The mainstream reaction to the Bernard Madoff scandal was inevitable. Whenever a government regulatory agency proves itself to be incredibly incompetent or corrupt, the respectable media swoop in to declare that the "free market" has failed and the agency in question obviously needs more money and power.

Whether it’s the Department of Education’s failure to produce kids who can read, the FBI’s accusations against innocent people in high-profile cases, or the FDA cracking down on tomatoes, the answer is always the same: proponents of bigger government argue that yes, mistakes were made, but the solution of course is to shovel more taxpayer money into the agencies in question.

In the private sector, when a firm fails, it ceases operations. The opposite happens in government. There is literally nothing a government agency could do that would make the talking heads on the Sunday shows ask, "Should we just abolish this agency? Is it doing more harm than good?" It’s not just Fannie Mae and Freddie Mac: throughout history, virtually every agency created by the federal government has been deemed too important to fail. (I vaguely remember some Republicans in the mid-1990s holding a press conference and declaring that the Department of Commerce was done, and that voters could "stick a fork in it." I guess they found it was still pink inside.)

Madoff’s Ponzi Scheme

The pattern plays out perfectly with the SEC and the Madoff bombshell. Suppose a few years ago, I told a group of MBAs to imagine the worst screwup that the SEC could possibly perform, something so monumentally incompetent that members of Congress might openly question whether the agency should continue. I think that at least half of the class would have come up with something far less outrageous than what has happened in fact.

Everyone who reads the headlines knows that Bernard Madoff is accused of running a massive Ponzi scheme that, for over a decade, has ripped off investors to the tune of $50 billion. But those who dig a bit deeper learn that Harry Markopolos, who used to work for a Madoff rival, has been writing the SEC since at least May 1999, urging them to put a stop to Madoff’s Ponzi scheme. (Markopolos examined the options markets that Madoff told investors he used to hedge his positions and yield his steady stream of dividends, and Markopolos concluded that Madoff’s results were impossible.) Incredibly, the SEC apparently had evidence in front of its face sixteen years ago (in relation to another case) that Madoff was a crook.

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