Madoff Hedge Fund = $50 Billion Ponzi Scheme

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Ah, hedge funds, so sexy with their “rich people only” requirements and secretive investments. I have been catching up on a bunch of news articles about Bernard Madoff, who was recently arrested after admitting that his hedge fund was “all just one big lie” and a “giant Ponzi scheme”, estimated that his investors will lose about $50 billion. If true, this represents the one of the largest cases of investor fraud and definitely largest Ponzi schemes in history. The SEC said it appeared that virtually all of the assets of his hedge fund business were missing. Oops.

According to this NY Times article, lucky investors included J. Ezra Merkin, the chairman of GMAC; Fred Wilpon, the principal owner of the New York Mets; and Norman Braman, who owned the Philadelphia Eagles. Unfortunately, there was also substantial money from several charities and endowments. Finally, throw in a few other hedge funds which did zero original thinking and instead simply invested their money in Madoff’s hedge fund as well.

Mr. Merkin, a prominent philanthropist and the founder of several hedge funds, including one called Ascot Partners, jolted his clients on Thursday with a letter announcing that “substantially all” of that fund’s $1.8 billion in assets were invested with Mr. Madoff.

“These investors were never aware that all of their money was invested with Madoff,” Mr. Susman said. “They are obviously shocked.”

Surprise! I also love the marketing techniques:

Mr. Madoff emphasized secrecy, lending his investment accounts a mysterious allure and sense of exclusivity. The initial marketing often was in the hands of what one source described as “a macher” (the Yiddish term for a big shot). At the country club or another exclusive rendezvous, the macher would brag, “I’ve got my money invested with Madoff and he’s doing really well.” When his listener expressed interest, the macher would reply, “You can’t get in unless you’re invited…but I can probably get you in.” [WSJ]

Sometimes it seems that human nature just dooms us to want to believe in impossibly easy money. If you aren’t familiar, check out this previous post on 12DailyPro (another Ponzi which suckered in a much less wealthy crowd) and a book about life of the original 1920s Charles Ponzi.

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  1. Yeah, you hear these things all over the world. Look at what happened recently in Colombia. There were also a big number of these schemes in the eastern block right after 1990’s.

    I, for one, would support more regulation and transparency on hedge funds.

  2. What about Rennaisance Technologies, the fund owned by multi-billionaire James Simons? Here is another ultra-secretive company, whose flagship product, the Medallion fund has been offering outsized returns, year after year.

    They claim they have developed mathematical forumlas and algorithms that allow them to obtain postive returns irrespective of market conditions. But they don’t offer any clues as to what these techniques are based on. And we are all expected to just believe it.

  3. Over the Cubicle Wall says

    The lure of easy money strikes again. Sad.

  4. Technically, this was not a hedge fund.

  5. I like that at one point he told Barron’s this regarding how they invest their funds:

    “It’s a proprietary strategy. I can’t go into it in great detail.”

    What a joke.

  6. There were plenty of warnings signs in this situation, but you seem to be a little smug. Is there something inherently wrong with being wealthy and being able to invest one’s money? Isn’t your goal — and one of the reasons for this blog — to increase your wealth?

    “Unfortunately, there was also substantial money from several charities and endowments. Finally, throw in a few other hedge funds which did zero original thinking and instead simply invested their money in Madoff’s hedge fund as well.” So it’s only unfortunate that charities and endowments were hurt but those who pay taxes have no one but themselves to blame? What’s the difference between the two? They were all to blame or none were to blame. Charities and endowments don’t get a free pass in the thinking department.

    Again, it’s certainly a big hit to a lot of people and they all probably should have seen it coming, but (a) I don’t understand why you seem to have a feeling of shadenfreude, and (b) I don’t understand why there’s a double standard.

  7. Unbelievable. At least his rich clients have the money to lose.

  8. Curt, not really. The affluent clients also have a much more expensive lifestyle. Many of these clients have second homes in the hamptons, for which they have monthly utility bills to pay for. Add that to their golf club membership fees, and you quickly realize how high their monthly expenses are. With much less funds to withdraw from, you can imagine that his clients are devastated by this. His scam has affected everyone, including the rich.

  9. David Nofsinger says

    Did any of these people even look at a prospectus before they invested? It seems that they were more interested in buying something exclusive than making an actual financial decision.

  10. Interestingly I read the same article over the weekend. It also said that a lot of people understand that he was doing some kind of illegal activity but most believed he was profiting from insider trading. As a result, they decided to invest in him because of his previous ties with the Nasdaq exchange

  11. I think we will start seeing an end to all this hedge funds, most of them are closing down and we start seeing more fold as the year progresses. Nothing that is too secretive usually survives.

  12. I agree with Brent. Rich or poor, charity or not, nobody deserves to be robbed and cheated. They are all victims of an evil (alleged) perpetrator.

  13. No, charities don’t get a pass in the thinking department. But, my point was in the other cases, the people who invested in the fund were “accredited investors” by the SEC who invested in a risky, non-transparent, minimally-regulated investment got hurt. Defrauded, yes, but as I see it the results where not much worse than those who invested in Bear Stearns subprime-mortgage-laced hedge funds or the Long-Term Capital Management blow-up and also lost their money.

    In the case of a charity, those that had no say in the decision, who would have gotten assistance will no longer get that help. It’s charity administrators who made that decision. Same thing for potential scholarship recipients from endowments.

  14. My dearly departed mother who worked in a factory all her life and was lucky to have $20 to make it two weeks to payday always said, “If it is too good to be true, it is!”

    So I have ZERO sympathy for any person, organization and (yes) even charity that invested with this guy. They were greedy and this is a result of their greed — so enjoy it. Maybe it’s a HARD lesson they will never forget.

    Now maybe a few of them will know what its like to worry about getting your electricity turned off because you have to decide whether your have lights or food for the week. I doubt it, but one can only hope.

  15. One of the things that disturbs me about this story was that his family turned him in when he ‘fessed up to them. It seems like it should have been possible for the SEC or SOME kind of regulatory body to pick up on his extraordinarily non-volatile returns or his opaque prospectus or his Z-grade auditor. If they didn’t, what’s wrong with the way we regulate hedge funds and how can we fix it? I mean, this was going on for a really long time.

    Also anyone out there seen “Boiler Room”? Super movie, and they used a lot of the same techniques to reel in investors.

  16. This is to Robert Stinnet. My father had money with Madoff. My father did not graduate high school and worked his ass off to earn his money which he invested to take care of his kids. He lugged pipe in and out of asbestos filled basements to EARN his money. He did not deserve this. You need to learn a lesson that just because you have money, it doesn’t make you a greedy bad person. Maybe if you worked a little harder you would have a little more money and not feel the need to make crass comments about other people that you know nothing about. This is the true American dream to work and go from rags to riches. Did you ever stop to think that some of these people do know what it’s like to worry about having their electricity turned off, but overcame the odds and made something of themselves. You should be ashamed of yourself. Maybe one day you’ll get what you deserve.

  17. Aussie Observer says

    “Technically, this was not a hedge fund.”

    I agree. In Australia we’d define it more accurately as “outright theft”.

    But what puzzles me as an outsider is (1) why do these things ALWAYS seem to emanate from America, and (2) what does this kind of rampant greed and dishonesty say about the American psyche in general?

    You people have brought the entire world’s economy to the brink of collapse. It started of course with the US financial sector signing people up to housing loans knowing full well that their clients had no chance of meeting the repayments, and caring nothing that entire families would probably end up sleeping on park benches. The only thing that DID matter at the time was the bottom line, and extra bonuses paid to CEO’s on higher base salaries than your president.

    Like a robot, I reckon Madoff was probably only acting out what your avaricious system programmed him to do — make as much money as you can today (even if it’s more than you could possibly spend in your lifetime if you tried), and worry about tomorrow when that day comes. Oh, and take no prisoners on the way to your goal. If a few bottom-feeders in the food chain are chewed up and spat out on the way up: TOUGH!

    Time for another bailout, courtesy of the idiot US taxpayer? After all, what’s a mere $50,000,000,000 added to the existing bill for mismanagement, greed and stupidity…

  18. All gloating, recriminations and gnashing-of-teeth aside, here again we see the results of an unregulated industry. Put a cop back on the beat or the thugs in pinstripe suits will mug any passerby, rich and poor alike.

  19. @ Robert & Tina

    This has nothing to do with how someone earned their money (or how hard their life may have been) and everything to do with how someone invests their money. This is a simple case of Risk/Reward. Even if you ignore all of the warning signs of this particular case (and their were plenty) there is always a great risk when their is great potential reward. THERE IS ABSOLUTELY NO SAFE INVESTMENT THAT GUARANTEES 10-12% GAIN! If you have an investment that is making those kind of gains, you must realize that you could lose your money at any one time. The greater the potential reward, the greater the risk.

  20. goedkoop geld lenen says

    I wonder why people do such things. And what is going to be his punishment?

  21. Madoff is just the tip of the iceberg. If the truth be told the financial markets are riddled with this type of crime. Coupled with the fact that the financial markets have been turned into a giant casino and you can easily guess what’s going to happen next. Dominos.

  22. This is just insane. So many institutions and individuals were taken for a ride. This guy must have been slick. But he’s going to hell…that’s for sure.

  23. Roddenberry says

    Financial capitalism is an huge ponzi scheme

  24. Retired at 40 says

    My favorite Ponzi scheme is the United States of America. Luckily, we still have buyers.

  25. It amazes me that it went on for so long. There must be deeper connections into government over the whole thing. It is sick that all these people are going to get hurt because of it and you know that they’re going to go to the government with their hands out just like the auto makers, banks, and mortgage companies. Of course the upside of all this is it should send gold and silver higher.

  26. To Aussie Observer:

    I’ll take on your questions:

    “(1) why do these things ALWAYS seem to emanate from America”

    The simple answer is, “They don’t”. But when they do it is because we live in a free society. Part of that freedom, unfortunately, means a man can act in violation of existing laws and victimize the willing and ignorant alike before he is caught and punished, which will surely happen in this case. Perhaps you would prefer a country with despotic leaders who offer protection to her citizenry by controlling every aspect of their lives to include where and with whom they may invest. I would not.

    “(2)what does this kind of rampant greed and dishonesty say about the American psyche in general”

    Not much. And in the grand scheme of things most of America, and the world for that matter, will be completely unaffected by this crime. But your question was rhetorical and really designed to be insulting.

    It’s evident from your comments you dislike America. Your type of invective is so commonplace now that other posters here have simply ignored it, at least as I write this. I probably should, too. But since you took the opportunity to use a post that really has nothing to do with the points stated in your comments for no other reason than to trash my country, I shall do the same (Sorry, Johnathan): This is the greatest country that has ever existed and I am humbled that I was fortunate enough to have been born here and proud that I will be buried in her soil when my life is through.

    You may consider me a “greedy”, “idiotic”, “stupid” “bottom-feeding” – and proud – “US Taxpayer”.

  27. $50 Billion? Please, this pales in comparison to social security, the greatest Ponzi scheme of them all.

  28. My gosh, people need to be careful about where they put their hard earned money. I read any prospectus I invest in. If something sounds too good to be true, I don’t invest! Like another poster said, there is no safe investment that guarantees 10-12% gains! All you have to do is look at the stock market over the last 40 years to see that. There were warning signs here. It is difficult for me to feel sorry for these people. I read about one woman who had to retire at around age 55 from her job as an office manager due to Parkinsons disease and even though she had saved 2 million dollars, she wanted more! So she invested with Madoff, increased her wealth to 3.8 million and then lost it all. I don’t feel sorry for her. I would have been able to make do VERY well with 2 million in retirement! I have one word for these people…GREED.

  29. I totally agree with you, Michelle, in regard to guaranteed investments of 10-12%. And greed! Is definitely a core problem.

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