What do regulators DO?

I have just read a book by Harry Markopolos (No One Would Listen: A True Financial Thriller, John Wiley 2010) which reads like fiction and astonishes with every turned page. Harry (pictured above right) was working as a product developer at a fund management company in Boston in the 1990s. His management asked him to come up with an investment strategy which replicated the extraordinary performance of Bernie Madoff’s fund – the latter made money every month and had never had a losing year. He looked into what Bernie (pictured above left) was doing, did some basic investigative work, and concluded that it was a Ponzi scheme. Madoff’s strategy was to buy stocks, then to sell calls and buy puts around the position in order to hedge the downside. Harry knew that you were unlikely to make much money doing this, as your upside was limited by your short calls, and the hedging strategy was expensive. Given that Bernie was managing about $8 billion, this would result in some large volumes going through the stock options markets. Harry checked – there were no trades. This was a fraud. He compiled a file of his work, evidence and conclusions, and handed it to the SEC in Boston. They forwarded it to the SEC in Manhattan, who decided that there was nothing in the story – Bernie was a respected Wall Street figure, co-founder of Nasdaq and all round good man. Without any irony, they said that Madoff showed no signs of being a Ponzi fraudster (is that not a pre- requisite of a successful Ponzi?). They made no enquiries, looked no further. This was in 1998. Over the next ten years, Markopolos gave the SEC more and more concrete evidence that Madoff was a fraud. They rejected his allegations without lifting a finger to examine them. In 2008, the collapse of the financial markets meant Madoff ran out of money, since the Ponzi relies on constant fresh money to pay out to existing investors. The SEC never rumbled Madoff – he actually turned himself in. He had stolen $85 billion.

The SEC was subsequently decapitated, gutted and roundly abused by Congress. But I bet it operates now in broadly the same way it did then. The FCA here in the UK, which also

has a dismal record in preventing major financial car crashes, is totally ineffective. A friend of mine worked for them recently – he left in disgust. He said they spend most of their time in very long meetings, are paid a lot less than the people they regulate (so are doing their time before getting a highly paid compliance job at a bank), and have no real understanding of the industry they are trying to oversee. He said that on the floor he worked the had one Bloomberg machine, but when he tried to use it, the PC was broken, and had not been fixed by the time he left. When you apply to be put on the FCA register, they spend a lot of time rummaging around in your credit history. Has having to produce a gas bill for your address ever stopped a criminal from laundering money? I doubt. Every one of those senior bank executives at RBS, HBOS, Lloyds, Lehman Brothers, Northern Rock was on the FCA register and their employer was overseen by the Bank Of England and the FCA. That worked out well for us all did it not?

The point the FCA and others have missed is that the financial crisis was a disaster of corporate governance and corporate culture, rather than a financial disaster. Large numbers of people saw the crash coming and were able to get short the appropriate products. Lehman, RBS, AIG, Bear Stearns were run by over-powerful chief executives who had no challenge to their authority, who ruled as dictators and who drove their companies headlong to destruction. They were aided by auditors and rating agencies who were paid to lie. Dick Fuld at Lehman was still buying property-related debt a week before Lehman collapsed into bankruptcy; anyone who challenged him had been fired. Fred Goodwin ruled RBS in the same way. Deranged CEO, supine board with huge share awards and big salaries. I don’t believe the Bank of England or the FCA have addressed any of these fundamental issues at the heart of the disaster in 2008. Which means that it could happen again. Has anyone from a ratings agency gone to prison? From an accountancy firm? Regulators have an extraordinary ability to tackle the wrong problem: after 2008, the SEC forced the banks to stop trading commodities. Which part of the financial crisis had been caused by a bank trading iron ore?

Mark Owen-Lloyd,

Owen-Lloyd Futures