Tuesday, March 24, 2009

Madoff’s 19th Century Forerunner Shows Flaws of Rules

Some say that we should not pass laws that would penalize AIG retroactively for using our tax money to give big bonuses to their executives who created their problems. I don't think retroactive laws should be common, but when people use their creativity to come up with a new way to enrich themselves at the expense of others, which is not covered by law , it is not right that they should be able to get away with it simply because their actions were not anticipated by decent people.


By Tom Cahill

March 20 (Bloomberg) -- John Sadleir, a British member of parliament, newspaper publisher, bank and railroad chairman, lay down under a bush on London’s Hampstead Heath and sipped poison prussic acid from a silver jug.

His suicide on Feb. 16, 1856, exposed a fraud that would wipe out at least three companies and cause “ruin and misery and disgrace to thousands -- aye to tens of thousands,” as Sadleir correctly predicted in a final letter to a friend.

Charles Dickens, Anthony Trollope and at least three other Victorian novelists used Sadleir as the inspiration for fictional villains. And in a note that foreshadowed the response to Bernard Madoff, 70, who last week pleaded guilty to defrauding investors of as much as $65 billion, politicians found him an inspiration for increased regulation.

“Whenever frauds like Sadleir’s or Madoff’s are exposed, people clamor for government regulation,” said George Robb, a professor at William Patterson University in Wayne, New Jersey, and author of “White-Collar Crime in Modern England: Financial Fraud and Business Morality 1845-1929” (Cambridge University Press, 1992). “The problem with regulation is it’s always reactive, they solve the last scandal. In 10 years people forget and crooks figure out a way to circumvent it.”

Less than a year after Sadleir’s death, two more bank frauds came to light, one of which also ended in suicide, according to Robb. The scams helped accelerate the Banking Crisis of 1857, a panic that started in the U.S. and spread to the U.K., prompting one of the last bank runs in Britain until Northern Rock Plc, the U.K. bank nationalized in 2008.

Adair Turner, chairman of the Financial Services Authority, this week called for “profound” regulatory change to prevent future financial crises.

Parliament went through a similar exercise after Sadleir’s fraud in 1856, including Treasury select committee hearings. Among the results was the introduction of limited liability banks in which each investor was liable only for the amount of money he put into the company, a change designed to protect shareholders from the misdeeds of others.

Within a decade, the U.K. had another panic, the commercial crisis of 1866, blamed in part on the limited liability rules.

C. Hoare & Co., a family-owned bank that’s operated on London’s Fleet Street since 1672, credits its status as the sole U.K. bank to reject limited liability for its success in navigating the credit crisis unscathed.

“Unlimited liability, the joy of it is it keeps you jolly nervous,” Chief Executive Officer Alexander Hoare said in an interview. “Everything apart from the shirt on our back is at risk.”

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