05/30/2009 05:12 am ET | Updated May 25, 2011

The Fake Out: Imitating Regulation in the Era of Madoff

The size and scope of the financial crisis and the resulting financial bailout require all sorts of simplifications. Some are necessary just to allow the general public to talk about what went wrong. We no longer explain in detail what a CDS is. Rather, it has become a symbol: everyone knows what one "means" when you say that "CDSs caused the financial crisis." (No matter that your friend in finance calls CDSs "essential" to modern finance.)

In the same way, the great fraudsters have been blamed - mostly by the media - for many of the financial difficulties we are currently experiencing. Bernie Madoff is, of course, the most famous because his fraud was biggest or perhaps because his behavior as a billionaire was so anodyne and, thus, the fraud so inexplicable. My personal favorite is that of the lawyer Marc Dreier who impersonated executives inside of their own offices in order to sell promissory notes (one executive even watched the impersonation, albeit unknowingly) and lived with the pomp and excess expected of such bilkers. Allen Stanford, who chose cricket manipulation as his guilty pleasure, is an equally intriguing thief.

But these villains are doubly bad in a way that simplifications like "financial weapons of mass destruction", which Warren Buffet famously used to describe derivatives, are not.

These villains, and the media voices that villanize them, create public support for the least common denominator: ending financial fraud. So this week the Senate took up, debated for a week (a long time), and then passed antifraud legislation that extended mortgage fraud regulations to nonbank mortgage companies and strengthened some protections against fraudulent manipulation of TARP. Senator Reid stated confidently:

Passing this bill will be a crucial step toward deterring the type of financial fraud and illegal manipulation of markets that were the root cause of the current economic crisis.

The Senate, in other words, is capable of making activity illegal that the general public already assumes is illegal.

But neither the Senate nor the House has taken steps to, say, create a mortgage lending market that works in the interests of homeowners most of the time, instead of against them. Nor has Congress passed legislation that prevents credit card companies from charging exorbitant fees because a cardholder has withdrawn more than the credit limit set by the card company.

But notice who has been tossed around in the mud: Madoff, Dreier, Stanford, Wagner. Do we believe that the gentlemen and gentlewomen atop Goldman Sachs, for instance, think twice about these crooks while they are quite cleverly figuring out how to wiggle out of the weak restrictions imposed by TARP?

Really, it's not the bad guys we should be worrying so much about. The causes of the financial crisis - and the causes of so much pain to consumers, of which abusive credit card interest rate hikes are just the start - are radioactive because they are not illegal nor thought to be so. If regulation is going to be robust and effective, it must originate from the perspective of the homeowner and the credit card customer, not from the perspective of the villain.