How to Destroy a Nation by Undermining Trust (Part 1)

What We Can Learn About Bureaucratic Incompetence from the Bernie Madoff and Uvalde Debacles

On a December evening in 2008, Harry Markopolos told his wife Faith to go into battle drill. They had rehearsed it many times. If someone entered their premises, he would go down to the first floor to confront the intruders, armed with offensive and defensive weapons. Meanwhile, Faith would wait upstairs, fully loaded. Her instructions were simple: if anyone approached who wasn’t him, she would start shooting and continue shooting until she ran out of ammo.

To the outside world, Harry Markopolos and his wife Faith seemed like the last people to become violent. Harry was the portfolio manager for a respectable options trading company and the former President of the Boston Security Analysts Society. Faith also worked in the financial industry.

The action that triggered their battle drill had begun earlier that evening, when Harry was at a Boston-area karate studio where his twin sons were having a lesson. To pass the time, Markopolos started listening to his voice messages. A couple of messages told him that Bernie Madoff, a financier and respected market maker in S&P 500 stocks, had surrendered to the police, admitting that his $64.8 billion investment management business was a Ponzi scheme.

A Ponzi scheme is an illegal business model in which a money manager pays existing investors with funds collected from new investors. This can work as long as there is a continuous flow of new investors and actual withdrawals are kept to a minimum. This was the type of business Bernie Madoff had been running for at least four decades. Because he provided investors with false statements of earnings, they were incentivized to keep their money in the fund. Meanwhile, occasional withdrawal requests could always be covered using money from incoming investors. But after the economic crash of 2008, withdrawal requests exceeded the money in the fund, leaving Madoff with no choice but to admit that the whole thing was, as he put it, “one big lie.” He confessed to his sons who turned him in to the authorities the next day.

And that brings us back to Harry Markopolos. When he was at the karate studio and learned that Madoff had been arrested for securities fraud, he immediately concluded that his family was in danger. He had to rush home and get ready to protect his home and family. You see, eight years earlier, Markopolos had discovered that Bernie Madoff was a fraud. He initially realized this just using basic math: quite simply, the numbers Bernie reported didn’t make sense. From there, Markopolos had begun sleuthing around, until he acquired a mountain of evidence proving that Madoff was running the largest Ponzi scheme in history.

Markopolos handed his findings over to the Securities and Exchange Commission (SEC), the government body responsible for regulating the financial sector and investigating fraud. He delivered formal complaints to the SEC in 2000, 2001, and 2005, in addition to using his contacts in the financial industry and media to try to force the SEC to investigate the veracity of his complaints.

Yet the SEC failed to act. They even failed to act when Boston SEC investigator, Ed Manion, desperately tried to convince them to consider Markopolos’s submission.

What could explain the SEC’s failure to act after receiving proof of Madoff’s criminality? The only explanation Harry Markopolos could think of is that the SEC must be complicit in the corruption. Having discovered that Madoff took money from criminal gangs and drug cartels, Markopolos understood that this was a widespread criminal conspiracy involving very dangerous elements. Madoff  obviously had inside people at the SEC.

That is why, once the scandal blew up and became public, Markopolos assumed the SEC would want to cover their backs and destroy his documents, especially those showing that the SEC failed to act on evidence that Madoff was engaged in securities fraud. They would probably want to take him out of the picture as well, and perhaps even his family.

Bureaucratic Incompetence at the SEC

But Harry was wrong. His family had never been in danger. The real explanation for what happened at the SEC was more mundane. The SEC had failed to respond to the evidence from Markopolos, not because they were criminals, but because they were incompetent bureaucrats. Quite simply, the SEC—like most government bureaucracies—had procedures in place that stopped things from actually getting done.

For example, they had internal policies that prevented them from pursuing cases against investment managers, even though the law required them to pursue such cases. Also, there were turf wars happening between the Boston and New York branches of the SEC, leading to inefficiencies and gross incompetence. Moreover, the SEC was mainly staffed by lawyers, rather than people who actually understood finance. For another thing, Markopolos wasn’t actually a “whistleblower” according to the strict definition of the term, since he didn’t work for Madoff’s organization but had discovered the fraud through facts in the public domain; consequently, the normal procedures the SEC used for dealing with whistleblower complaints didn’t kick in. And on and on and on. In short, the incompetence at the SEC had reached unthinkable proportions.

In the days following the Madoff scandal, Markopolos became a national hero and appeared on numerous talk shows. He was approached by every major movie studio about doing a film based on his story. He was asked to testify before Congress about the SEC’s failures. But unfortunately, the attention he received was too late, after $64.8 billion had been stollen from unwitting victims.

How Our Society Incentivizes Incompetence

Looking at these events fifteen years later, it seems hard to fathom how the SEC could be so incompetent. Yet the problems at the SEC serve as a cameo for a larger malaise that has become endemic to the modern world. Last year we reported on how the hallmark of many professional cultures is “a deliberate muddiness of mind,” that enables incompetent bureaucracies to flourish. We observed that “this type of incoherence is even perceived as a mark of professionalism, since it has become a proxy for the skills required by a successful bureaucrat or administrator.”

Bureaucratic Incompetence at Uvalde

More recently, this type of incompetent behavior was on full display in the school shooting at Uvalde, Texas in May this year. After Salvador Ramos began his shooting spree at Robb Elementary, armed police remained on site for 74 minutes before finally storming the classroom where the shooter was located. During this time, parents attempted to go in to rescue their children, but police used force to stop them. Ruben Ruiz, a school district police officer, tried to enter to save his wife who taught at the school. In response to his initiative, Ruiz was detained, had his gun taken away, and was escorted off the grounds.

Although there were a variety of reasons for inaction at the Uvalde shooting, one key factor was that police got bogged down by red tape and bureaucracy. For example, they were ordered to follow the procedure for a “barricaded suspect” rather than an “active shooter.” Following this protocol required them to wait outside the building for special equipment to arrive, even as victims bled to death inside the building.

As a result of these bureaucratic hurdles, law enforcement inadvertently positioned itself on the side of the shooter, just like the SEC had inadvertently given cover to Madoff. When the police finally did act, 21 people were dead and 17 injured. Among the dead were Ruben Ruiz’s wife, the fourth-grade teacher Eva Mireles.

Never Sacrifice Trust!

The failure to respond at the Uvalde shooting, like the SEC’s failure to respond to Markopolos’s warnings about Madoff, profoundly disturbs us because it means we can be let down by the very institutions that are meant to be protecting us. When this type of incompetence becomes systemic, it leads to a breakdown in the type of trust necessary for a viable society to function in the first place.

Without trust in the institutions that create, mediate, and enforce our laws, the relationship between the rulers and the ruled has to be renegotiated in terms of mere power. This is because no regime can be sustained over time unless there is self-enforcement of law from a critical mass of citizens. But this requires trust; it requires that a sufficient number of citizens trust their rulers enough to be invested in the survival of the system. This is precisely why rulers and their functionaries must never be willing to sacrifice the people’s trust.

This has been understood since ancient times. The 6th century BC philosopher Confucius told his disciple Tzu-kung that a stable society can only exist when the people trust their rulers. Accordingly, he taught, a ruler’s most necessary resources are weapons, food, and trust. If one must forego one of these, Confucius explained, he should first forgo weapons. After that, the ruler should forego food. But never, under any circumstance, must a ruler forego the people’s trust, since “without trust we cannot stand.”

How to Destroy a Nation

Bureaucratic incompetence is not the only way a government can lose the people’s trust. Other vices that erode trust between the governing and the governed include:

• capricious and inconsistent decision making
• corruption
• over-legislating
• self-interested rulership
• unjust or excessive use of force
• unfair privileges or penalties to certain groups
• indifference to truth

Of the vices in this list, indifference to truth is probably the least understood, especially today. But that will be the topic of Part 2. We will see why fidelity to truth is the glue that holds society together, and what this means for America today.