– James Saft is a Reuters columnist. The opinions expressed are his own –
It was perhaps inevitable that we ended 2008, the year we learned we were up the creek, with a great financial scandal: the Madoff Ponzi case.
What is even more remarkable is the way in which the alleged fleecing of many billions of dollars from wealthy people and charities — investors who should have known better or employed people who did — serves as a mirror for the broader culture, showing how we went wrong and where we are left now that we realize our errors.
The main difference really is that Madoff’s purported victims, or enablers or co-fantasists, say they found out their wealth was illusory all of a sudden whereas for most people in the English-speaking world, this is happening little by little.
Bernard Madoff, for those of you just waking after a long winter’s nap, is accused of defrauding as much as $50 billion from investors in funds he promised would deliver a steady — suspiciously steady — 12 percent or so a year in good times or bad. But rather than a miraculous hedging strategy, authorities say Madoff has confessed to running a pretty simple Ponzi operation: paying out “earnings” to those who demanded them from new commitments of cash from those who wanted in. And of course, given that the man could “make” heady sums with no risk in all markets, the cash flowed in and the redemption calls were, for a long time, manageable.
Madoff has not appeared in court to formally answer the charges. But that there was one man, or a man with confederates perhaps, who was willing to engage in a harebrained fraud that was mathematically doomed to failure would not be that surprising, sadly. That an army of either rich sophisticated investors or their highly paid advisors played along and, seemingly, genuinely believed that they were growing rich is far more interesting.
One point, highlighted by Tim Lee of consultancy piEconomics in Stamford, Connecticut, is that the $50 billion headline figure is about as inflated as California real estate prices were a year ago. That $50 billion is likely to turn out to be not the amount lost but the amount people wrongly thought they had. It’s likely that the actual strategy followed by Madoff could return little more than Treasury notes minus fees; in other words he could make for you what you could get for yourself with no help but then pay himself handsomely for the gymnastics.
That implies that a lot — for long-time investors the vast majority — of their “money” invested and now “lost” with Madoff was about as notional as a credit default swap contract with a man you met outside the bus station downtown. Much of the money never existed, other than on the attractive and no-doubt glossy statements sent by Madoff. It was simply what people would have had if he’d been a genie.
EXTRAORDINARY POPULAR DELUSIONS
And it’s in this way that we are all Ponzi limited partners: we too thought our retirement funds and houses were growing miraculously, though ours was an illusion fueled by debt rather than fraud, and we too made plans based on those asset values that now stand in ruins.
“The financial system as a whole has had the characteristics of a Ponzi scheme if we look at it fundamentally,” said Lee, who was very early in warning about deflation.
“By this I mean that we should think about the true value of assets as being derived from the future flow of goods and services that the assets can lay claim to or produce. If market prices of financial and real estate assets rise a lot but there is no increase in the ability of the economy to provide goods and services in the future, then the apparent increase in wealth is illusory.”
That means that savings must rise and expectations about the kind of growth and income that capital can safely command must fall. The process of everyone figuring that out over the next year or so will be a continued hole in the side of the stock market and, despite the risks inherent in Treasuries due to quantitative easing and fiscal stimulus, a boon to holders of government debt.
There are a lot of individuals, pension funds and non-profits out there who have penciled in benchmarks for returns on assets that are probably too high for the coming cycle, irrespective of the losses of this year, and I am talking about people thinking of a modest 8 percent.
Those people and institutions will be forced to take steps to right that, and this time it won’t be by searching for risk or yield, it will be by saving more and cutting back on expenditure.
This will cascade through the economy and until the savings are replenished and productively deployed, higher government spending will be a balm on a burn at best.
– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on here. –
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Despite all the known things happened, the question here is where and how the money from many people to few people gone.
The biggest Ponzi Scheme operators were those people who borrowed money that they can never repay. They took the life savings of retirees and blew it on cars, homes, appliances, etc. As soon as they stopped paying their instalments the Ponzi collapsed
Maybe the current financial crisis heralds the arrival of an era when we can all judge our “neighbours” on the basis of appearances. Gone will be the days that your neighbour can create an artificial aura of wealth by living in an expensive house and drive a top of the range SUV all of which are financed by 100% debt.
Why don’t we just accept that so long as we keep money as a central organizing principle in our society, then why don’t we just legalize it all.
Ponzi Markets - Imagine it…
…The guy you gave your savings to could be in hand cuffs tomorrow! Unheard of wealth creation!
The best part is - if you ran the best Ponzi scheme (most money) then you could be Ponzi Market Director! Every Ponzi transaction would remit 5% of initial investment directly to you!
Act now, and talk your way to your first million…
…call me when you get a few billion, kid.
Dear James
What goes up must come down. Unless, of course, we are outside the earth orbit! In which case we could be floating to anywhere.
A house is not a home. I do not understand why people need to over-eat, over-consume on future income without any saving for the rainy days.
The business model of pursuing growth for growth sake is broken. We need to have sustainable growth and responsible consumption. It will not come naturally as we are brought up to expect ‘growth is a good thing’ and to consume is divine!
Growth in our investment return, growth in our bonuses for a ‘growth performance’ in revene/profit/whatever, drives our behaviors. Sometimes, as in this current financial tsunami brought on after the credit meltdown initially from subprime detbs, our behaviors are reckless and irresponsble due to greed!
Many of the ‘culprits’ are very educated, very articulate, and very smart. Unfortunately, none or most do not have basic integrity. Integrity to admit that they are perpetuating a lie, that property prices can only go up and up and defy gravitational pull, that steady return in the teen is NORMAL, that there is no need to save for rainy days as INFLATION (especially the housing market) will make saving a fairly unsophisticaed and stupid thing to do!, etc…
The USA consumers buy on credit and on future income. The world produces to meet these big spenders. Now, the world smartest bankers, financers,etc are asking the people of China and India to develop the over-eating and over-consuming habits and behaviors of the USA consumers so that the WORLD can spend itself out of recession! How ironical can it be!
I do not have the answer for a ‘responsible sustainable consumption and production’ model, maybe the smartest economists, bankers, regulators, governments, etc can come up with one.
All I do know is that it will get much uglier before we can have ‘normal’ growth with ‘normal’ expectation in quality of living, and work and life.
Best regards
LU Keehong Mr.
From the horse’s mouth, to wit:
http://www.ssa.gov/pubs/10055.html#curre nt
“The trust funds will be exhausted in 2041. At that time, Social Security will not be able to meet all of its benefit obligations if no changes are made.”
Like Paul Rosa said, a “fraud”, is not really a fraud, if it has the ability to go on indefinitely.
If somehow, Bernard Madoff, could keep generating the cash to pay back his investors, using whatever method he could, no one would have found out it was a Ponzi scam. However, he does not control the entire economy, thus sooner or later, he would lack the funds to pay up; that’s the only reason why he was busted in the end.
At present, the government is able to fund its social programs without much trouble, and is likely to be able to do so for a long time to come. If anything happens to those funds, at the very most, we would receive slightly less benefits from those programs instead of getting zero returns in an instant, unlike the victims of the Madoff scandal.
To claim that social security is a “Ponzi scheme” is an expression of “simpliciter” If you extended that reasoning, than all government, at every level, from the federal to the town hall, is a fraud. You could just as easily say that all tax colection and expenditure is a “ponzi scheme”. That is nonsense.
Doesn’t the Social Security trust fund have assets in the form of IOUs from the treasury? Of course they lend the fund. What else can an agency do with billions of dollars? Keep it in millions of cookie jars? Those IOUs are evidently more than Madoff’s customer’s got. The government owns billions of dollars of real estate and facilities of all kinds. There are assets behind its debts and it has the ultimate money gathering power, the ability to tax!.
But before even a bankrupt country has to resort to a national garage sale - they have the legislative power to “design reality”; economic, social and political. Even a fraud of a country would never disappear. It would simply create a new one. There aren’t a whole lot of options in that regard.
It’s my understanding that if one seeks a long-term perspective as to real, post-tax returns on capital invested, the relevant number is in the range of 3.0-3.5%. Any projected let alone promised return above that level is suspect. Granted, there will be deviations from the norm, whether due to individual ability or individual fortune. Still, those are the hard numbers. Any expectation of sustained returns above that level entails an accompany expectation of consistently defying the averages. Which seems, in truth, not to happen, at least not for long. Increased return equals increased risk, with no exceptions, Ever.
Supposing and investor’s statement with Madoff showed a $200,000 gain in October, 2008, and such an investor had spent such an amount from other sources after allowing for taxes, believing he was spending money he had in his Madoff account, it is certainly “lost” to this investor.
Simple and well written. Funny how simple realities are revolutionary when too many people made money selling other ones. I think PVR captured that “red white and broke” still haven’t understood the fundamental acknowledgement, they’ve yet to acknowledge that the “value” of what they held-real estate, or investments were always variables. When something is pushed for so long as a “sure money maker”, when people finally do invest, they feel entitled to large appreciations or returns. When these numbers arrive it’s not a gift, it’s what the investors feel entitled to. If their investment loses value, the investors feel tricked, wronged, or suckered. The true weakness to investing in our economic system is when investors don’t understand that the “value” they hold is as fickle as the human psyche, since, to the largest extent, that is what drives the market.
Madoff did replicate the US dollar ponzi scheme. In case of dollar the govenrnment just makes sure that other countries are willing to accept paper dollar first and then just collects those dollars by issuing treasuries.
I am surprised nobody has killed him yet out of anger.
These guys need to know that they won’t get away with these scams…stealing money especially.
There is less alleged about Madoff’s guilt than about O.J.Simpson’s. His own son’s apparently turned him in as noted in several articles in Reuters alone. And according to several of those same articles he was arousing the suspicions of the Security and Exchange Commission. The SEC blames Bush budget cuts for their inability to prove anything while he was active. That also was mentioned in Reuters and the International Herald Tribune among others.
Speak for yourself when you say we all wanted to believe in the miracle economy. Property taxes in my area went giddy just like the phony economy. The market collapsed but there are still true believers in the bubble cost of housing alive but maybe not so well in the Town Halls of red white and broke USA. Somehow they haven’t got the picture yet.
During the Keating S&L bailout,Keating’s Catholic faith was brought into the picture several times.Will Madoff’s Jewish faith be also taken into consideration,or are we to be believe this particular Crook came into being in a vacuum ?
Food for thought, Patrick. I suppose people will save, but maybe not as much as before! It doesn’t pay as well as we’d gotten to expecting. I think there will be an inclination to spend your money for pleasure, and live in a home in which you can survive on Social Security (true of a lot more homes now than formerly), because investing can’t be counted upon to make a fundamental difference. Oh, and of course just plan on continuing to work. Handy, with all those boomers leaving the workforce (and eating their assets). I think Social Security, the eternal Ponzi scheme, will still be with us, but it won’t pay much.
The sad truth is that the entire wall street structure has become a legal Ponzi scheme. When the owners (stockholders) pay for stock that contains no assets because of leverage (debt) and managers become rich while leaving investors without equity (value) there is no difference between what Madoff, Fuld, Prince, Wagoner, etc.
It would be easy to write an extensive paper on why there is no essential difference between these players actions. Investor’s trust will be restored by limiting leverage, aligning management pay to the long term performance of the company, making pay levels sensible, and ensuring management is unable to provide misleading statements to investors (owners). Lehman, Citi, Aig, etc all knew they were heading for bankruptcy yet had no plans to carry it out in an orderly manner. That is the height of incompetency, yet they are left with enough money to ensure their entire families never have to work another day for multiple generations. I as a stockholder (owner) am left with nothing. That is the definition of a Ponzi scheme!!!!Can someone please explain to me why their actions are legal, because I can’t see the difference.
Socialist Security system in America was developed to counter Communist threat.
Americans do not like Communism, but prefer Socialist Security system of paying a few after collecting from a large pool of workers.
If situation reverses itself, which is paying a large number of elderly people after taking from a smaller number of young workers, Socialist Security system will collapse.
In that case, Federal Reserve and the U.S. Treasury will bail everyone out by printing more greenbacks. So, don’t worry!
I hear now that there is a strong possibility of a massive $50 billion Federal Reserve bailout of all Madoff victims too as soon as the new president takes his oath of office.
““The financial system as a whole has had the characteristics of a Ponzi scheme if we look at it fundamentally,” ”
Thank you, I came to the same conclusion when I looked up “fractional reserve banking”. And that even though - or is it precisely because? - I haven’t been taught economics and finance at the university or some fancy MBA factory.
We might even find - after some careful introspection and reflection - that “growth” itself is a inlusion if not a hoax. Even the “modest 8%” is too much and might turn out to be illusionary.
Good article, congratulations.
This whole affair reminds me of the Hans Andersen story “The King’s new clothes”
All these “Professional” investors who carried out no checks and just believed what they were told. Amazing!
Social Security = Ponzi Scheme. Are they not taking my money to pay off earlier “investors”?
When it’s my time to collect, will this Ponzi still be operating? Probably not!!