The $50 billion lost by the Ponzi scheme run by the former NASDAQ president, Bernard Madoff, has ushered in strong words from the President-elect calling for more regulation of the financial sector so as to create a sense of confidence in the markets. But could efforts to establish confidence - which is necessary - lead inadvertently to complacency among investors?

James Grant - editor of the Grant’s Interest-Rate Observer newsletter - argues that the SEC - the body meant to monitor the financial sector - is worse than being ineffective. The SEC’s inefficiency is measured by the fact that it’s always behind financial scandals, rather than preempting them. But that does not make counterproductive though. What does, argues Grant, is that the SEC creates a false sense of comfort among investors. Thus instead of more closely monitoring their investments, many investors become complacent in the belief that the SEC is looking out for them.

Mr. Madoff’s fraud was not beyond detection. It is true that the SEC was “asleep at the switch” [to borrow Obama’s phrase]; this was so despite being tipped off from the late 90’s that Madoff might be engaging in improprieties. The SEC investigated the firm’s division books in 2003 and in 2006 “discovered that Mr Madoff had misled it over how he managed his money,” but in both cases it did not follow up.

Though will the SEC is caught off-guard, some private firms recognized Madoff’s irregularities [though, admittedly, most financial firms were also off-guard]. Aksia, a Wall Street advisory firm, advised its clients not to invest with Madoff after their monitors concluded “that the S&P 100 options market that Mr Madoff claimed to trade was far too small to handle a portfolio of his size.” Another private firm, MPI, a quantitative-research firm, found after an analysis that there was no “legitimate strategy” that would allow Madoff to record his returns. MPI found that whatever Madoff was employing was similar to that of a defunct hedge-fund, Bayou.

There were other signs as well. The operation was incredibly secretive with clients denied online access to accounts. Madoff refused to provide detail and once kicked out a client who asked too many question. Many clients didn’t mind as long as returns were high (of course there weren’t, he topped off “returns” with new investment) and given Madoff’s reputation.

His firm was once audited for clearing trades without a outside custodian, it had been probed for trading its own account before attending to clients, and found guilty for several technical violations. Even more of Madoff’s clients thought he might be up to illegalities, though they though it was insider trading that would land Madoff in trouble but provide gains for them; so they didn’t mind.

In light of all of this, one may conclude that the main problem with the Madoff scandal was the lack of vigilance among investors.

The lesson from the Madoff scandal is not that government does too little, but that in seeking to do too much government undermines personal responsibility, a key component of capitalism.