Even in Ponzi Schemes, the Rich End Up Richer

If you're going to invest in a Ponzi scheme, look for the biggest and most exclusive ones. Find scams in which really wealthy people and large, prominent financial institutions are involved. A swindle in the Hamptons or Palm Beach is a much better choice than a scam in Moline, Ill. or Tulsa, Okla. Why? Look at what's happening in the Bernie Madoff case.

Irving Picard, the trustee in bankruptcy for the case, has collected about $1.5 billion so far. The time for him to file claims to recover money for injured investors is expiring, and he has recently brought a flurry of additional cases. Big banks, like J.P. Morgan Chase, UBS and HSBC, have been sued. Other financial firms and people that may have fed investors into the scheme have been targeted. Overall, Picard has filed claims for over $50 billion recently. Since he reportedly estimates actual cash losses from the scheme in the range of $20 million, he's trying to collect more than the actual losses (evidently on the theory that some actors, like those soliciting or providing investors, may have liability for damages). His chances of recovering 100 cents on the dollar of actual losses is likely to be low, and the chances to obtain damages probably lower. Nevertheless, many of the recently named defendants are important players in the financial services industry with reputations to protect. If their cases go to trial, unflattering information about them might be revealed in court. They could have strong incentives to settle. Many of them, like the large financial institutions, can't claim inability to pay. That means they will have to pay something.

We're still a long way from the end of the Madoff case. But his victims, who two years ago may have thought they had lost everything, may receive non-pathetic recoveries. For many, recovering 20 or 25 cents on the dollar could bring a little champagne and a new leased Mercedes into their lives. The Bentley may not reappear. But dog food (other than for the pet) could be dropped from the grocery budget.

In the grand scheme of things, being duped in a big and brazen scam of the wealthy is better than being ripped off by a guy selling investments in the parking lot of a big box store. When the wealthy are victimized, other wealthy people and large institutions can possibly be made defendants. Such defendants will often be inclined to settle. Con artists who practice their chicanery in middle class settings are likely to spend the money as fast as it comes in, and there's nothing to collect when the house of cards collapses. Even when victimized by con artists, it would seem, the rich end up richer than everyone else.

Looking for Bernie Madoff

If you could get the candid assessment of the financial markets from a lot of investors today, it would probably be something like returns are low and risks are high. That explains why so much money, especially that held by individual investors, remains in bank accounts, money market funds, ultra short bond funds and other relatively low risk places. The financial markets have given us so many unpleasant surprises in the last 3 years, people are afraid the future holds more.

At the same time, with incomes stagnant and inflation increasing (regardless of government statistics and what high ranking government officials claim), many are under pressure to seek higher returns from their savings. There's nothing wrong with looking for a better return. Just remember that, even though we now live in the era of the endless bailout, there still isn't a free lunch. Unless you're a major bank, a sovereign nation, or a very large business corporation. Stocks and lower rated bonds might offer greater potential for profit, but they also offer greater potential for loss. Risk and reward walk hand-in-hand down Wall Street.

Some investment products include guarantees against loss. These often are touted by insurance companies and should be scrutinized closely. The promise against loss is going to cost you. It could be in the form of tight limits on upside returns (i.e., if the product generates a return, the insurance company is going to keep a good portion of it), stiff penalties for early termination or withdrawal, and in other forms. Remember that if the markets perform poorly and your return is zero, even though your losses are also zero, you would have been better off in passbook savings. (That's not a theoretical point; anyone who put money in passbook savings ten years ago instead of stocks is ahead of the market.) While no one knows what the future will bring, investing in a no-lose product doesn't mean you'll win.

Even though many insurance companies might want to sell you a lousy deal, in general they aren't fraudsters. The worst thing you could encounter in your quest for higher returns is the markets magician who claims to consistently produce good, albeit not spectacular yields, day in and day out, year after year. No one can do that, period. If you meet anyone who says he or she can, put your hand on your wallet and run away. Fast. No matter how tempted you are, and no matter how good the sales pitch sounds, don't invest.

The biggest frauds are perpetrated, not because the bad guy lies, but because investors lie to themselves. They convince themselves that lead can indeed be turned into gold. They brush aside contrary evidence and the rationality of naysayers. They want to hear, however improbably, that good returns can be secured with no risk. They seek out the con artists who promise the sun, the stars and the moon.

Bernie Madoff didn't have to find many of his victims. They found him, and they were ready to believe every word of his web of lies. He'll be in prison for the rest of his life. But there are plenty of latter day Bernie's around. Often, the gullible and greedy will find them. As a matter of law, the con artist is liable and should be punished sternly. As a matter of reality, if you go looking for a latter day Bernie Madoff, you'll probably find him. And you'll regret it.

Bernie's Burdens

New York magazine reports that Bernie Madoff, when hassled about his Ponzi scheme by a fellow inmate at the federal medium security prison in Butner, NC, said, "F*ck my victims. I carried them for twenty years, and now I'm doing 150 years." http://nymag.com/news/crimelaw/66468/.

Poor Bernie. Life can be truly unfair. Perhaps he can take comfort from being the inspiration for millions of blogs, none of them complimentary. He's our inspiration today. The following is entirely fictional.


The young man was glad to escape the viscous humidity of summertime North Carolina as he entered the visitor's room at the prison. Perspiration dampened even the back of his hands. But when he spotted the man he had come to see, he forgot his discomfort. Business, as always, came first.

"Mr. Madoff?" he asked.

"Yes, I'm Bernie Madoff," said the older, gray-haired man.

"Alvin Doe," said the young man, as the two men shook hands. He tried to project the cheerfulness he had learned people beyond college age expected when first meeting someone.

Bernie wondered if that was the name on the young fellow's birth certificate. He was generic: about 5' 10", medium brown hair, brown eyes and a face you could readily forget. His clothes were also generic--a white polo shirt and khaki slacks. But his precociously jaunty manner seemed out of place for a guy who couldn't be more than a year or two out of college.

"Alvin, it's nice to meet you," said Bernie.

"Here are the things I promised," said Doe, handing three small glass jars over to Bernie.

"The real stuff?" Bernie asked.

"Russian caviar. Cost me more than the plane ticket down here. I asked my Mom to buy it because she would make sure it wasn't fake."

"Well, if your Mom says it's real, that's good enough for me," said Bernie, turning on his salesman's affability and unwinding his impenetrable half-smile. "So, what's on your mind, Alvin?"

"Mr. Madoff, I got an idea . . . an idea for a business. I wanted to talk to you about it."

"Glad to listen, Alvin. My time is yours."

"I was thinking that there's a tremendous opportunity for a business that provides people with excuses," said Doe.

"Excuses?" asked Bernie, genuinely puzzled.

"Look at today's world," continued Doe. "Everyone wants an excuse. No one wants to take responsibility for anything. A business that can supply excuses would be an instant hit."

"Hmm, you have a point there," said Bernie, warming to the idea.

"One of the biggest needs is excuses for financial screwups. There's an almost unlimited pool of customers. We have millions of defaulting homeowners. The ones who strategically default would make especially good prospects. Then there are banks that took bailouts and then made huge profits while the taxpayers who bailed them out struggle with unemployment and falling home values. The banks have armies of lawyers and lobbyists, but their image is terrible. They need the services of a business like mine. Also, there are entire countries over in Europe that borrowed a lot more than they should have and covered it up. But the truth has come out, and they're circling the drain. They don't want to actually take responsibility for all their debts. So they need help talking their way out of trouble. I think there's a lot of money to be made."

Bernie's brow wrinkled. "What you say is true, Alvin. But how do I fit into the picture?"

"Mr. Madoff, you're the champ when it comes to excuses. I mean, you went on for decades and got billions of dollars, all just with good sounding excuses. You didn't need anything else--no real business, no real trading strategy. You made a fortune for yourself out of talk. You have more talent for making excuses than anyone in history. I want you to join my business."

Bernie took a deep breath, while looking over Alvin Doe closely. He could be a junior federal agent, assigned to entrap Bernie in a criminal scheme. But he didn't look like he was wearing a wire under his polo shirt. And why would the feds bother? Bernie was 71 years old and sentenced to 150 years. He couldn't be punished more than he already had been. Doe had the eager enthusiasm of a young guy who saw goals more than he saw obstacles. That was the kind of fellow who would probably succeed.

"Well, Alvin, I might be interested," said Bernie. "How would things work? Since I'm here in prison, I can't put in days at the office. The prison people monitor my phone calls and we can't have computers or Internet access."

"We don't need any of that stuff," said Doe. "I or someone working for me will visit you and talk about the problems clients have. We don't need a lot of paper and we don't need to be connected online. I mean, all we're doing is coming up with excuses. You help us create excuses for the clients when we meet with you. That's all. No need for paper, no need for computers."

"That could work," conceded Bernie. "But what's the split on the money? Fifty-fifty?"

"I was thinking I should get three-quarters and you get one-quarter," said Doe. "I'll be out lining up clients and doing all the administrative work. And I have to handle communications with them and you."

"Don't I have the brainpower, the shamelessness that you can't find anywhere else?"

"Yes, you do, Mr. Madoff . . . "

"Bernie. Call me Bernie."

"Okay, Bernie. You do have the brainpower. But I can't exactly advertise that I'm partnering with a criminal, if you know what I mean. People won't think they're getting a legitimate excuse if it comes from a con artist."

Bernie paused, and then continued. "I think I understand that point, Alvin. Let's say I'll agree to 75 for you, 25 for me, at least to start with. Now, it seems to me that I should get a $1,000,000 advance on profits."

Doe sat back, momentarily stunned into silence. "Are you kidding?"

"Not at all. This is business. Money talks."

"I haven't got a million. I haven't even got air fare. I had to borrow it from my Mom."

"Tell you what, Alvin, I'll settle for $100,000 paid in advance."

"Bernie, I don't have $100,000. I barely have $100, and I have to cover the car rental and crappy airline food. Besides, you can't keep that kind of money, not here."

"There are places where it can go. We can get into that when you find the money," said Bernie.

"That's impossible, Bernie. I can't come up with a hundred grand. Can't you just help me out and take a split of the profits once we start making some money?"

"Well, Alvin, a man doesn't work for free. And a smart man doesn't work for just a promise. Take my word for it. I'll start out for $10,000."

"Well," said Doe, reluctantly rising to leave. "That won't be easy. I'll see what I can do."

"I think you have a great idea, Alvin, with a huge market. People, banks, governments, nobody wants to take responsibility any more. Everyone wants an excuse. Palming off an excuse is much easier than doing real work. Hell, if we took responsibility for things, we'd all have to stop acting like kids and become adults. No one wants to do that. So keep at it, Alvin."

"Okay, Bernie," said Doe, smiling broadly for the first time and extending his hand again.

"That's a nice smile you have, Alvin. Good for sales presentations," said Bernie. "Chin up. The world may be going to hell, but there's always opportunity in adversity. Making excuses will be a great business because you can count on people to pay for what they want to hear. That's what the real estate bubble market was all about. That's what Wall Street is all about. That's what politics are all about. You'll have a great business while it lasts."

The two men parted with a warm handshake. It wasn't until later, after Alvin had boarded his flight home, that he wondered if Bernie's last words meant he should rethink things.

Bernie Madoff's Ponzi Scheme is Cleaned Up While the Federal Scheme Keeps on Rolling

How much would you pay for Jesse James' revolver? He was highly felonious, robbing numerous banks and taking a role in many murders. But his revolver, if it ever were auctioned, would probably sell in the millions. Crime, as long as it's notorious, confers value. We saw this last weekend.

The federal marshalls' auction of Bernie and Ruth's paraphernalia produced some surprisingly large bids. A pair of diamond earrings thought to be worth $21,400 went for $70,000. Bernie's Mets jacket went for $14,500. A wooden duck decoy thought to be worth $60 went for $4,750. A pair of boogie boards estimated at $90 went for $1,000. Someone even paid $500 for a table made from a tree trunk, saying he hoped Bernie had stashed some money inside it. (This is a long shot; Bernie didn't have to salt away money since he could always rip off another investor if he needed more cash.) All told, the auction yielded over $900,000, well over the $500,000 or so that was expected.

Some of the aggressive bidding could come from the eBay effect--put "Madoff" into the Search function on eBay and you'll see a few of the auctioned items already for sale. Since you can't flip houses today, try Bernie's and Ruth's belongings. Other buyers may be biding their time, as the continuing Madoff saga leads to more prosecutions, further revelations and enhanced value for his erstwhile possessions. Still other buyers may hold onto their acquisitions, feeling good about owning something that once belonged to someone who was seriously bad.

Meanwhile, back at the ranch, the U.S. government continues to operate the biggest Ponzi scheme of all. The official federal debt will probably end the year over $12 trillion, around 90% of the U.S. Gross Domestic Product. Ten years ago, it was under 60% of GDP. By 2011, it will probably exceed 100% of GDP. And we're not counting unbooked liabilities from Social Security, Medicare, Medicaid, Fannie Mae, Freddie Mac, FHA and continued bank bailouts. Let's not even go there because the RAM in most personal computers can't handle numbers that large.

America's government debt will never be repaid. It's gotten too big. The government pays debt coming due by finding new lenders or convincing holders of old debt to roll their investments over. The government is lucky that the dollar is the world's reserve currency, or it would be up a poorly lit creek. (For more on this point, see http://blogger.uncleleosden.com/2009/11/is-federal-government-tempted-by-moral.html.)

Using new loans to pay off old loans isn't by itself illegal. Many corporations do that with their bonds and commercial paper. All banks fund daily operations that way. A Ponzi scheme differs from legitimate enterprise because the bad guys don't use the money they take in to operate bona fide businesses. They pocket it and use it to buy cars, jewelry, houses, clothing, vacations, expensive meals and so on. In short, it's used for consumption.

What does the U.S. government do with all its borrowed money? Stuff that looks suspiciously like consumption. Most government operations aren't meant to generate profits. Law enforcement and regulation protect lives and property. The courts are there to resolve disputes. The President is supposed to manage the Executive branch departments and provide leadership. The legislative process is supposed to do something useful, although what that might be seems to have been lost in the mists of time. These operations are not intended to yield dividends or create wealth. They are forms of consumption. So, too, is most of the federal stimulus spending. And the federal bailouts and accommodations that are never repaid (which could total to a large amount) will end up as consumption.

Granted, not personal consumption. But that simply means that the federal government isn't operating an illegal Ponzi scheme. Since the government survives mainly by wheedling money out of Peter to pay Paul, its finances sure look like some kind of Ponzi scheme. To make things worse, nowadays when Peter doesn't have enough cash to cover all the government's spending, the Federal Reserve simply prints money. Indeed, trillions of dollars worth. Paul gets . . . paper spun out of thin air.

Recent comments by Chairman Bernanke and other governors indicate that the Fed isn't about to pull back those printed dollars. The Fed's balance sheet will apparently stay its Brobdingnagian size as far into the future as one can foresee. The latest thinking at the Fed about "withdrawing" liquidity seems to be that it would pay higher interest rates on member bank deposits at Federal Reserve banks. That would put a floor under fed fund rates, and arguably reduce interbank lending (and thereby constrain overall lending). But the target for fed fund rates these days is zero to 0.25%, so even if the Fed pays 0.2% and effectively prevents fed fund rates from going below 0.2%, how much will lending be constrained? The hot, new thing in the financial markets is the carry trade, where speculators borrow dollars, convert them into foreign currencies, and invest overseas for returns expected to be a shipload larger than 0.25%. A 0.2% interest rate on member bank deposits won't constrain an unemployed novice day trader let alone a multi-billion dollar hedge fund. We hesitate to delve into anathema, but the Fed needs to raise its fed funds target rate before it will constrain much of anything.

So we have a government ponzi scheme, which gives itself a boost by printing money whenever it can't find new lenders. What a racket. No wonder the Chinese and other foreign creditors of America are nervous.

There is a way out of the federal Ponzi scheme--a marked increase in federal tax revenues, which is devoted to debt repayment. That could come from a brisk resumption of economic growth or by increasing taxes. The former seems as likely as Godot's arrival. The latter may happen, although the additional tax dollars don't seem destined for debt reduction.

Nevertheless, let's accentuate the positive. With all these freshly minted dollars floating around, it's understandable why the bids at the Madoff auction were higher than expected. Bernie's victims, at least, can be grateful for federal profligacy.

The Bernard Madoff Scandal: How Many More Ponzi Schemes Are There?

An important question arising from the Bernard Madoff scandal is what wider impact will it have? The proportions of the reported fraud--$50 billion over the course of years--probably set some sort of record. The victims included a number of people who could be featured in Lifestyles of the Rich and Famous. The fact that some charities--and, consequently, the beneficiaries of their charitable activities--were also victims darkens the tragedy of the events.

This is the sort of event that shakes investor confidence--in this case, the investors who have enough to turn it over to money managers. These aren't the people with $50,000 or $100,000 in a mutual fund; or $200,000 in a stock trading account. These are people with millions, who hand their hard-earned assets over to investment professionals that supposedly can provide them with selective access to especially good investments. Many of these investors have tony addresses in West Palm Beach, the Hamptons, La Jolla and Marin County. But others live relatively modestly in suburbs better known for the quality of their schools than the opulence of their neighborhoods. These folks tend to be highly skilled in their chosen fields or professions, but not terribly sophisticated about money. That's why they rely on money managers.

When it's reported that a man of Bernard Madoff's prominence (well known financial executive and former Chairman of the Nasdaq Stock Market) is a crook, investors naturally begin wondering if their own money manager is a crook. They'll make inquiries, and perhaps check with other sources. Many of them will submit withdrawal requests, preferring to live with the low returns that accompany federal deposit insurance than the possibility that they could lose everything. Those withdrawal requests will be like a hound flushing a rabbit, forcing whatever other frauds there might be out into the open when the fraudster can't honor the withdrawal requests.

Are there other Madoff-like scams? We don't know, but probably yes. Money managers, as Madoff purported to be, need to do better, somehow, than the market. There's no need to hire a money manager if all the performance you'll get is the market average. An inexpensive index fund is a much easier and more profitable way to go.

According to news reports, Bernie Madoff claimed to have an investment strategy that would produce unusually stable earnings. If you can take the volatility out of the stock market, but produce stock market-like 8% to 12% per year returns on average, your product will be an easy sell with the monied classes. Think back, say, to the stock market volatility of the last few months and you'll see the appeal of stable, stock market-like returns. Of course, as reported, Madoff didn't really have a magic investment formula that did away with volatility, and the recent volatility of the stock market did him in when he couldn't honor investor withdrawal requests.

Other money managers make their own claims as to how they'll improve on the market. But what if the law of averages catches up with them and they can't meet their claims? The honest ones will admit their failings and take their lumps. The sleazy ones will perpetrate a fraud.

Rising financial markets cover up a multitude of frauds. Good times draw investment dollars into the market and make investors inclined to believe that anything is possible. But the law of averages hasn't been repealed and markets also fall. Falling financial markets reveal frauds, when investors try to pull out and discover they can't get their money back. Unless you've been hanging with Rip van Winkle for the last year, you've probably noticed that our financial markets have been bungee jumping without a rope. As the financial tide ebbs low, all kinds of scum will be exposed.

Investor withdrawal requests were a major reason for the sharp drop in the stock market in September, October and November of this year. The market has, momentarily, appeared to level off. The Madoff case, and any others of its ilk that emerge, will probably trigger more investor withdrawal requests. If the money managers are legit, they'll have to sell securities in order to meet those requests. If the money managers are crooks, the ensuing scandal will further erode investor confidence. Either way, the existence of, or even potential for, more large Ponzi schemes a la Bernie Madoff will dampen already battered investor spirits and add to the sell pressure in the market.

Will the impact of the Madoff scandal and any others like it drive the stock market down? That's hard to say. The Federal Reserve has printed a trillion dollars plus in the last three months in order to prop up the financial system, and there's no limit on how much more it can print. It's also evident that the Fed and other federal authorities are intent on supporting stock market values, regardless of what they might have said to the contrary. But no amount of government bookkeeping--in actuality, the Fed creates money by making computer entries on its records of the accounts of member banks--can serve as a long term substitute for investor confidence. We now have a continuing mortgage crisis, a widening credit crunch, worldwide recession and a mega scam, and it's not at all clear that the federal cavalry riding over the crest of the hill can slay all these dragons.