Lesson Learned from Madoff's Ponzi Scheme 13 comments
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As more and more news comes out about Bernie Madoff and how he managed to defraud many very smart people out of billions of dollars, it is useful to ask a simple question; what should we learn from what happened? From my perch the answer is very basic.
The few people who avoided Madoff’s funds did so due to doubts over the highly suspicious consistent returns he claimed (many concluded he could not produce such steady profits from the strategies he claimed to be using). They avoided disaster because they lacked information and without knowledge of what their money was invested in, they were not comfortable investing with Madoff.
The others were not as fortunate, but it begs the question, does it make sense for anyone to invest money with a money manager if they are forbidden from knowing where the money is invested? I don’t think so. I know I certainly could never look one of my clients in the eye and ask them to stop receiving account statements so their holdings could be secret. Trusting someone, as Madoff’s investors have learned the hard way, is not a good enough reason to put a blindfold on and hand someone millions of dollars.
Now, many hedge funds will argue that disclosing their holdings strips them of their “edge” since many people will simply mimic top managers’ trades and thereby reduce returns for the people coming up with the ideas. To curb this concern it is certainly reasonable to allow a slight delay in the reporting of actual holdings to ensure that a hedge fund manager can establish a full position before disclosing it to the public. You could also have investors sign a contract saying they will not act on or alert anyone to the nature of the fund’s investments.
Regardless, if you are investing in any fund that does not adequately disclose where your money is allocated, I would strongly consider ceasing such an investment. It sounds obvious to many, but given what has transpired recently, it warrants mention.
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This article has 13 comments:
On picky point: you've used 'beg the question' inappropriately, as do many others. You meant 'raise the question'. 'Beg the question' implies a circular argument within a statement, for example 'The bible is true, because god wrote the bible, and god would never lie'. This begs the question, 'how do you know that god would never lie?'. As you can see, your usage has nothing to do with a circular argument.
If they had a list of the specific securities he used, that probably would not have helped because he could have and probably did lie about it. If they had accurate information about where their money was, that might not have helped because the securities raters didn't do their job. Many of Madoffs clients used "Financial Advisors" of one kind or another, and they didn't do their job.
There is an opportunity here. PRIVATIZE THE SEC!
On Jan 01 12:52 PM toobad41 wrote:
> Nice review of this ponzi scheme. I still can't believe these people
> fell for the scam. To put all of ones money in one basket is a cardinal
> sin for investors. But if they were all crooks they deserve their
> losses.
I see this attitude everywhere even in the smallest things in my field: homeowners too lazy to investigate their project management company and board of directors even when both reject yearly outside audits of financial statements that have run amok. They still think these people are trying to do what is right! What more do you need to know in this case to figure that something is terribly wrong and people are being cheated? Clues are hard to get when you don't care enough to look for them.
Personal apathy and greed took over at the start of the Reagan era and allowed the Madoff's of the world to make a killing until our artificially propped up economy failed and thereby pulled the curtain up on what they were doing. As a result, blind faith and trust in everyone will now take a hard step back to where it should have always been all along. Yes, we are friendly Americans, but that doesn't mean we also must be as stupid as rocks.
"I trust everyone, but show me your cards."
As the UK TV series “Hustle” points out, “you cannot con an honest man”. Gamblers need to believe in a system that can beat the odds, and people wanted to believe Madoff was doing something slightly extraordinary to explain his exceptional returns. As long as they were beneficiaries, his investors preferred not to ask hard questions.
Madoff is surely only very small fry, just a cheap crook “caught swimming naked as the tide goes out”, as Warren Buffett puts it so delightfully. I can’t see why so many commentators treat him with a sort of grudging respect. The scale of deliberate deception is much greater than this and our culpability, or lack of “collective mindfulness”, is far more profound.
For instance, Fareed Zakaria’s GPS programme on CNN (December 28, 2008 - English slightly edited) hosted this frank discussion between pundits:
Hernando De Soto, President, Institute for Liberty and Democracy:
From a Third World point of view, the interesting thing is that, as trust breaks down in Western societies, like the United States, banks have stopped lending to each other because nobody really knows who owns what assets and what liabilities. You are starting to find out that the real economy has a lot more to do with trust than with the so-called fundamentals.
We have lost track. And we’ve lost track, because instead of having universal documentation as to who owns what — which is what international cooperation would give us — today, most of the paper in the world is untraceable.
Jagdish Bhagwati, Professor of Economics, Columbia University:
In each of these financial crises, the new instruments and changes have usually gone way beyond comprehension, and that is really at the heart of financial innovation.
Hernando De Soto:
It is about transparency.
Jagdish Bhagwati:
The downside is really important. When we say we must regulate, the regulators must first understand what has to be regulated.
Joseph Stiglitz, Nobel Prize-Winning Economist, Columbia University:
I think the point that Jagdish made is exactly right, that much of the innovation that we have had in the financial sector in the last two decades has been of negative value. It has been creating complexity. It is not a question of disclosure. You could disclose these documents, but nobody — the buyer, the seller, the regulators — can understand them. And it was done deliberately. It was done deliberately so people could not understand what was going on.
Hernando De Soto:
The reason you are in paralysis, the reason you are collapsing, is because you no longer know who’s got whose hand in whose pockets. You have to make a distinction. And remember that financing is there at the service of production, in combination, and is not center stage.
***
Sadly, because we did not challenge things we did not understand, we have become collectively liable for the consequences of the deception. We have failed in our responsibility to be truthful to ourselves and to demand the same standards of honesty in others.