend on being right, fell for Madoff, to the tune of something like $50 billion. Which is why I am extremely skeptical of the idea that we need more government regulation to avert such losses in the future. No new regulations are necessary to ban schemes like Madoff's; Madoff's fraud was already illegal when Ponzi did it. And if hundreds of experts--professionals who bet their livelihoods on Madoff's fund--couldn't figure out that he was a crook rather than a genius, why should we think that some government bureaucrat is going to do better?

Maybe the difference is that financial advisors deeply, truly want a Madoff to be genuine. They want to believe that a Madoff is possible, first because it allows them an easy way to seem brilliant to their clients, to appear to actually earn their fees, and second because it means that the whole enterprise of financial advisement is not necessarily trivial, not necessarily a sham. It's not all just random walks this way and that; Madoff proves that there is a science here, after all. The watchdog bureaucrat, on the other hand, is paid to be skeptical. He's like the cop taking statements at a crime scene whose experience has taught him that everybody's lying. That's why the bureaucrat should be more likely to discover that Madoff is a fake.

In fact, of course, that doesn't seem to have happened either, even though Madoff's amazing rate of return should have set off the 100-dB fraud sirens. As I understand it, the economic downturn decreased new investment inflow to a level insufficient to pay off earlier investors, the classic crash of Ponzi schemes and chain letters. But the end came only when Madoff's sons turned him in.

If you're the Ponzi schemer, how do you stop the thing once it's rolling? It seems like the only mathematically possible endings are either (1) prison/suicide or (2) an unannounced relocation to some country that has no extradition agreement with the US. Since he didn't shoot himself or fly to Brazil, I can't figure out how Madoff thought the game was going to end, where he thought it was headed. Was he just a hopeless captive of his own scheme, numbly plugging along waiting for somebody to tap him on the shoulder and say it was time to trundle off to jail? No hint of a dramatic gesture, nothing. It's hard to imagine what his psychological life has been like.

The other question this raises concerns the financial advice industry, and the question is "Why?" Consider an investor who spends his earning years dollar-cost-averaging into a no-load Total Stock Market index fund, and who then uses the IRS life expectancy tables and average current interest rates to withdraw that money in retirement. How many investment gurus are going to do better for him, net?

The problem with that, of course, is that it's just too boring for many people. You can say they lack discipline, but that's just another way of saying the same thing. We want to take flyers, to chase the big kill, the supernova. The fact that individuals will actually play the commodities markets proves that beyond doubt. But if you proceed that way, you will almost certainly lose all your money. So, to protect us from ourselves, we prudently turn the reins over to somebody else. They then take our money and, for a hefty fee, invest it with....Madoff! It's too rich.

Finally, what does this business about $50 billion "disappearing" mean? If the money invested didn't come out as management fees, and if it didn't get distributed to other investors, then isn't it still there in the Ponzi Pile? Or is that $50 billion almost all paper profits investors thought they had in their accounts, but that were never there in reality? But if the claimed rates of return were unrealistic, then the $50 billion figure would also be unrealistic to the same degree. What people actually lost were the genuine returns they could have received in some alternative, genuine investment.

Byron

Meaning of Mumbai

The attacks in Mumbai, by yet another Islamic terrorist organization nobody's heard of before, have some people lamenting the fact the there is no Muslim Pope. Worldwide Islam is a decentralized, multifarious thing; it has no single hierarchy topped by someone with the authority to issue edicts condemning terrorist attacks on innocent civilians. There is no Pope-like figure with the power to call off the dogs.

But swords have two edges, so we need to be careful about what we wish for. If Christian Popes, even given the underlying turn-the-other-cheek and ascetic ethics of Christianity, could order up Crusades and Inquisitions, what manner of worldwide jihad could an Islamic Pope call for? Given the aggressive ethical base of Islam, the lack of an Islamic Pope is more likely a feature, not a bug. It was Saddam, remember, who dreamed of himself as the head of a worldwide Caliphate, and I don't think his model was a modern Catholic pope, padding benignly about offering harmless blessings to one and all.

To continue the computer analogy, the reform of Islam will have to occur as a massively parallel operation, not a hierarchical one. Slower, but also less dangerous. I think reform is possible, and even likely, because what the Islamists are selling is not at all attractive to ordinary Muslims anywhere in the world. We see repeatedly that the more up-close exposure they get to that shop, the less they want to live under its tender mercies. It's not that Islam itself got worse, it's just that the rest of the world got so much better and has so much more to offer. One would have to count Muslims as extraordinarily stupid to imagine that they do not see that.

The obvious path forward is one that goes through societal and religious reform, not the miserable retrograde vision offered by the jihadists. Radical Islam is purely reactionary, and movements like that are always self-limiting. The overarching long-term trend will be incremental, similarly motivated, parallel reform in Islamic societies across the globe. As with their Christian counterparts in the West, the mullahs will mostly follow and adjust, not lead. The importance of Iraq is its potential to be an example that gives this process a significant boost. Like the song says, if you can make it there, you can make it anywhere. People who think Iraq was about WMDs are truly stuck on stupid.

Not that jihadists can't produce a lot of mayhem in the meantime, made worse by urban living, global interdependence, and modern weaponry. Jihadist Islam will always have its attractions for disaffected young men with romantic inclinations, and the job going forward is to make that career path as punishing as possible. The US military has been learning a lot about how to do that. The jihadist future is back in the 12th century, and that's where it will stay. The more successful a Mumbai-type operation is, the more widely repulsive radical Islam becomes.

The peaceful ascendency of ordinary Islam in Europe is different, and it's much less problematic. Cultural-civilizational change is the one constant in world history. I hate to see it happen in this case, but it's up to Europeans to decide whether maintaining their own cultural and demographic hegemony is worth the effort. Meanwhile, China and India are developing space programs, so the Sun is coming up fast in the East. Mankind will survive with or without Europe as we have known it.

Byron