Madoff and the "Idiot Plot"

Dec 17, 2008

First of all, a confession: I’ve read very little about l’affaire Madoff. I just don’t want the facts as I’m almost certain they are to be muddied by the facts as they actually are.

Second, a note on the title: I first heard the term “idiot plot” on Siskel & Ebert at the Movies, to describe a movie whose plot progression depends on the characters behaving in ways that normal people never would – like having the attractive, inadequately dressed, and very endangered young woman protect herself by barricading her doors with sofa cushions, instead of picking up the phone and dialing 911.

Where was I? Oh, yes, Madoff. Most of the reporting I’ve seen has focused on two causes for what might be the most spectacular financial fraud in history:
  1. Inadequate regulation. Yes, yes, yes, the SEC missed this one – they themselves have acknowledged that they failed to react to complaints about Madoff’s practices. [Yet another example showing that self-criticism is the new saintliness.]
  2. Investor due diligence. The reportage I’ve seen cites many people who didn’t invest with Madoff because of red flags they noticed. While these reports don’t actually blame the suckers who did invest, there’s at least an implicit criticism here, and some schadenfreude directed at the Palm Beach cocktail party set. [I’m somehow reminded of one of my favorite scenes from Ferris Buehler’s Day Off, when a character phones in her absence from high school because she says her grandmother has died, and the suspicious principal demands to see the death certificate.]

But these criticisms are terribly unfair. Do we really want to have a control system that depends principally on an agency competent enough to distinguishing the real problems from the many crank calls, or well-funded enough to check them all? And the U.S. investment climate is the envy of the world – or at least it was – precisely because investors don’t have to rely on heroic due diligence measures.

Here’s an even simpler solution: Require all funds that invest other people’s money to have an annual audit by a reputable firm. It’s inconceivable to me that Madoff’s operation ever had such a thing. The audit could focus simply on whether investor funds were being used for their stated purpose – you know, like being used to buy listed securities, and not just transferred to the accounts of other investors. Such a requirement falls far, far short of “excessive regulation,” even to a free-marketeer like me.

So Madoff is a movie with an “idiot plot” that would never have been filmed without archaic views about information. The solution isn’t more “regulation.” Nor is it more “due diligence.” It’s disclosure. Disclosure. DISCLOSURE. Got it?

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