“The trouble with socialism is socialism. The trouble with capitalism is capitalists.” Willi Schlamm, former Austrian communist
Ponzi schemes are fascinating. Why would anyone do one unless they have a plane to Rio waiting on the runway? They know that they have to get off the train at some point and then it’s all over.
Why did Bernie Madoff do it?
$50 billion is real money. Aside from the question of what he did with the money, why did he think he’d get away with it and why did it last so long?
Most Ponzi schemes appeal to investors’ greed by claiming 20% returns or more. Money flows in. And it’s great until it falls apart. Once the dust settles the receivers take over and all the investors are screwed–even those that got their money out (they are subject to reach-backs, depending on the time passed and relationship).
Bernie really didn’t appeal to people’s outrageous greed as in most Ponzi schemes. He claimed he annually churned out a 10.5% return since he started in 1990. While there was some skepticism of the claim, money poured into the fund. He had about $17 billion under management. Now, this kind of return is not unusual in the markets as we all know, but its consistency was the key. Most funds have some really good years, followed by bad years, and it all averages out to a 10%–11% annual return. His investors suspended disbelief.
Here the returns appeared to be safe, steady, and well, Bernie was a pillar of the financial community. He cloaked his fraud with an aura of respectability. Even his institutional investors dropped the ball. As professionals they have no excuse for their losses.
It takes a lot of chutzpah to pull one of these things off. All those questions about: How to they sleep at night? Don’t they have a conscience? What is the nature of the human ego? How could people fall for it? How would I have pulled it off? Aren’t these things regulated? What about the audits? Why didn’t investors check a bit more? You know, all the usual stuff.
I have a theory why they are occurring more frequently: In the age of financial and economic lies that we live in, people are looking for an easy path to wealth. They see more and more credit bubbles brought to us by the Fed. Every time one of these occurs people see “other people” making lots and lots of money (tech stocks, houses, etc.). People feel they’ve lost out. When the next cycle starts they feel they’re not going to miss this time.
The elements of this phenomenon are:
- The belief that you are entitled to make much better than average returns without any effort;
- The thought that everyone’s making a lot of money and you should get your share;
- A referral from a friend or someone you respect which excuses you from research and due diligence investigation;
- The popular myth that money is made by a small group of people “in the know;”
- A vast unappreciation of risk;
- The belief that the government won’t let these things happen;
- And the belief that someone will bail you out.
I’m not suggesting that greed is a new human trait. But if you check out Wikipedia on the subject, these schemes seem to be occurring more frequently and on a larger scale. And it doesn’t seem to have anything to do with whether or not you are a savvy investor. According to the report in the Wall Street Journal, Bernie managed money for “high-net-worth individuals, hedge funds and other institutions.”
I firmly believe in personal responsibility for one’s actions. This should not excuse people for not being more careful. But I believe our educators, and political and economic leaders have created an economic environment based on fairy tales. They have wrapped up Keynesian and socialist ideas into a package they have sold to us. People believe that government will solve our problems and that by pulling a few monetary levers and passing a few more laws that things will be fine. Welcome to Bernie’s world.
