Rot in the Apple

René-Thierry Magon de la Villehuchet, founder of investment fund Access International, committed suicide last night after learning that his firm had lost the $1.4B it had entrusted to scam artist Bernard Madoff.

Some wit in the Globe's comments page wrote, "suicide is the sincerest form of self-criticism." In this case, there's some sense to that.

The problem seems to be that the investment community has sliced and diced risk in more ways than creating new financial instruments. Another way the rich got richer in the last ten years was to form investment companies that out-sourced investment analysis. Someone well-connected like Villehuchet could gain the confidence of wealthy people and convince them to entrust him with their money, but then he could minimize his costs by sub-contracting to someone like Madoff. I read recently about Wall Street investment companies that have no software for analysing risk or optimizing portfolios; they're essentially dumb fronts - and the people who invest with them don't know it.

Villehuchet probably justified the scam to himself as just being good capitalism: maximizing profit by minimizing costs. Free market capitalism isn't good at drawing a line between smart business and gross negligence.

The recent Globe article on Lehman Brothers had this to say about financial deregulation:

...in 1999 [the subprime sector] received another boost. On the last day before the Christmas holidays that year, U.S. law makers led by Senator Phil Gramm – a champion of deregulation – proposed an 11th-hour bill known as the Commodities Futures Modernization Act.

The 262-page bill, tucked into an 11,000-page government reauthorization bill, largely escaped the attention of Congress. But it contained a crucial change. Credit default swaps, those complex insurance products that protected investors in CDOs and other securities, would not only be legal under the proposed law – they would be allowed to trade off of exchanges and thus beyond regulatory scrutiny.

...The writeoffs for the banking industry are now expected to ultimately top $1-trillion. Economists are forecasting the worst global recession since at least the Second World War, and possibly since the Depression.