The Volokh Conspiracy

Sk wrote at 12.12.2008 2:03pm:

Billion, Bernard, Bernstein. All have a 'b.' Coincidence?

As The Honorable Chester Cadaver said, "Sure, understanding today's complex world of the future is a little like having bees live in your head. But, there they are."

The size of his fraud was quite shocking.

A far less shocking quote from the WSJ article on Madoff: "He has made major donations to Democratic candidates and organizations."

Stealing your first billion is always the hardest.

I had some money with him. Safe 8% (historically) in a market where almost everybody else is tanking. Too good to be true?

NOW you tell me.

Billion, Bernard, Bernstein. All have a 'b.' Coincidence?

You forgot Bush.

and Bill and Barack.

"What I don't understand is that news stories said he recently had $17 billion under management, according to NASDAQ records, and that he now has $200 million left. Many investors over the years had cashed out. So how is there $50 billion in losses? Unless investors thought he had $50 billion under management?"

Investors didn't know how much money other investors had invested or even how many other investors were investing. So you could have had 50 investors who each invested $1 billion, and with each of the 50 investors thinking that he had $17 billion under management, including their $1 billion.

Bernard L. Madoff Investment Securities LLC

With an extra-special emphasis on the "LL."

Former President of NASDAQ, huh.
I don't think he even collected management fees.

You people, always looking on the downside.

So he ripped off $50 billion in 20 years in an enormous Ponzi scheme?

Arrest him, hell. Let's put him in charge of Social Security. He's got a much lower burn rate than the SSA does.

David:

Here are two possible explanations for the numbers discrepancy:

1. He could have been telling investors he had $50 billion, whereas he had only $200 to $300 million.

2. This could be the sum total he raised over the years, in his fraudulent scheme. So that, while now, investors think he had $17 billion, and he only had $200-300 million, he took in much more than that over the years, but gave some of it back.

As for why he would do it, this probably didn't start off as a Ponzi, but he lost money and didn't want to tell anyone, so he sent out false returns information, thinking he could get the money back. As the years went by, and he didn't get it back, he got deeper and deeper into the Ponzi type hole --needing to raise more money from new investors, to repay others. This all crashed when people didn't want to invest anymore in the markets, because of the recent problems. So, he was now faced with $7 billion in redemption requests he could not honor.

Also, please bear in mind that investment advisors typically charge a fee of 1 to 2 percent of "assets under management." If he was running the fraud through his hedge fund, he would earn similar fees, and likely a share of the fund's reported profits (20 percent). 1 to 2 percent of a fraudulently inflated number that high can make you rich, pretty quickly.

Lets explain what a Ponzi scheme is. The creator of the Ponzi scheme (Madoff) pays large profits to investors who seek withdrawals from the money that was placed in by new invesotrs.

It's not like he just took people's money and disappeared with it. He created account statements that showed large profits for his investors. If an investor sought to take a withdrawal of that money, they got it. Some investors made a fortune from investing with Bernie Madoff. That helped him consistently attract new investors.

Only one problem. There was nothing to back up those account statements. The actual assets couldn't come close to paying off those accounts if a massive amount of withdrawals came. And, those withdrawals finally came in 2008 of this year. And Madoff was caught.

Now there is an issue that the Professor could help me undertand. Suppose someone invested 2 million with Madoff in 1998 and takes a withdrawal of that 2 million plus 5 million dollars in profit in October 2008. Do the other investors have a course of action against that investor? There were 6 billion dollars in withdrawls so somebody made some money with Mr. Madoff.

--- Suppose someone invested 2 million with Madoff in 1998 and takes a withdrawal of that 2 million plus 5 million dollars in profit in October 2008. Do the other investors have a course of action against that investor? There were 6 billion dollars in withdrawls so somebody made some money with Mr. Madoff. ---

The investors would not be able to sue, but the court appointed receiver could sue those that received the fake profits under the theory of unjust enrichment. To have a cause of action for unjust enrichment, all you need to show is that one party is unjustly enriched at the expense of another. You do not need to prove that the party that was enriched did any wrongful act.

Well, I can see how this supports the idea that regulation of financial markets is a bad idea. (sarc/)

And how exactly does this differ from the Ponzi scheme known as Social Security/Medicare? SS/M pays benefits to retirees with cash provided by current taxpayers. The "lockbox" is an accounting fiction that has zero cash in it, just IOU's from future taxpayers. The unfunded liability is measured in the tens of trillions (that's trillions with a "t").

The capital loss/ordinary income limit has been in place since 1976. It seems to me that with 25 years of inflation,
that $3,000 limit is far too low. Moreover, if we want to encourage investors to take financial risks investing in new
frontier technologies, there should be a cushion for
the financial blow if the venture does not succeed. Best way to do that is to allow a greater portion of the write off.

One angle Madoff enjoyed not mentioned in the MSM is that as a broker/dealer, his firm was set up to control everything - custody of accounts, client statements, every single thing was done internally except the auditing, which was done by a tiny firm with 3 employees.

On the total amount of assets ($17 billion vs $50 billion), there's some confusion about the accounting for all the "feeder funds" such as Fairfield Greenwich, Tremont Capital and Maxam that operated as semi-independent marketing arms of Madoff. Plus the fact that since the product was sold to many/most of the investors as a stable income fund, over the years Madoff probably paid out 10%-15% of assets under management in income (in contrast, investors in most hedge funds and equity mutual funds choose the reinvest my returns option and so returns are rolled over rather than paid out).

As an investment professional, I'm somewhat surprised at how many other investment professionals are "shocked" that Madoff was running a Ponzi scheme - though he was considered an upstanding member of the community, the investment process had all the earmarks of a traditional Ponzi scheme: investment returns that were so consistently positive as to defy belief, an investment process that included a "black box" market timing tool so secretive that no details could be disclosed to anyone, a split-strike options conversion strategy that couldn't come close to generating the returns reported by Madoff and custody of client assets which precluded third party auditing and verification of returns.