A Lesson From the Madoff Fiasco

The default response to news of fiscal wrongdoings is to lay on greater government oversight and regulation.

But perhaps we should take a lesson from this New York Times article:

Based on the vagueness of the complaints against Mr. Madoff, his confession, as detailed in court filings, seems to have taken the F.B.I. and S.E.C. by surprise. Investigators have not explained when they believe the fraud began, how much money was ultimately lost and whether Mr. Madoff lost investors’ money in the markets, spent it, or both....

[T]he S.E.C. had already investigated Mr. Madoff and two accountants who raised money for him in 1992, believing they might have found a Ponzi scheme. “We went into this thing just thinking it might be a huge catastrophe,” an S.E.C. official told The Wall Street Journal in December 1992.

Instead, Mr. Madoff turned out to have delivered the returns that the investment advisers had promised their clients. It is not clear whether the results of the 1992 inquiry discouraged the S.E.C. from examining Mr. Madoff again, even when new red flags surfaced.

According to an S.E.C. statement released on Friday night, the agency looked at Mr. Madoff’s operations twice in recent years — in 2005 and 2007. The 2005 review found only three technical violations of trading rules. The 2007 inquiry found nothing that prompted the regional enforcement staff to take further action by referring the matter to Washington, the statement said.

Ponzi schemes are already illegal, so for additional regulation to have helped it would have needed to be in the form of additional auditing, disclosures, etc. But having one of the most powerful organizations in Washington look into the firm -- three times -- didn't stop Mr. Madoff from making off with other people's money.

So if you want more government oversight to prevent these kinds of problems, ask yourself: What specific kinds of additional oversight would have prevented this? And are you willing to pay for the drag that it would have on the economy as a whole to have that level of oversight required of every institution of reasonable size in America?

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