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Intervention by Denise Caruso Read Intervention by Denise Caruso, Executive Director of the Hybrid Vigor Silver Award Winner, 2007 Independent Publisher Book Awards; Best Business Books 2007, Strategy+Business Magazine

THE $50 BILLION CONFIDENCE MAN: HOW MADOFF MADE OFF WITH YOUR MONEY

by ~ December 13, 2008.
Permalink | Filed under: Hybrid Vigor, Policy and Decisions, Social Trust Online.

In the media coverage of how Bernard L. Madoff pulled off a massive Ponzi scheme, the references “trust” and “loyalty” border on the gratuitous:

“For Investors, Trust Lost, and Money Too”

“Thirty-six years of loyalty, through two generations, and this is what we get”

“People came to trust him so much that, eventually, they trusted him with everything.”

“Madoff’s betrayal imperils a generation of trust”

Unfortunately, this yet another $50 billion wake-up call that our instinctual ability to trust is completely overwhelmed by modern institutions. Not even the smartest people in the room caught on to Madoff. I think Charles Green summed up the problem as well as anyone:

How? How could some of the world’s supposedly smartest investors … have been hoodwinked by something that, in the rear view mirror, was a blatant scam?

The answer reveals a common myth about trust in business. The myth is that good businesspeople make rational decisions about trust.

But let’s look at the problem from a different angle: who better to defraud wealthy, intelligent people than a $50 billion confidence man? Only trusted individuals get that kind of privilege! It usually takes an entire industry of lesser fraudsters to come up with that kind of cash.

Madoff as Archetype

It’s obvious now that Madoff is a particularly evil and odious man. But that doesn’t explain how he was able to pull off such an enormous fraud or whether such tragedies can be averted. Clearly there were others who helped him stage this Royal Nonesuch, many of whom were unwitting participants.

As a society, our understanding of Madoff is a categorical imperative, because Madoff isn’t an aberrant freak of nature. Madoff is a representation of what’s wrong in society. Madoff the man is irrelevant; Madoff the archetype is terribly frightening. Consider Milan Kundera’s analysis of “eternal returns” in the first chapter of “The Unbearable Lightness of Being”:

If the French Revolution were to recur eternally, French historians would be less proud of Robespierre. But because they deal with something that will not return, the bloody years of the Revolution have turned into mere words, theories, and discussions, have become lighter than feathers, frightening no one. There is an infinite difference between a Robespierre who occurs only once in history and a Robespierre who eternally returns, chopping off French heads.

Will there be another Ponzi? Another Madoff? Of course! In fact, there are already many more of them in existence than we realize. Forget Madoff the man. How do we take down the Achetypal Madoff?

The “How” is in the Structure of the Relationship

The Laws of Relation are my attempt to analyze these breach-of-trust phenomena and how hopefully to improve the structure of relations. I think they provide a lot of clues in outing the world’s Madoffs.

Clue # 1: Asymmetric relationships inexorably lead to exploitation

Asymmetrical relations are exploitive relations by their very constitution. This is true even when the participants have a high degree of good will toward each other. The structure of the relationship is an environmental factor that necessitates exploitation. In short, absolute trust corrupts absolutely.

This is even more true when people interact with organizations, institutions, business, and governments. In the book “The Asymmetric Society,” James Coleman distinguishes between natural persons and organizations, and then discusses how rules of interpersonal trust don’t apply to organizations. For example, you can be loyal to your employer, your union, and your brokerage. But these institutions aren’t human, so are incapable of loyalty, love, and caring. Of course, organizations really want your loyalty and trust, because it’s great for business. But organizations don’t have the “empathy gene” that makes them want to protect you in a crisis.

Imagine this: What if Madoff was an honest man early in his career and never thought he’d become the world’s biggest Ponzi? But slowly Madoff comes to see real-estate boom, credit default swaps, and the Nasdaq itself as enormous Ponzi schemes. Almost serendipitously he finds himself inextricably linked to a system of Ponzism, with himself holding all the strings. He holds all the money; he sets all the rules; he runs the circus… and people all trust him with their money. He also realizes that creating asymmetric relationships with his clients provides him unprecedented leverage. He allows people to believe that multi-generational loyalty matters in their relationship, when in fact in their loyalty only plays into Madoff’s master plan.

Clue #2: Disproportionate Risk

The Law of Relational Risk says that “contribution to the relationship that is not met proportionally by the other participants is a loss to the contributor.”

It’s telling that Madoff made the $10 million bail. He even talked about distributing the $200 million or so left in the fund to close friends and relatives. Didn’t he “lose everything?” Well, Madoff lost his reputation and his ability to do “business.” He’ll probably spend some time in jail. But he’s no Dr. Faustus. After all wouldn’t most people line up to spend a few years in jail and suffer a public humiliation if they could spend 30 years as a billionaire? Just look to reality TV to see what people are willing to suffer in hopes of winning a few bucks!

Here’s the point: If you contribute something to a relationship and the other party doesn’t reciprocate with a proportional degree of risk, you’re doomed. Think of your contribution as a charitable contribution.

Clue #3: High security

If good fences make good neighbors, then what do high security fences make? There are lots of people that would like you to believe that strong security is the pathway to confidence, safety, and trust. In my previous post, I commented briefly on how the CSIS panel’s focus on security was well meaning, but off base. A security apparatus is more effectively used as tool of exploitation than as a pathway to trust. Institutions that thrive on secrecy, high security, and controls are most likely unworthy of trust.

Clue #4: Shallow signals

How impressed should you be that someone has a lot of money? Or that they have a position of power? Or that they’re a Harvard grad? Does it follow that people with diplomas, position, and wealth are trustworthy? History proves otherwise.

Give me the most selfless billionaire on the planet and I’ll give you Gandhi. It’s much more difficult to live the life of Gandhi than the life of Madoff. Too bad Gandhi wouldn’t take a Wall Street job. He might have a few things to say about the way Wall Street ought to be run.

In conclusion, I’ll reiterate something from my October 12 post, “Money Can’t Buy You Trust: What We Won’t be Getting for $1 Trillion“:

Yes, good bankers do know how to manage risk—their own risk. Which is why the best investment bankers view a recession more like a sabbatical, while the rest of us have to figure out how to keep food on the table.

3 Responses to THE $50 BILLION CONFIDENCE MAN: HOW MADOFF MADE OFF WITH YOUR MONEY

  1. Matt Barney

    I agree with you that he’s not an abberation - and it’s appauling that after Enron, Adelphi, and Lucent fraud that spawned SOX404 and Enterprise Risk Management, that organizations still ignore the science of leadership due diligence. More here - http://blog.scientificleader.com/2008/12/13/madoff-destroys-50-billion-with-giant-ponzie-scheme/

  2. Christopher Prince Boucher

    Can you say Scorcese movie?

  3. Nick Givotovsky

    Excellent observations and references. Perhaps the very imbalance you mention, between organizations’ constitutional lack of an in built capacity for empathy and individuals’ default expectation of such suggests the need to reconsider corporations as even legally, “persons”.

    Certainly the misuse of people to which corporations are prone, treating them as they too often do, as only means and not ends of intrinsic and unquantifiable value in and of themselves, deserving of and entitled to honesty, fairness and care, suggests that we might want to entirely reconsider things like our often rather blind “loyalty” to brands.

    What I’d rather be able to know, in assessing a service or product or offering of any commercial kind, is the aggregate, but unfiltered, experience of all its users, over time, and up to the minute. I’d also like to know that for any firm operating in a given category, its obligations to lawful conduct are certifiably being met. This I think puts me in agreement with you that it is transparency and accountability, rather than secrecy, that is required to merit, and is most likely to engender trust.

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