– 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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It is all game and is being played by the high ups who run the governments, how a person like him can go without detection for such long time and more worstly in the USA? A nation claiming is champion of all trades.
“We are all Madoff Investors”
Baloney. Speak for yourself. I agree that the value of everything is subjective and transitory, but to suggest that any of the stakeholders in the Madoff mess and, for that matter, the initial housing and credit crises, somehow represent all of us is ridiculous and insulting. I’ve worked very hard and lived on a short string for a long time to have absolutely no debt, never have in fact (except for those student loans.) I earn less than 25,000/year, but I’ve managed to bank nearly 100,000 in cash, so I don’t have to touch the stocks that I have. I can wait until they bounce back. And I’m sipping a very nice bloody Mary as we speak, thank you. I have no pity for anybody caught up in this mess, and I think all the bailouts are a scam in themselves. What an idiotic blog posting.
I would advise everyone to read the Op-ed piece by david einhorn in this Sundays New York Times. It is insightful, and while I won’t go so far as to say there is an active conspiracy it certainly at least points to an unwritten one in which the rules are known by all of the players.
As I have said many times there is too much vested interest money involved in the system to expect any real reform, and I doubt the real causes of this crisis will get much attention in the media. The only way to fix things is by making sure those in Washington know they won’t be elected without reform. Therefore, since we have to depend on the voting public to actually pay attention to such issues I can clearly state the chances of anything meaningful happening is slim to none.
No more bailouts!
When the very rich suffer, put the blame to the middle classes and the poor guys. Yes, now, we are told : «We are all Madoff Investors». Shame on us who were just harrassed by phone, mail, e-mails to buy whatever our bank or insurance wanted us to buy eyes wide shut.
And now, yes, we are the guilty party. We are to have to share the part of our poor fellows the wealthy people, we have to be the fellow-sufferers.
This story has been told again and again.
For the same purpose: make the poorer guys compensate for the richers’ losses.
Good commentary on the illusory nature of our investments, whether they be real estate or other market-driven equities.
There are a few people who made out very well in the past decades: those who sold their homes, stocks, etc., and got out when the going was good. Of course, most people followed conventional wisdom, feared the taxes on profits, and didn’t do that by “letting it ride.”
Assuming investments are continually gaining value is always a gamble. And listening to people in the investment world who are paid to tell us exactly that is akin to holding onto Enron stock when Ken Lay and Jeff Skilling said it was sound.
Ponzi operations are everywhere. Most if detected do not make headlines.
The alarming act comes from the investors, especially the last one who gave Mr. Madoff $10 million just few days before the collapse of the alleged Ponzi scheme.
Ask for the audited financials. Check who is the external auditor. Assess the internal controls.
First red flag: it is a “one man show” implies risks are high. Decisions are made by one person.
Second red flag: the external auditor is highly unprofessional (as mentioned in prior related articles).
If I was investing such a large amount, the least I will ask to check the financial statements and request an interim audit. The cost is minimal with respect to the amount to be invested and to the amount of return expected or promised.
Were the investors “shy” in asking questions and getting some answers before putting the money in?
So the Investors share the blame.
TomK, you are dead wrong. Laisse-fair did not fail. Stop misleading people. The “capitalism failed” precisely because of Government intervention: Fannie Maes and Freddie Macs, Citigroup and Crysler bailouts in the past, Welfare state, Corporate Welfare system, FDIC insure savings - this is not laissez fair at all. This is government meddling into free markets and creating moral hazards. But it does not matter what you think and how much you try to fool people with your arguments about “failed free market”. This time around the Free Market will be so powerful that it will wipe out all these meddling Keynsians. We can hope that they lose power and their heads roll.
The Ponzi/casino nature of US economy, so-called laissez fair, is well-known by many including the G8 countries. All past laissez fair have blown up. Have lessons been learned? Well, 2 of G8 countries have experienced their own near-death in the early 90’s and have learned.
After Japan great real estate bubble blew up the country went into a decade-long tailspin. After the usual banking mess and industry slowdown, many in the west say Japan never recovered. Because it did not apply huge stimulus fast enough. Wrong. What happened is Japan did learn the lesson. People and industry refused to play the insane financial leverage games. Growth is slow, but the economy is utterly real.
During the 80’s Canada played the welfare state game and deluded itself into believing it can finance unlimited welfare with unlimited debt. Because such welfare will always create a higher future growth. Of course the whole thing blew up and the country went into a debt black hole. It took a decade of tight-fisted economics to dig out. When, during the go-go 2000’s, tech, real estate and financial boom went into the stratosphere in the US, Canadian steadfastly refused to play along. They have learned lessons. Today, despite big dependency in Canada economy on the US, the ill-winds of the century blows up north and Canadians only sneeze a bit. Canada economy is strong and solidly real. The result of learning lessons.
The big question of 2009 is: Will America learn lessons?
James: My regard for your oinion has deminished remarkably with this opinion piece of yours. I would expect this kind of juvenile, dilitant style of writing from a neofyte, but from a seasoned professional like yourself, I expect more. In sum, you are doing what seems to be a growing cottage industry in the financial journalism trade….and that: 1. “we”, the collective all of us, are to blame for this, and that, 2. that “we” are all stupid, greedy, uninformed, or lazy not to realized your new-found “truths”. Well, Jim, this collective blame game, of investors in this case, is an old scape-goat tactic that is cheap journalism and demeans you and your criticism of this financial calamity.
George
“Lee [...] was very early in warning about deflation.”
Why do I keep hearing about deflation? It’s defined as (Wikipedia) “a persistent decrease in the general price level [...] only when annual inflation is below zero percent.” Our annual inflation rate is nowhere near zero right now. We’re not experiencing deflation. Huge increases in the money supply without a corresponding increase in goods and services means: INFLATION
Very good commentary. We are financially illiterate and dsitracted by greed.
Your statement that we have now learned our lesson , is laughable Mr. Saft. I remember the very same statement being put forth by others. During the 70’s fuel crisis, during the 80’s S&L Debacle, during the 90’s Tech melt down, during the 1999/2000 economic down turn, And now in this 2008/2009 crash and money grab. No lessons have been and will not be learned. Lessons don’t want to be learned as long as Wall Street and the Government can fleece taxpayers and use us as their own private ATM’s. Please don’t insult yours or my intelligance by saying lessons will be learned. It is way past time to rescue this country in the form which we now know it. Both of us can see “THAT” writing on the wall. Have a good and safe year.
I’d been warning people about the illusory nature of the economy and the will-o-the-wisp of nothingness that are their retirement funds, 401k’s, etc., for over 25 years. I’ve predicted an economic collapse for about as long a time. It was obvious to me that you can’t spend your way to prosperity. It certainly didn’t seem quote so obvious to 99.999999% of the rest of the population, though.
Now I read all of the business-as-usual cheerleaders who propped up the debt system act like they knew this was coming all along. (Not sure if this writer is one of them, but this article reads like a lot of them out there now.)
I now will make another prediction that people will ignore and/or scoff at until it materializes: Within the next 5-10 years 90% of the human population will die from starvation (or from disease as a result of such). And due to the human tendency to bask in the comforting waters of denial until things have reached the point of no return, there is nothing anyone will be able to do about it at this point. It’s too late.
Have a nice day.
What is surprising in this entire happening is the role of auditors and madoff was practically running a huge wealth management institution managing billions of dollars of wealth of dubious wealth of wealthy people all over the world . How come auditors not able to check these basic facts and it raises serious credibility issue not only from the point of view of sanctity of audit of such a large firm where such ponzi scheme was being managed for so long . More so it is important to publish the names of all the people whose wealth was being managed by Mandoff as in all probablity Mandoff was providing cover for the black money of these wealthy individual by keeping regulators in dark . In no case auditors were in dark as this cannot happen without auditors giving clean cheat to Madoff . There is serious need to scan the books of all such wealth management institution which gets support of regulatory authorities and in some cases governments as well .But the question remains unanswered as to who will scan the books of such institution and had there not been recent crisis entire world would have remained under dark about the misdeeds of so called high profile wealth management and investment banking institution . Time has come where governments of the world need to unite and form some association with authority to independently question the functioning of all such institution involved in wealth management and other financial dealings .
Maurice - Paul Rosa did not say that a fraud is not a fraud until it is detected. And a Ponzi scheme cannot go on indefinitely. Social Security is not a Ponze scheme. Another comment suggested that most government taxation is. But obviously all taxation is dependent on the ability of the economy to withstand it. PVR - also me - said that the rapid escalation of real estate prices also feeds a windfall for the municipalities who rely on real estate taxes. They do that where I live. Within the last few years I saw the real estate assessments on a small house and lot escalated almost $100,000 - the lot alone jumped from a slowly rising (over 20 years) and more sane appraisal of $7500, to $28000 the next year to $75,000 the year after that. Not even the most speculated bubble prices were rising at that rate. I think that assessments were a fraud but not a Ponze Scheme.
Something like carpetbagger taxation in the old south comes to mind for what this town did. But now that the town has those assessments on the record (no change whatever to the physical condition of the property mind you) I think they want to wait and hope that the old bubble reinflates. In as much as we are not an economy that does much of anything that is useful anymore - most of the new products on this house are imports - we really don’t do much more than charge more for less. I think that bubble will be limp for a very long time.
It is quite easy to say, and it is often said after the crisis began, that all assets should be valued at “fair” value and at what those assets really earn. However, nobody says how to do this. Where is the guaranty, that few years (or decades) after the end of this crisis the situation will not repeat?
It seems more reasonable that fair value of something is not constant and may fluctuate significantly depending on different conditions. When supply/demand changes nobody can say what the real price of something is: low is it is today, or high as it was yesterday.
As to the idea of article, the author is right, yes, we are all Madoff investors.
What about social security, which counts on future
generations’ continue and ever increasing taxes to
promise something no better than ponzi!
Mr. Saft, thanks again for simplifying what others want to make complicated.The idea of netting debt growth against asset price growth to arrive at real value, however, is not going to sit well in Congress, the Fed or on Wall Street, or anywhere that Keynesian principles are being advocated.
Regarding productivity, I have used the simplification of imagining an economy that had only one product, say pork chops, and then requesting that one imagine the effect of increasing the money supply without increasing the supply of pork chops.Are the holders of pork chops any better off after the price rises?
The obvious and simple must be terribly flawed or we wouldn’t be seeing the measures implemented that we are seeing. I can’t wait to find out what the mystical, magical multiplier is going to be that justifies bailouts and stimulus.
This is good reading. It also gives hope that life, in tangibles, won’t necessarily deteriorate mad max style next year. The recession is only a disaster if you invested in loteries of real estate and mind boggling double digit investment return, and weren’t smart enough to cash out before everyone “got it.”
I lived in a house for 10 months, and it was suddenly worth $50k more than I paid, which was rational market price for the community, and it’s product. It’s not like I installed solid gold siding. Or even another bathroom. If someone’s offering you 10% on your money, don’t forget that smart older people have been ecstatic to get 6.5 for the last 10 years.
Geez, why can’t we raise the price of gas $.10. It’s not like the same ding dongs shopping today are going to stop going to Target and Old Navy.