What Would We Do Without Experts?

Headline of the day: “US anti-kidnapping expert kidnapped in Mexico.”

Which, of course, is reminiscent of “British and Irish anti-piracy experts rescued – after pirates attack.”

Which in turn reminds me–I’m free-associating here–of the Bernie Madoff fraud. It appears that Madoff is just another in a long line of Ponzi schemers, only on a huge scale. A reader comments:

Looks like a straightforward if absolutely spectacular plain old fraud….on a huge scale with incredible personal cunning….I do note the several skeptics who smelled a rat in the past and wouldn’t invest with him…the others?…unbelievable!…THE most FUNDAMENTAL rule of the financial markets is the link between risk and return….which implies an inability to beat the market consistently….

Those who invested tens of billions with Madoff–largely other people’s money–now look extremely silly:

Some folks who looked at Madoff’s trading strategy in detail say they could not understand or replicate his returns. We look forward to reading the documents that made FGG comfortable that Bernie’s trading strategy wasn’t just some black box that spit out attractive-looking numbers on a page.

This reminds me of a case, quite a few years ago, in which I represented the trustees of a pension plan that invested with a guy who claimed to have a computer program that could consistently beat the market. No one was quite clear how it worked, but what they knew for sure was that he had an unblemished record of delivering top-notch returns. So they invested with him.

The day came when it was rumored that some investors who had tried to get their money out were unable to do so. The guy who ran the fund wrote all the investors and invited them to a meeting at an auditorium in Denver at which all would be explained. My trustees showed up, a little nervously. The auditorium was crowded. But the guy who ran the fund didn’t appear. Instead, at the appointed hour, the curtain was drawn back, and in the middle of the stage was a television set. A man walked on to the stage, popped a VCR tape into the television and turned it on. The man who ran the fund appeared on the screen and told the assembled investors that his fund had been a Ponzi scheme and that he was sorry, but their money was all gone.

The tipoff should have been the very “track record” that was so attractive to investors. As our reader says, there is no reward without risk. When the risk seems to disappear–when above-average returns materialize year after year–one should investigate the likelihood that the mysterious “computer program” is just “spit[ting] out attractive numbers on a page.”

Hey, that’s how I know my broker is honest, although it would be nice to have a moment of doubt now and then.

What does this have to do with kidnappers and pirates? Experts. Experts who are highly paid to invest money, and whose careers depend on being right, fell for Madoff, to the tune of something like $50 billion. Which is why I am extremely skeptical of the idea that we need more government regulation to avert such losses in the future. No new regulations are necessary to ban schemes like Madoff’s; Madoff’s fraud was already illegal when Ponzi did it. And if hundreds of experts–professionals who bet their livelihoods on Madoff’s fund–couldn’t figure out that he was a crook rather than a genius, why should we think that some government bureaucrat is going to do better?

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