The Real Meaning of L’Affaire Madoff

It is tempting to dwell on the horror of Bernard Madoff. (Thanks to Robert Scheer for teeing up this issue).  How could he have done it?  What kind of a man does that?  Is 150 years in prison enough?  And so on.

Tempting—but largely wrong. If we lay all the blame at the feet of one aberrant individual, then we avoid taking a hard look at broader issues of institutional trust. 

Remember: Madoff was once the Chairman of NASDAQ and served on SEC advisory committees—he was the ultimate insider.  So it’s relevant to ask: if Madoff was such Evil Incarnate, what does that say about the sea he swam in?

Is Madoff a Bad Apple?  Or From a Rotten Barrel?

Recently the former CEO of the National Association of Personal Financial Planners was sued by the SEC for participating in a kickback scheme.   The current president missed a great opportunity to condemn or announce new initiatives; instead, she sadly bemoaned the negative impression this might cause of the character of others in the profession. 

The bad apple argument begs the question: just who elected the Bad Apples head of the barrel?

One single piece of data convinced me that Madoff was not evil incarnate, but a cheap two-bit hustler who hit it big.  It was his taped conversation with Fairfield Greenwich feeder fund starting with, ‘First, this conversation never happened, OK?

What industry elects a man like that to positions of high influence? 

Some say financial excesses were caused by misaligned incentives.  But an industry doesn’t become trustworthy by un-tweaking incentives.  Remember Chris Rock’s statement of marital fidelity: “A man is as faithful as his options.”  There’s truth to that, but let’s not confuse it with ethics or trust.

The whole point of being trustworthy is that you have just enough moral backbone to resist temptation.  We expect dogs to eat the roast if left on the counter; fixing the Madoff issue by aligning incentives is the equivalent of moving the roast to the back of the counter.  It may save the roast this time, but the dog gets the message—we are now playing a game of “who gets the meat,” no longer a game of “don’t eat the meat.” 

Which is precisely the problem with too much of the financial sector—the proposed options too often suborn more untrustworthy behavior by focusing only on consequences.    

How Not to Fix the Barrel

The real drivers of trust have got to be the personal beliefs about one’s relationship to others.  Are you in it for them, or are you only in it for yourself?  Are you an individual existing in a state of nature with no obligations beyond self-aggrandizement?  Or do you feel some connection and obligation to others, to society?

If you believe others exist mainly for you to make money from them, then you will find ways to exploit them, within (or slightly outside of) the law.  You will devise short-term transactional behaviors to lower the risk of exposure to others, and to help you do unto others before they do unto you.  You will seek to hide, and to prevaricate. 

You will, in short, violate the (four) basic principles of trustworthiness.

But if you believe you and your business and your industry exist to serve customers, and that you too will benefit in the longer run by doing so, then you’ll behave differently.  You’ll understand the word ‘fiduciary’ is critical to trust. You’ll understand the connection between being trusted and being financially rewarded.  You’ll have nothing to hide because you’ll have no reason to hide.  You’ll welcome long-term relationships, because that’s what it’s all about.

And you’ll never begin a sentence saying, ‘First, this conversation never happened.’

How To Fix the Barrel, and Apples as a byproduct.

I have said before that mass, public shaming is a more effective antidote to low trust than most other solutions being bandied about.

Erecting more airport security measures, more Sarboxes, more Chinese walls, and aligning incentives are all ham-handed, expensive ways to reduce exposure to bad people.  They do nothing to exert social leverage to reduce badness itself.

Social virtues are built by societies.  If we limit our social solutions to imprisonment and walled communities, we’re using our social capital to create criminals.

Principled enforcement—surprise audits and large penalties–is one way society teaches virtues: the IRS uses it very effectively.

Public shaming has a great history too: the muckrakers and activists have achieved great things—think Sinclair Lewis, Gandhi, ML King, the kid in front of the tank in Tiananmen Square, and investigative journalism. All have called on our innate sense of goodness to cause change.

Trustworthiness worthy of the name is an internally felt response to an externally-taught relationship. Don’t cheapen it by just moving the cheese.