Betrayal of trust a Wall St. tradition

It’s conventional wisdom that Bernie Madoff, with his alleged $50-billion Ponzi scheme, has dealt a massive blow to Wall Street’s credibility.

That idea ought to give many individual investors a good laugh at the end of a devastating year for their own finances.

I don’t want to minimize the path of destruction, financial and psychological, that Madoff blazed. But I’m amazed that there seems to be such shock out there that the man could have ripped off people who trusted him.

On Wall Street, we’ve seen time and again that the obliteration of investor trust is the house specialty. The only real surprise here is the length of Madoff’s blue-chip client list.


Indeed, the small investor who would never have been invited into Madoff’s club can be excused for harboring a tinge of schadenfreude about this affair. We now see the rich can be suckered too.

Your mind can go numb recalling the many major episodes of financial fraud at individual investors’ expense just in the last decade.

Remember how brokerages gamed the market for initial public stock offerings in the dot-com era, awarding hot shares to favored clients who paid kickbacks? That ensured that the average investor couldn’t get in on the deals.

That era also brought us the Wall Street analyst scandal, which ultimately cost big brokerages a total of $1.4 billion in fines. The crime: To make their fee-hungry investment banking units happy, analysts would routinely exhort investors to buy stocks that they privately regarded as garbage. Nice touch, eh?

We had barely digested that debacle in 2003 when we found out that mutual fund firms were allowing hedge fund clients to trade illegally in fund shares after market hours.

Then the brokerage business had to ‘fess up about pressuring brokers to pitch to clients only those funds that provided kickbacks.

Along the way, investors suffered through the Enron and WorldCom accounting frauds that helped drive the U.S. market down as much as 32% in 2002, extending the bear market that began in 2000 and that might otherwise have been nearing its end.

Is Bernie Madoff worse than all that? To his hapless clients he is, but for the rest of us, many other recent scandals have had much greater reach, implications and shock value.


This year, trust in Wall Street was already well on its way to a wipeout before Madoff’s apparent scam surfaced a week ago.

As we know, the mortgage market bust fueled a credit crisis of proportions few investment professionals believed possible.

At the heart of the mortgage disaster was a borrowing mania financed by the unfathomable debt securities concocted by brokerage rocket scientists and hawked to investors worldwide.

And for the longest time, as it all went bad, the Bush administration and the Federal Reserve kept assuring us that the problem was “contained.”


The fallout from this nightmare has left the average U.S. stock mutual fund down nearly 40% this year, and pushed the economy into a deep recession.

So how much Wall Street credibility was there left for Madoff to snuff out?

There’s even a case to be made that his alleged fraud, and the unrelated demise of so many hedge funds for the well-heeled, might actually help rebuild the credibility and appeal of some plain-vanilla investments -- including mutual funds, despite their losses this year.

Why? Losing 40% in a mutual fund has to feel better than losing every penny in Madoff’s fund. And mutual funds, for the most part, are designed to be transparent in terms of where they put your money, their performance and the fees they charge.


With Madoff, otherwise intelligent investors simply went along blindly, failing to ask even the most basic questions about what he was doing with their capital. Neither, apparently, was the Securities and Exchange Commission inclined to ask questions.

If there is a lasting effect from Madoff, it will be to accelerate a shift already well underway: the idea that, when it comes to their money, the only thing many Americans now truly trust is a specific government promise.

In his inaugural address in 1981, President Reagan intoned that “government is not the solution to our problem; government is the problem.”

In this financial mess, government is turning out to be the only solution.


There have been runs on plenty of hedge funds this year, but no run on the banks overall, because the government insures deposits and most people (thankfully) still have faith in that insurance.

Likewise, many investors have been happy to sink their savings into low-yielding U.S. Treasury securities because they’re confident that, at the very least, Uncle Sam will return their principal intact.

At the SEC, libertarian-minded Chairman Christopher Cox will be replaced by Mary Schapiro, the career financial-industry regulator who was picked for the post by President-elect Barack Obama.

Schapiro will be asked to do whatever it takes to make sure more Madoffs don’t happen. Of course, that’s an impossible task. But we don’t disband our police departments because we figure they’ll never eradicate all crime.


As for the issue of Wall Street’s wretched image, history is clear: It’s nothing that a good bull market, somewhere down the line, won’t make a lot people forget, if not forgive.