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Madoff’s unusually toxic Ponzi scheme

June 29, 2009

Ponzi schemes are not always such a bad investment.

Typically they offer such high rates of return that at least a portion of investors end up winning. Tamar Frankel, a professor at the University of Boston, who has made a study of Ponzi schemes believes that it is not unusual for around a third of participants to come out ahead. The eponymous Charles Ponzi offered rates of about 10 percent a month at a time when banks were offering 5 percent a year. Mike Calozza’s scheme benefited about a quarter of those who invested.

Madoff’s scheme may have been more pernicious than either. This is firstly because his rates of return – between 10-17 percent a year – were somewhat parsimonious by the standards of most confidence tricksters. Many investors were loyal enough to stay with Madoff long enough to recoup the equivalent of their principal – in many cases just six or seven years. Sadly, due to the kind of investor that Madoff attracted, Frankel argues, many would plough returns right back into his funds rather than withdrawing them. Part of Madoff’s talent was to attract savers rather than speculators. Rates of return were attractive but not absurdly suspicious.

Investors who have managed to avoid loss may fall into one of two broad categories; those who cashed out when they sensed a problem and investors like pension funds who needed regular returns to pay obligations. This would include retirees who lived off the annual returns. (Of course, some of these winners may be forced to repay some of their gains during the bankruptcy process.)

The composition of Madoff’s investor base may mean there are fewer net beneficiaries than in past Ponzi schemes.

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  • About Christopher

    "I am a columnist at Thomson Reuters focusing on the energy industry and hedge funds. Prior to this I worked at Bloomberg and the Financial Times."
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