Bernie Madoff Comes Out of the Closet 44 comments
-
Font Size:
-
Print
- TweetThis
Reposted from fund manager 'Cassandra', with author's permission:
Not a year has gone by during the past fifteen that I have not contemplated what Bernie Madoff did (or didn't do) to make his money. Seventy to one-hundred basis-points-a-month. Net. Net. Net. During tempests, earthquakes, panics and crashes - even during the closure of the exchange itself, Bernie apparently minted coin like few others. Even Renaissance and Shaw tripped occasionally. Not Bernie. Yet no one knew what he did. It was one of the best kept secrets in the world. Oh yeah, sure, split-strike conversions were the official line. But every skeptical arb trader knew this couldn't be true.
I also never came across an ex-Madoff trader the way one meets ex-Shaw, ex-Moore Cap, or ex-Citadel employees. Resumes are sent in reply to postings and guys have done the rounds, even if they weren't unhappy and making a moral statement. A spouse moves...whatever. Surely there must be disgruntled Madoffians somewhere, right?. Were they ummm underground? I mean, literally? My friends at a large IB (who were soliciting business from them years ago) who'd been to their offices said they looked like the bridge from the USS Enterprise (the Starship - The Next Generation version). Entry to the IM sub was strictly verboten. Uh huh. He said it was a paperless office. No paper trails. Hmmmm. Violators were fired. Weird. No one transgressed.
Whatever he did, he came a long way from arbing the odd-lots that were the reputed foundation of his activities. I knew his shop from London where he was one of the few to make markets in US stocks out of hours, and if my clients for whatever (mostly ill-advised) reason needed to trade instantly, Bernie would make a price. Not necessarily a good price, but a price. But one does so at their peril since the folk with material non-public information are more predisposed to want to trade outside hours, so the pick-off risk was huge. But he never complained.
Next thing I know, he's at the center of an electronic trading revolution - an electronic market-maker facilitator at the center of the trading universe. Yet even Timber Hill has bad hair days. Volkswagen ord-pref days. Not Bernie. Is he arbing the exchange fee structure? Is he algorithmically scalping cause he's seeing the order flow before it gets to the exchange? Maybe. Profitably? Who knows? But I didn't have a problem with an old Jewish guy making markets. This is what we DO. But there are these investment funds - Fairfield Sentry and Kingate, and these are the issue. They are Madoff-only feeders reputed to be $7bn each. Are they funding his market-making? Why does he need so much capital? What the f*ck f*ck f*cking f*ck could he be doing in the equity markets with that much capital and still keep it a secret AND deliver returns? They say they are doing these split strike conversions but I can't see how the numbers work. Nor can anyone else. The Wall Street Journal raises the red flags in an article, but it's dismissed as hyperbole disseminated by jealous competitors. But the nagging thing is: there are lots of smart guys out there. More than sixty of them near Stonybrook with Simons focused on cracking the nut faster, better quicker, and this activity and result, I can understand. But there is no sign of such exactitude or intellectual firepower at Madoff. Just 70 to 100 bps per month, secretiveness, and dissonance.
In 2000, I advised a family-office on their alternative investments and constructed a portfolio on their behalf. I had free rein. Included in their legacy portfolio was a sizable Madoff position. As a fiduciary - and a conservative one - coming on the heels of LTCM which also lacked transparency and which made it hard for me to raise capital - I dug, asked every well-connected equity-finance, prime-broker, electronic trader and HF allocator type I knew and it still didn't add up. The best and brightest still had no more insight than I, though the skeptical shared my suspicions. So, I strongly suggested they "dump it". "One isn't being compensated sufficiently for not knowing, and something just isn't right here. Yeah maybe it's OK, but I think it's not". But they liked "it" and they liked "him". "He's always paid", they said. "We've been with him a long time". Old school they were. Trusting. What the f*ck did I know anyway?
Well, it seemed to me that the "split-strike conversions" were profit shifting bookkeeping tools. Money invested in the feeders did obtain split-strike conversion positions on their books that had an implied "yield" equal to their return but it seemed these were pre-arranged combinations that shifted return back to the investment vehicles and were "phantom" positions vs. Madoff securities. In the interim, Madoff presumably has use of the entire pool of capital, to do what he pleased, plus whatever that pool could command in terms of leverage from bank lines and financing sources. It could be in anything and everything. He could be doing mutual fund timing, or mutual fund market impact trades. Credit arbitrage. Funding coup d'etats in Africa. Or buying GSCI commodity swaps. More plausibly, he could be doing option and index-option market impact trades since he was ostensibly at the center of market flow, or he could be at the center of a loan-sharking network across America earning 50%pa, and here he was passing a paltry 9% back to investors. Either he was crooked beyond belief or he was an evil contrapreneurial genius. Who would have have thought he was both??!!
Some crimes are too perfect. Some facades too well-painted to be original or convincing. A good hustler knows he must lose sometimes in order to win. THAT is the reflection of reality that makes it believable, and gives confidence to the punter who will shortly be taken out. THAT was what was wrong with Bernie Madoff's Ponzi. The people who were taken - like the Family Office and many other investors who in time will go public on their fleecing - wanted badly to believe they were onto something that was so good that they ignored the most obvious signs of bogusness. It just didn't make sense. It just didn't add up. Even Jim Simons earns it. There is no free lunch.
There is something fitting and just in the timing of this. It is emblematic of America since Reagan and the Great Leveraging. Something for nothing. Thank you, Mr Laffer. But as a philosophy and modus operandi it is, quite literally, bankrupt and without merit. And Laffer has since been proven to be full of sh*t. Now, Americans will have to confront this, the premise that greed is good and self-guiding and somehow omnisciently beneficial, for it has had repercussions down to the core of our society and values. "Sorry everyone....what you've been pursuing has all been a lie, a big Ponzi, a rat-hole to nowhere....". Re-boot.
Related Articles
|
Find People on SA
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largest
increase in followers
in the last 7 days-
1
David Fry
-
2
Philip Davis
-
3
Bill Gross
-
4
Tyler Durden
-
5
TraderMark
Fastest Climbers » -
1
-
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 44 comments:
I can assure you that if Madoff was a Christian his religion would not have been brought up.
There's no way of making an honest quick buck without hurting someone down the line. If this market crash spells the end of retail investing for a long time, so be it. Hopefully, better regulation and legistated financial responsibility with some clawback provisions will end all the Ponzi schemes.
On Dec 12 09:43 AM Augustus wrote:
> It was a pretty well written articl until the author decided that
> it was "blame it on Reagan" time. If you can find any instance where
> Reagan advocated "something for nothing" let me know and I's send
> you a bottle of whiskey. Madoff has been just another crook fleecing
> the unsuspecting wealthy who did not know how to make money on their
> own.
. Madoff was using a "secret" trading method.
. He did virtually all of the "trading" himself.
. Virtually all of the people involved in the "trading" operation will be family members.
. The "advisors" funneling him money did not investigate and profited very nicely from their "management".
. Madoff constructed his own client reports.
. There were no brokerage statements from an independent firm.
. Clients were actually fearful of withdrawing money from him because they might lose their access to the returns.
. Monthly returns were consistently boring. Never or very infrequently showing even a small loss.
. No one (attorneys, accountants, etc) questioned his returns, as he was paying their fees.
. He had an outstanding reputation and held himself out to the community as a philanthropist.
People who do not know how to manage their own money are always suckers for these guys. Now they will turn on him like avenging angels. They will find that there is no money to recover and their legal and accounting fees are going to go through the roof.
A receiver will be appointed. He will spend years and soak up millions in his investigation. Any investors who withdrew money will be forced to pay it back as they will be named as "profiteers". Charities who received distributions will have to pay it back. "Advisors" who earned fees on the false profits will be sued by their clients to return their fees.
It will go on and on and on for many years. The Maricopa fraud was disclosed in March 2000. The perpetrator (David Mobley) has been in federal prison since 2001. I received a final distribution from the receiver this past October. Fortunately, we recovered 45% of our capital, since there were assets to find and the investors who had gotten earlier distributions were forced to return them. Many of them had to declare bankruptcy.
As long as there is greed, people are easily deceived.
But none of them went to jail.
On Dec 12 10:24 AM SteveTN wrote:
> "....But I didn't have a problem with an old jewish guy making markets.
> This is what we DO."
>
> I can assure you that if Madoff was a Christian his religion would
> not have been brought up.
The author goes off the rails at the end when he denigrates Laffer. Laffer's theory has not been disproved, but it is often distorted into a straw man and that straw man theory is disproved.
Laffer did not say that cutting tax rates would increase tax revenue above what would have been collected at a higher tax rate. Rather, he suggested that the tax revenue would not decrease proportionally to the decrease in rates. That this is true is demonstrable. Conversely, raising tax rates does not increase tax revenues in proportion to the rate increase.
The difference, of course, is attributable to the incentive to work more productively when one's work effort is taxed less.
The cheap shots in this article contribute to its overall snarky tone, one presumably meant to enhance the perception of the author's wisdom or prescience. Instead, they are a distraction from an otherwise interesting and evocative analysis.
FGG's Due Diligence Process
FGG's due diligence process is deeper and broader than a typical Fund of Funds, resembling that of an asset management company acquiring another asset manager, rather than a passive investor entering a disposable investment.
A number of areas of inquiry are examined by a team of FGG professionals who specialize in evaluating respective areas of risk. Typically, a manager has been investigated and monitored for six to 12 months before that firm can be accepted onto the FGG platform. Long negotiating periods enable FGG to be more confident of its decisions before proceeding with a manager. Areas of examination are centered around the following:
1. Portfolio Evaluation, Investment Performance, and Financial Risks:
A core area for further analysis is to attempt to dissect and further understand investment performance, how a manager generates alpha, and what risks are taken in doing so. As portfolio management and risk management incorporate elements of both art and science, FGG applies both qualitative and quantitative measures. FGG:
Examines independent prime broker trading records
Conducts detailed interviews to better understand the manager's methodology for forming a market view, and for selecting and exiting core positions
Analyses trading records
Conducts a number of qualitative and quantitative tests to determine adherence to risk limits over time
Confirms portfolio loss risk controls, diversification and other risk-related control policies, as well as any experience regarding unexpected or extreme market events
Reviews the risk and return factors inherent in the strategy
Evaluates capacity issues, which may affect alpha, as well as expected opportunities going forward within each candidate's strategy
Analyses the various drivers underlying a particular portfolio's risk
Evaluates credit risk and market risk both at the instrument and portfolio level
Assesses the extent to which leverage is used by a manager, as well as how it is used, the funding sources, and the impact on the risk profile of the fund
Investigate whether or not private or special registration securities are held, and determine how the daily trading volume and inventory held compares to the float and/or daily trading volume for a given security
FGG also conducts many quantitative reviews of investment performance in light of:
Fees and fee structure
Historical draw-downs
Return volatility
Commissions earned
Performance return in calm versus volatile markets
Current/historical correlation of the fund under consideration with standard industry benchmarks, peer groups, and other FGG or competitor funds used as benchmarks
FGG attempts to understand the return attribution for individual securities in the portfolio, and conducts a full suite of VaR analyses and stress tests to model the loss distribution function under extreme market scenarios. Leverage, concentration limits, and long/short exposures are examined over time to assess whether they have remained within operating guidelines.
Style fidelity is another key area of inquiry; the manager's trading pattern over time and through various market environments, FGG determines whether the manager is prone to trade outside of their area of expertise.
2. Personal Background Investigation:
FGG examines the abilities and personalities of the individuals involved in managing the fund through extensive interviews, as well as background investigations.
FGG verifies:
Education
Personal credit standing
Litigation and regulatory background
Track record
Other indicators
FGG explores the manager's experience and qualifications relative to the strategy being managed. Prior professional associations of a manager's key personnel can be crucial in understanding a person's experience and character and how they run their investment management business.
3. Structural and Operational Risk:
"Operational risk" refers to the risk of loss resulting from inadequate or failed internal processes, human resources, or systems, or from external events. Operational failures, including misrepresentation of valuations and outright fraud, constitute the vast majority of instances where massive investor losses occur. Other operational risks include staff processing errors, technology failure, and poor data.
Pricing models, as well as the adequacy, independence, and transparency of valuation procedures, contingency plans, and other trading and settlement procedures are all matters for close scrutiny by FGG professionals.
FGG seeks a sound understanding of whether a hedge fund possesses key controls in the areas of portfolio management, conflicts of interest, segregation of duties, and compliance. FGG carefully assesses the controls and procedures that managers have in place and seek to determine actual compliance with those procedures, often suggesting modifications, separations of responsibilities, and remedial staff additions.
4. Legal, Compliance, and Regulatory Risk:
FGG's legal, compliance, and accounting teams specialize in investment management regulation, securities compliance, corporate operations, and tax issues. Hedge fund managers function within an ever more complex legal and regulatory landscape, and the role of this part of the diligence exam is to determine the seriousness of any deficiencies in this area which may cause risk of sanction, loss, or reputational embarrassment.
Both in-house and retained legal professionals interview the management and staff of the manager, research regulatory filings, and review corporate organizational documents, as well as fund memoranda and related material contracts.
The problem with communism is communism. The problem with capitalism is capitalists.
It makes Bernie's criminal enterprise look like a joke. He should know. He was in the stock market being NASDAQ's chairman long enough to see what the punters and financial institutions were up to. It isn't pretty as we are finding out. FYI, how can the overseas semi stocks shoew a 80% drop off and existing customers still say business is slow but will recover. Hello. Your inventory has been cut to zero and you aren't ordering new stuff to sell. What are you doing telling your stock holders everything is even close to ok.
Wake up. The US disclosure of assets is all a very big deception. Every Euopean and Asian country has better disclosure than the US these days. And I can tell you, their disclosures are not very good.
Good luck to all the bulls. I hope the new administration goes alonmg with the monkey sees no wevil and hears no evil like the last 8 years has yielded. For America's sake, I hope not even if it tanks the market.
If someone gave him money 15 years ago and got 9% returns, is that so bad? Better than someone who gave him money last year for sure.
It will be interesting to see the final accounting in all this. Our system needs to be set up to maximize recovery in these kinds of situations- anything this guy owns should be all in.
Nobody, I mean NOBODY, cares about your money more than you. Get educated and handle it yourself. It is not nearly as hard as the "so-called" financial experts say.
The condition set up by Bush and the Republicans in Congress over the last years have brought us to this. They who preached the wonders of Capitalism without regulations and oversight have brought us to this state of affairs.
Does it work only for hedgefunds?
Can we oust Cox now and let him get on with his pending hedgefund position?
Give him a 'great job, Brownie' sendoff and ship him to the gulag.
"You can't cheat an honest man" W.C. Fields
On Dec 13 12:32 PM notsosmart wrote:
> the greed of the wealthy(lazy) who gave him the money are just as
> much to blame. how much do you need?
The answer is YES!
Let us look at Bernie Madoff affair as it was told to us:
- Madoff alone, without anybody help and assistance, was running for 25 years plus a multi-billion dollar hedge fund that
- Had ~$50B (give or take a few) in assets
- Had at least 25 large clients
- Had to
-- Find new clients, promote and market his fund
-- Support financial, investment and administration and other array of business operations
-- Issue to its clients and IRS a mountain of financial statements and reports
-- Two of his sons as his Executive VPs
- And on and on and on and on
And
- NOBODY KNEW NOTHING
- His own family turned him to FBI finding that he was a crook.
What a story? It is just an incredible miracle!!!!! But is it?
People who believe in this story deserve their miserable destiny. It is that simple! It tells volumes about American people and the society as a whole.
PS
One more "fair story". About Detroit. Nobody in the entire world knew until Nov. 2008 that Detroit automakers are losing tons of money and running out of cash before the year-end.
The funny story is that NOBODY at the Wall-Street was arrested yet for ruining the US and world economy and robbing American people on a tune of tens of trillions dollars...WOW!
On Dec 12 09:07 AM Herbert Hoover wrote:
> This will kill any chance of drawing back retail investors to Wall
> Street. Say goodbye to any chance the Dow hits 10000 in my lifetime
> again
The system is completely broken – regulators, auditors, investment banks – all of them are incompetent and corrupt. I will not be surprised there would (should) be major run on hedge funds as a result of this scandal. Complete confidence is shaken in the system. With all the uncertainty and losses, now a major fraud, as an investor I would just flee this market.
Market is banking on Obama-Pelosi stimuluses, GM bailouts and is going up. None of these things are going to work – US is bankrupt – too much debt, corrupt politicians; consumer confidence is shaken, next month’s job losses could approach a million.
Get out stay out of this market, Wall Street is just a Den of Thieves, a giant Ponzi scheme.
"What the f*ck f*ck f*cking f*ck could he be doing"
Vocabulary a bit limited, don't you think? Maybe it needs just one more "f*ck" to really make your point.
On Dec 12 11:08 AM hoover wrote:
> While Reagan didn't start out advocating bubble economics, his philosophy
> of anti-regulation and free markets without oversight were begun
> and slowly took effect over the next twenty five years. Laffer,
> who had been consider a joke before the far right annointed him as
> the savior of the wealthy, became the spokesman for economic philosphy.
> Supply side economics worked for a while, until the demand side was
> decimated. Now we have conditions somewhat like we had before the
> 30's depression -- lots of supply (from all over the world) but not
> enough people with adequate credit or cash to buy the stuff.
>
> On Dec 12 09:43 AM Augustus wrote:
When govmnt and corporations do when they issue bonds is fairly well documented and understood, so let's not try to equate this to what Madoff was doing because this gives him credibility that he doesn't deserve. This saying "everything is crooked" somehow makes what he did less of a crime. I hope the jury isn't going to buy that crap.
Rather than using the derivatives and all that complicated stuff, he had been using a simple ponzi scheme, taking from one guy and giving it to the next guy... LOL.
This guy shoiuld resign today before his failure to do his job causes more investor losses. Paul Voclker has been mentioned as a possible candidate for several high level positions. How about Vo;lcker for SEC CHairman, it would certainly help to restore the agency's serverely damaged reputation.