By John Sexton

In time we may reflect that nothing in the annus horribilis of 2008 more thoroughly exposed the rot at the core of the world financial system than the US$50 billion collapse of US financier Bernard Madoff's Investment Securities LLC. Madoff is alleged by US prosecutors to have confessed to running a pyramid scheme that collapsed when the financial crisis led investors to ask for their money back.

To put the sum involved into perspective, 50 billion dollars is greater than the annual GDP of more than 120 countries, including at least 8 on the European continent. It is one-sixth of the annual GDP of Denmark. A lawyer representing a group of Madoff's investors said yesterday that he believed the alleged fraud would turn out to be "bigger than Enron".

This is not just a matter of the plight of elderly and (formerly) wealthy residents of Florida. The list of major banks likely to lose out grows by the hour. The worst hit include two that had so far been relatively untouched by the financial crisis; Spain's Banco Santander, exposed to Madoff to the tune of 3 billion dollars, and HSBC, which has revealed it may have to write off 1 billion dollars in loans to Madoff investors. Other likely losers include the Royal Bank of Scotland (nearly US$600 million), and Nomura (US$300 million). There are unconfirmed reports that three Swiss private banks are facing combined losses of over US$2 billion.

Some of the market's most sophisticated players have been ensnared. Nicola Horlick, lionized as Superwoman by the UK press for her ability to juggle family commitments and wealth, has been struggling to explain why her firm, Bramdean Securities, entrusted nearly 10 percent of its managed funds to Madoff. At the moment she appears to be blaming the American regulators, which seems an inadequate defense for a professional investor.

But the impact of the Madoff case is not just about the scale of the losses. Madoff is no bit player on the US financial scene; he has been at its heart for decades. He is a former chairman of NASDAQ, the stock exchange that became the symbol of the transition of advanced industrial economies to a clean, post-industrial, weightless future where money makes money without the intervention of grubby details like workforces and production, all safely off-shored to India and China.

The 2008 crisis was prefigured by the Dotcom boom and bust during which billions were invested via NASDAQ by the perennially optimistic or merely insane – in projects such as websites designed to offer fashion tips. Compared to this kind of nonsense, speculating in tulip bulbs was relatively rational. In the surreal period around the Millennium, tens of thousands quit their jobs to become day traders, and the rest spend their working days on the phone to their brokers.

The property bubble and the sub-prime crisis in turn dwarfed the Dotcom bubble and finally the financial casino brought the "real economy" crashing down. Recent research by Susan Smith of Durham University has confirmed what everybody suspected – the extraordinary extent to which millions of ordinary people have been financing their everyday expenditure by extracting equity from their homes. Now that equity has evaporated, and spending on credit is no longer desirable or possible, consumer demand – the motor of the advanced economies – has dried up. It is hard to see where an alternative engine of growth is to be found.

The weightless economy has turned out to be the worthless economy, and the world, like Bernard Madoff's investors, is left asking where has all the money gone?

The credit crunch forced governments to improvise solutions. Free market dogma was jettisoned as banks were nationalized and major public investment programs announced to avert economic collapse. State intervention in the economy is back for the foreseeable future, and politicians in surprising quarters have begun to theorize its return. Nicolas Sarkozy was photographed reading Karl Marx. Peter Mandelson, the UK business secretary, once New Labor's arch neo-liberal who proclaimed himself "intensely relaxed about people getting filthy rich", now baulks at the description of the UK as post-industrial, and is busy dusting off a 1970s-style Industrial Strategy.

Meanwhile, the nagging question remains – as the tide of financial speculation ebbs, what other wreckage will it reveal? We may still be just at the beginning of the bad news.

(China.org.cn December 17, 2008)