Page 1 of 2 Madoff and the folly of blind faith
By Julian Delasantellis
My wife was born and raised in one of those old, insular industrial towns of
the US northeast, one of those places that headed off down the road to
extinction following the 1973 oil embargo. Growing up among Irish-Americans,
Polish-Americans, Italian-Americans, Portuguese-Americans and others, there was
a remarkably high degree of respect for all manners and forms of diversity, all
the various rainbow colors of race, creed and faith - as long as that creed was
Roman Catholic.
My wife's family had her totally onboard with the program, from
baptism through confirmation to high-school graduation from St Patrick's. She's
told me that following graduation she had no knowledge of such historical
personages as Cicero, Tom Paine or Archduke Franz Ferdinand, but she was
absolutely, positively sure that Martin Luther was still down there roasting
away in the hottest circle of hell.
When the sexual abuse by Roman Catholic priests scandal germinated in Boston in
2002 and then metastasized across North America, I asked her if she was
surprised by the revelations of perfidious ecclesiastical pederasty. "Not
really," she told me.
She said that it was pretty common knowledge among the kids at school that some
of the private "spiritual instruction" conferences with a few specific priests
in the parish involved some pretty strange doings. When I asked her if the kids
protested or complained to their parents, she said that was unthinkable.
To begin with, the kids had been kept so in the dark on matters of human
sexuality that they had no real way to determine what was aberrant or not. The
perpetrators frequently swore their victims to secrecy, and with the kids being
told over and over again that the priests were Jesus' eyes and ears on Earth,
these were no easy oaths to break. Besides, even if the kids had told their
parents, it would not have made much of a difference. They never would have
been believed.
The institutions of the Roman Catholic faith, and the clerics who were its
avatars, were marbled into the community like fat on a prime rib, present and
officiating at the birth, death and all the other life-passage events in
between of almost everyone in town. In much the same way that the French
philosopher Michel Foucault, in his 1975 book Discipline and Punish,
argued that modern societies exercise power not through gendarmes and bayonets,
but by having each citizen under power's control internalize his submission
within himself, by accepting the role, rule and legitimacy of the church over
them, the parents unwittingly acquiesced and enabled the violation of their
children.
Now, the God is money, its governing credenda is Alpha, finance-speak for above
market-average investment returns, and Bernard Madoff was one of the faith's
high priests. When you ask how the people who have lost millions, or billions,
could have been so foolish, think of the betrayed parents. Even if they had
doubts, how could they reject the faith, in Madoff's case, a faith that was
delivering to them, in both good markets and bad, a supposedly safe, steady and
secure 10% gain a year?
In the 1997 movie The Devil's Advocate, high-powered lawyer John Milton
(played by Al Pacino, portraying, well, you can guess who he's supposed to be
with a name like "John Milton") describes any current scandal de jour in
the media-sodden Big Apple as a "Class A New York style pig f**k."
If that's the case, passion's squeals and oinks were particularly loud in
Manhattan last week. Starting with lurid coverage in both of New York's major
tabloid newspapers, from Rupert Murdoch's New York Post (which on one cover
called Madoff "The Most Hated Man in New York") to the New York Daily News of
Mortimer Zuckerman (whose charitable trust is reportedly out US$30 million in
this) , to only slightly less gaudy, but equally breathless ink in The Wall
Street Journal and New York Times, to a media scrum following a Madoff bail
hearing last week that made an English soccer riot look like a debutante
cotillion, New Yorkers and the worldwide finance community are alike obsessed
with the story of Bernie Madoff, the man who ruled the world, the man who had
it all, if not for the fact that, in reality, he had just about nothing.
On Thursday, December 11, agents of the Federal Bureau of Investigation (FBI)
and the US Attorney's office for Southern Manhattan arrived at the Park Avenue
apartment of Bernard L Madoff, former chairman of the NASDAQ stock exchange,
and founder and principal of Bernard L Madoff Investment Securities LLC,
arresting him on charges of securities fraud. An FBI agent on the raid,
Theodore Cacioppi, described his fateful encounter with Madoff in an affidavit
filed with the Federal Court.
I spoke to BERNARD L MADOFF, the
defendant. After identifying myself, MADOFF invited me, and the FBI agent who
accompanied me, into his apartment. He acknowledged knowing why we were there.
After I stated, "We're here to find out if there's an innocent explanation,"
MADOFF stated, "There is no innocent explanation." MADOFF stated, in substance,
that he had personally traded and lost money for institutional clients, and
that it was all his fault. MADOFF further stated, in substance, that he "paid
investors with money that wasn't there". MADOFF also said that he was "broke"
and "insolvent" and that he had decided that "it could not go on", and that he
expected to go to jail.
In the charging document filed by the
US Attorney's office, more details are revealed.
On December 10, 2008, MADOFF informed the Senior Employees, in
substance, that his investment advisory business was a fraud. MADOFF stated
that he was "finished", that he had "absolutely nothing", that "it's all just
one big lie", and that it was "basically, a giant Ponzi scheme". MADOFF stated
that the business was insolvent, and that it had been for years. MADOFF also
stated that he estimated the losses from this fraud to be at least
approximately $50 billion.
Press coverage of the Madoff
scandal has focused on two factors, one of which is the prominence of many of
those allegedly defrauded in the worlds of society, the media and charity. My
colleague Spengler noted last week (see
The devil and Bernard Madoff, Asia Times Online, December 19, 2008),
the fecklessness of those, such as Dreamworks Studios co-founders Steven
Spielberg and Jeffrey Katzenberg, in falling victim to the scheme, but in a
list of over 80 purported victims published in The New York Times, a list The
Times promises will be "updated regularly as more clients are identified in the
case", one is struck by how many of the victims were not elderly Palm Beach
society doyennes or ditzy film stars, but some of the great houses of finance,
which presumably should have known much better.
From Ascot Partners, a hedge fund run by General Motors Acceptance Corp
chairman Ezra Merkin, to Sumitomo Life Insurance of Japan and the Union
Bancaire Privee of Switzerland, the list is filled with those who will never be
believed should they try to defend their actions to their principals by
claiming that they were just innocent rural rubes who had the wool pulled over
their eyes by shifty dealing city slickers.
Press reports have it that among the victims left destitute by these events is
Alexandra Penny, author of 1981's How to Make Love to a Man sex manual.
Hope she still remembers.
The other main focus of the press coverage has been the sheer enormity of this
crime; from the US Attorney's office complaint comes the $50 billion (at least,
according to the complaint) total amount of the fraud here. Not only is this
the greatest Ponzi scheme ever; it will likely go down as the greatest single
financial fraud of all time - the subprime scandal may eventually tip the
scales at around three or four trillion dollars, but that required a whole
worldwide industry of crooked bankers, realtors, securitizers, rating agencies
and appraisers to pull it off.
For a definition as to what a Ponzi, sometimes known as a pyramid, scheme,
actually is, I could do a lot worse than rely on what was reported by FBI agent
Cacioppi, in that Madoff told him that he "paid investors with money that
wasn't there".
What a great job it is to be a money manager - having people give you money all
day long. The fly in the ointment comes when the people want the money back,
preferably along with the added extra percentages of gain you promised you
would earn for them through the application of your purported investment
prowess.
Charles Ponzi, who emigrated from Italy to Boston in 1903, found a way to solve
this problem. In 1918, he set up an investment scheme involving the purchase
and sale of postal International Reply Coupons, in essence, stamps. Since Ponzi
promised his investors a 50% return in 45 days, his offering was wildly
popular. People re-mortgaged their homes and dedicated their life savings to
his scheme; then, after 45 days, they doubled up and did it again and again.
Of course, there was never any great riches to be had in International Reply
Coupons. Ponzi's returns, much like Madoff's, were all fictional. His claim
that he was making fabulous returns kept people from pulling their money out,
and if someone did, to deal with a death in the family or family emergency,
there was always enough new money coming in to deal with what little was going
out. At his high point, Ponzi was taking in $250,000 (and that's 1920 dollars)
a day, but a series of investigative articles in the Boston Post toppled the
pyramid. Ponzi did 12 years in jail, was deported and died in poverty in Italy.
So how did Bernie Madoff do it? What were his postal coupons?
Every month, clients of BMIS, much like clients of most brokerage houses,
received in the mail statements detailing the stock trades done in the funds
that they had interests in. However, along with the standard faire, like "BUY
100 shares GOOG", or "SELL 1,000 shares GM", clients noted a large number of
option trades, frequently in options of the stocks BMIS was trading and owned.
I sometimes tell people who want investment advice that there are two things
they should do - one easy, one hard. The easy thing is to buy a really good
book on stock option trading. The hard thing is to read and understand it.
Options books are heavy on jargon and math, light on easy-to-understand
language. Although you can get any number of software programs and spreadsheet
plug-ins to do the math for you once you understand the concepts, first you
have to understand the concepts.
Options are particularly powerful when used either in combination with other
options, or in combinations with other options and positions, whether long or
short, in the underlying stock that the option is based on. With proper
utilization of an option-based strategy, an investor can finely hone his
portfolio as to how much risk he desires to carry in order to earn a specific
return; if he wishes, a $1 rise or fall in the underlying stock can be turned
into a profit of from 10 cents to $1,000. The number of possible option
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