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In April 1932, a Swedish financier called Ivar Kreuger shot himself dead in his Paris flat. In the previous decade he had built a worldwide empire, starting off with the humble match market, which he cornered, and then going into telecommunications, mining, forestry and, above all, finance. Wall Street loved him, a retiring figure who appeared to think only of his work as he raised money in the United States on the back of the credit he inspired to lend to nations in need – first small states and then France and Germany. When he died he was dubbed "the very puritan of finance". But, before long, it became evident that he had been operating an enormous scheme of deception, shuffling money around his empire to inflate the figures, pouring money he raised from a new venture into the books of an old one (and crediting it in two places at once). His posthumous downfall ruined investors, humbled a big Wall Street broker and hit banks on both sides of the Atlantic.
The Kreuger saga was a classic example of a man who knew how to inspire trust from investors and then traded on it remorselessly to build a house of cards. The skill and audacity with which he did so was breathtaking (when it came to light). Had he been content to remain a conventional industrialist and financier, he would still have done well. But the momentum behind these types of adventures is such that the man at the centre is never able to stop. If the great and good of international finance pay homage and show such trust that they are willing to invest large volumes of their cash (or that of others), why halt the juggling act?
So it seems with Bernard Madoff and his alleged $50bn black hole. However that affair is resolved, it is yet another test of the trust we put in financial institutions. That does not refer to Madoff himself, but rather the web he spun. He traded on his links to the Jewish community in Florida, thus ruining several charities, and to prominent figures in New York and Hollywood. But he also managed to win the support of big global banks and hedge funds.
These are the people who are meant to apply due diligence before investing their clients' money – be it that of bank deposit holders or investors who think that a fund of funds which spreads its bets is safer than simply putting all their money in a single fund. Well, the regulators may have been shown up again, but the tougher question is why these custodians of other people's money did not follow the example of their peers who took one look at Madoff's amazingly regular good results and smelled a rat.
The result can only be to remove another brick from the wall of trust which is essential for an efficient financial system. This year has brought quite enough shocks in money terms, but the greater harm may result from this loss of trust. Banks are holding on to as much as possible of the money passed their way by governments in order to strengthen their capital bases and balance sheets. But the Madoff affair can only make them more leery to lend, while ordinary deposit holders lose yet more faith in financial institutions as a result of their trust in Madoff and their willingness not to do too many checks so long as the dividends rolled in. After Enron and its peers, followed by the antics seen from other Wall Street players this year, the reluctance of any person or institution to entrust their money to anything other than an absolutely copper-bottomed borrower can only increase. Next stop, money under the mattress.
With the real economy on the verge of meltdown from Beijing to Birmingham, with Detroit stumbling towards the sunset, and with the prospect of steeply rising unemployment, the financial and banking systems need to be supporting growth (or at least cushioning the decline), not pulling in their horns. Even at a time when mere millions hardly make an impression in financial affairs, $50bn is quite a sum. But the psychological effect is hugely dangerous.
The point with Kreuger was simply that so many well-placed people trusted him. Remove that trust on a systemic scale, and we risk seeing a bad crisis turn into a long-term depression in which the risk essential for economic progress is thrown out of the window and the financial system simply ceases to function as a constructive force.
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