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Madoff 's investment strategy is reminiscent to that of Charles Ponzi, who in the 1920s authored a similar fraud. Early investors were paid returns, which were not earned through legitimate investment, but from new money paid by later investors. Madoff's scheme worked for many years until the recession caused people to pull their money and lessened the supply of new investors.
As Warren Buffett famously remarked economic downturns allow us to see "who is swimming naked when the tide goes out."
Meanwhile, our new president will face multiple challenges at home and abroad, including the enormous expectations which Mr. Obama's election has created in the minds of many. I suspect that he will use his inaugural and State of the Union addresses later this month to frame a new policy agenda, while cautioning the nation that quick solutions aren't in the cards.
Congress and the new administration are likely to adopt a "stimulus package," which has variously been pegged to cost upwards of $1 trillion over a two-year period. This is on top of the $700 billion authorized (half already spent) to inject cash into the banking system. In addition, the balance sheet of the Federal Reserve system has ballooned from $800 billion to over $2 trillion in recent months, entirely via the printing of new money. Down the road, these policies are sure to set off an inflationary spiral, which will quickly get out of control unless checked.
And how will the stimulus be spent? Early indications are that significant increases in transportation spending are contemplated, as well as higher reimbursement to states for Medicaid expenses. Such assistance will be welcomed in Albany, but will only provide relatively modest assistance to Governor Paterson, as he wrestles with the state's $15-billion budget gap.
Meanwhile, other interests are lining up to get a piece of the federal pie. Retailers are asking the feds to pay for three sales-tax-free weeks. Cost: $20 billion. Realtors, homebuilders and, of course, the auto industry will also be looking for aid.
What are the consequences of all this activity? For one thing, we can expect more decisions governing our economy to be made by Washington. Witness the argument--made with a straight face--that a condition of an auto bailout would be appointment of a federal "car czar." Does anyone really believe that the federal government is competent to say how the auto industry should design its cars; or, which models to bring forth and which to discard?
Where does it end? How much authority and control are people willing to concede over their lives to Washington? What are the consequences to economic freedom? How high of a debt burden are we willing to impose on our children and grandchildren in order to pay for our stimulus today?
Short-term, we can expect more federal involvement and regulation of our economy. Hopefully, the mostly centrist Obama economic team will be able to restrain some of the more unworkable and expensive initiatives coming from the administration and Congress.
Similarly, a silver lining in this otherwise dark economic cloud will likely be a more fiscally prudent populace which, having been chastened by this downturn, decides to save more and spend less. Indeed, one hopes that the public also casts a skeptical eye towards a policy agenda from government which promises more than it can deliver and raises expectations that history and experience tell us are sure to be dashed.
We should all hope that President Obama is successful, but we shouldn't expect him to deliver on everything. After all, like Bernie Madoff's rate of return, if it seems too good to be true, then it probably is.
