Thursday, June 4, 2009

Ponzi and regulation

Ponzi scheme are much more frequent than one would think, although not as big the Madoff scheme. Ana Carvajal, Hunter Monroe, Brian Wynter and Catherine Pattillo report about a series of them in the Caribbean and in particular on how regulators intervened. For example in Jamaica, regulators alerted the public that the schemes were not licensed to accept deposits and to trade in what they advertised. The schemes were defended by other officials, seeing their effective sponsorships of events and parties. A legal battle ensued over the licensing, giving much publicity and leading, perversely, to further growth of the schemes and copycats. Looking at other instances, it appears that independence of the financial regulator is essential, as well as speedy courts. The regulator needs to have broad authority and be proactive.

Now, one may question why regulation is needed in the first place, as investors just need to draw the consequences of foolish acts. Well, first Ponzi scheme have a social cost, in the they unnecessarily reduce the confidence in the financial sectors, draw funds away from productive investments and can cause civil strife. The other is that if every investor needs to independently monitor, the cost of verification is much larger than if a regulation agency could do it. This could also be delegated to a private agency, but the latter does not have deep pockets if it screws up.

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