Felix Salmon examines the SEC's failure to uncover Madoff's Ponzi scheme even when they were explicitly investigating whether Madoff was operating a Ponzi scheme and concludes, "investors simply cannot rely on regulators to protect them. Either there's an explicit government guarantee, like the one on bank and brokerage accounts, or you're basically on your own." That seems correct. I'm not sure investors were really expecting that the government would protect them from being suckered into Ponzi schemes, but they did presume certain rules of the road: Traders understood financial instruments, the financial sector understood the assets it was heavily invested in, and the incentives were such that relatively few would assume too much risk and almost none would try and defraud. They didn't think, in other words, that they needed much protection. Madoff's scheme was large, but he's still only a single trader. Outright fraud hasn't been too much of a problem. The other assumptions, however, proved more dangerously incorrect.
