Greed, dishonesty and complacency - the recipe for any financial bubble

The Madoff $50 billion pyramid scheme has a parallel with our own domestically generated swindle – the UK housing market. All scams need three crucial elements; greed, dishonesty and complacency.

Greed

Madoff had a deep understanding of that old adage that “nothing succeeds like success”. His above market returns attracted banks, hedge funds and wealthy individuals to hand over their cash. Greed had blinded them, and left them unable to ask the obvious question; how could Madoff consistently outperform other hedge funds.

Likewise, rising house prices encouraged a cycle of greed and speculation. As prices increased, greed trumped caution. People bought into the lie that house prices could keep on rising forever. When something looks too good to be true, invariably that is exactly what it is. Greed debilitates good judgment.

Dishonesty

It takes more than greed to spin a scam. All scams need a murky core of deception. Madoff played out this role in this most recent outrage. He took the investors money, misled them about returns, and falsified the books.

The UK housing market does not have a single individual that provided this catalytic role. Instead, a shadowy confederation of bankers, estate agents, and TV property rampers supplied the deceitful lubricant that oiled the UK housing bubble. They provided the cash, talked up the market and spin the lies that deluded people into thinking that property was essentially a riskless investment.

However, greed and dishonesty is never quite enough to sustain a ponzi scheme. The third leg of this tripod is complacency.

Complacency

Since financial scams are as old as capitalism, society has a long history of legislating against ponzi schemes. In the US, the Securities and Exchange Commission was supposed to oversee Madoff’s operation. It failed lamentably. Here in the UK, responsibility for overseeing the housing market is a little more diffuse. However, the FSA should have kept a much closer eye on our banking system. Estate agents, with their self-serving investment advice, remain largely unregulated. Their dishonest “house prices never fall” sales patter has yet to be adequately challenged.

At the root of this regulatory failure is complacency. Although there was compelling circumstantial evidence that something wasn’t quite right with Madoff, regulators didn’t bother to investigate him. Again, there is a close parallel with the UK housing bubble. Regulators only had to look at mortgage spreads or housing price growth and see that something was going badly wrong and that a crash was imminent. Despite the accumulating evidence of an upcoming crisis, complacency always seemed to win over concern. The bubble grew, feeding on greed and dishonesty until it could grow no more.

The true return

This year will go down as the great moment of reckoning after years of greed, dishonesty and complacency. Madoff was exposed only after the entire hedge fund industry was devastated by the credit crunch. It was the same sudden evaporation of liquidity that destroyed our housing bubble. Now, at last, the true return is being calculated. The financial reckoning from both ponzi schemes will be horrific.