Dec. 18 (Bloomberg) -- Bernard Madoff’s amazing Ponzi scheme has put him in a league of his own, for now. He shouldn’t be alone for long.

In the end, as with all the great frauds, Madoff’s undoing was that he ran out of cash. For years, he paid returns to early investors with money he raised from new investors, which is the hallmark of every Ponzi scheme.

When the economy got tough, and his customers sought about $7 billion in redemptions, Madoff didn’t have the funds. It was around this time that he confessed to running a giant scam, the authorities say. The losses, by Madoff’s estimate, might be $50 billion. Heaven knows how many clients of other money managers could meet the same fate as redemption orders pour in.

It’s no great feat to arrest a man who tells a federal agent “there is no innocent explanation” for his actions and that he expects to go to jail. The Securities and Exchange Commission blew many chances over the past decade to uncover his ruse, even after receiving detailed tips.

It’s unclear why the SEC failed to stop Madoff, whether because of corruption, a lack of smarts, a dearth of interest, or some combination. We can say with confidence, though, that many other huge frauds are still operating freely today -- and that the government might not be inclined to intervene, even when it knows all about them.

Business Models

After all, Madoff’s scheme -- at least in spirit, if not in its nefarious intent -- wasn’t much different than the business models at some of the nation’s largest failed financial institutions.

Back in May, four months before it collapsed, American International Group Inc. increased its dividend at the same time it unveiled plans to raise $12.5 billion in capital. Later, when its cash ran out, AIG got a government bailout, the size of which has expanded to about $150 billion.

Whether you call that a Ponzi scheme or something less sinister, AIG was paying old investors with money raised from new investors. The same could be said of many banks that blew through billions of dollars in freshly raised capital the past couple of years, continuing to pay large dividends even as their balance sheets quietly imploded.

So why have other Ponzi-esque operators emerged scot-free (so far) with taxpayer bailouts, while Madoff gets pinched?

The Cox Theory

Sure, there is Madoff’s own confession, plus the sheer brazenness of his conduct. And Madoff’s collapse doesn’t threaten to bring down the global financial system, as far as we know. Yet perhaps the best explanation can be found in a Dec. 4 speech by SEC Chairman Christopher Cox on why the government needs an exit strategy to unwind its myriad bailout commitments.

“From the standpoint of the SEC, the most obvious problem with breaking down the arm’s-length relationship between government, as the regulator, and business, as the regulated, is that it threatens to undermine our enforcement and regulatory regime,” Cox said.

“When the government becomes both referee and player, the game changes rather dramatically for every other participant. Rules that might be rigorously applied to private-sector competitors will not necessarily be applied in the same way to the sovereign who makes the rules.”

Cox failed to mention that the SEC already was a toothless tiger under his watch, long before this year’s bailouts took root. Give him credit for candor, though. The chairman of the SEC is now on record saying the government can’t be expected to enforce the nation’s securities laws even-handedly at companies where its own financial interests are at stake.

Fair Game

He’s right. The government can’t live up to the task, even if it wanted to.

Madoff probably wasn’t the biggest Ponzi-scheme artist out there. He’s just the first of his size to get nailed during the current bear market.

He also knew he was fair game for the government. The people running companies with taxpayer bailout money know there’s an excellent chance they won’t be. As long as that remains true, this crisis of confidence isn’t over by a long shot.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net

Last Updated: December 18, 2008 00:04 EST