The shocking story of Bernard Madoff and his alleged $50 billion Ponzi scheme have implications that go well beyond the wealthy individuals and charities who were bilked of their money. As in all such scandals, this one involves a betrayal of trust. And trust ultimately is what allows economies, large and small, to function. Without it, our entire system of money would collapse.
What Madoff is alleged to have done is to create an upside-down pyramid in which he paid his investors phony "profits" from new investors' capital, while skimming off most of the money for himself. The scheme works only so long as new investors can be found to continue making payments to earlier investors, or until someone discovers the chicanery. In Madoff's case, his own children blew the whistle when they realized what he was doing.
Still, you wonder: How could so many savvy people be duped by the oldest trick in the book? Madoff's investors weren't naifs. They were some of the most astute investors around, including other billionaires who had made their own money largely by being meticulously careful in how they chose to invest. But they trusted Madoff because many of them knew him personally.
Madoff was no fly-by-night snake oil salesman. He lived and worked in the community. He was involved in the same charities as his investors. He was a co-religionist who, his investors believed, shared the same values and commitment to a strong code of ethics that would insure against deception and thievery. And so, investors handed over millions of dollars to a man they thought they knew and could trust, without doing due diligence.
In an important new book, "The Ascent of Money: A Financial History of the World," Niall Ferguson explains it this way: "When an American exchanges his goods or his labor for a fistful of dollars, he is essentially trusting (Treasury secretary) Hank Paulson (and by implication the Chairman of the Federal Reserve System, Ben Bernanke) not to … manufacture so many of these things that they end up being worth no more than the paper they are printed on. … (M)oney is a matter of belief, even faith: belief in the person paying us; belief in the person issuing the money he uses or the institution that honors his checks or transfers. Money is … trust inscribed."
And once trust breaks down, the system itself collapses. What is worrisome in today's troubled economy is that trust seems to be dissolving before our eyes. Why have banks stopped lending? Why are people pulling their money out of the stock market, driving down the Dow and NASDAQ? Why are people afraid to buy houses?
This breakdown in trust feeds on itself. Distrust becomes self-perpetuating and contagious.
The challenge will be how best to restore trust -- and to do so in ways that do not jeopardize freedom or the efficiencies of the market. As Ferguson's book illustrates, larcenies like the Madoff scheme or stock and real estate bubbles like the ones we've experienced over the last decade are nothing new and will, no doubt, occur again. But if we are to live and prosper in communities that extend beyond our immediate family members we must fall back on mutual trust, even when it sometimes fails us.