The public may soon forget that there is such a thing as an honest broker

 

Stanford caught out – at long last

Published: February 20 2009 20:01 | Last updated: February 20 2009 20:01
 

 
J.K. Galbraith once proposed a measure of the economic cycle called the "bezzle": the inventory that has been purloined from investors. In fat years, the bezzle grows as auditors relax. In the lean years, it shrinks as investors become cautious. The allegations against Bernard Madoff and, now, Sir Allen Stanford suggest the bezzle is large – but shrinking.
 
Mr Madoff's alleged $50bn Ponzi scheme appears to have been a classic confidence trick. Rather than demanding money upfront, he seems to have encouraged investors by suggesting they pour their cash into his funds gradually. By turning some investors away, he seems to have reassured his customers that they were benefiting from some kind of specialised inside track. In truth, he may just have been building the steadily increasing flow of money he needed to keep going.
 
Sir Allen runs institutions that are alleged to have misled investors about their exposure to risky, illiquid assets. But like a salesman who always drives a new car, Sir Allen made a show of his wealth to inspire confidence. Broiled a brilliant lobster-pink by the Caribbean sun, the Texan Terry-Thomas landed a golden helicopter at Lord's cricket ground and offered a $20m prize for a limited-overs competition hosted at his Antiguan stadium. The caddish billionaire's mere presence was a large part of his companies' guarantee of solvency.
 
There were real warning signs about both men. In both cases, analysts were suspicious of the returns they were claiming. In both cases, these men dominated their companies and used peculiarly inconspicuous auditing firms to check them. Yet so long as they were able to post high and metronomic returns, they evaded serious scrutiny.
 
Indeed, the US Securities and Exchange Commission investigated both men's companies, fining them for relatively minor transgressions – seeming to miss the wood for the trees. The case against Sir Allen was brought only after the public criticisms of a Venezuela-based analyst. Mr Madoff was turned in by his sons. Mary Schapiro, the SEC's new chairman, seems to be inheriting a toothless watchdog.
 
In a complex and opaque industry such as finance, a strong regulator is essential to make sure – at the bare minimum – that market participants are telling the truth. Fears that there are losses across the sector from multibillion dollar thefts that are still waiting to be uncovered by the regulator will exacerbate recent market volatility.
 
A strong overseer is also essential if people are going to have the confidence to invest. If the financial sector is not to be regulated into oblivion after the crisis, moreover, there must be popular acceptance that bankers are worth having. Yet if financial fraud is believed to be tolerated, this will not be possible. The public may soon forget that there is such a thing as an honest broker.

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