Investment Scam of the Year

The latest shock to come out of the financial industry on Wall Street is the Bernie Madoff scandal. Mr. Madoff has been involved in Wall Street business for almost fifty years. He was the head of NASDAQ for several years, and his securities firm occupies three floors of a downtown skyscraper.

The primary business of his firm was to act as a market maker, taking orders to buy and sell a number of stocks. However, he also ran an investment advisory firm, taking in money and investing it for people and institutions. At the beginning of the year this arm of his business reported holding $17 billion in other people’s money.

It now appears that the investment advisory part of his business was actually running like a giant Ponzi scheme, where the money that new investors put in was used to pay dividends to older investors. Hit by requests for $7 billion in redemptions by investors this quarter, the house of cards came tumbling down. Mr. Madoff’s own estimate of total losses to investors was $50 billion.

This is an amazing story, and it is only starting to unfold. From what little has been revealed so far, several aspects of the situation boggle the mind.

First, how did one guy pull this off? From all reports, only a couple of dozen people worked on the floor of the building where the investment firm was located. Most of the employees were on the two floors where the legitimate business was located. How did Mr. Madoff handle the mundane details like keeping everyone’s theoretical balance straight, or mailing out statements and dividend checks? Normally, managing billions of dollars takes hundreds of people. Of course, it is a lot easier when you aren’t actually managing the money. Still, the logistical details of a fraud this size must be daunting.

How do we know that Mr. Madoff was acting alone? Because he says so. At this point, if Bernie Madoff said the sun came up this morning, I would have to look out the window to check. I suspect this morality play has more villains than just Mr. Madoff.

The other astonishing part of this story is the victims of the scam. Some of the investors were relatively wealthy individuals who were taken in, and are now ruined. Mr. Madoff’s reputation and longevity, as well as his charm, had to help in duping his victims. But the big money came from other Wall Street investment firms, as well as a slew of international banks. How did these guys fall asleep at the switch?

It apparently never crossed their collective mind that Madoff was scamming them. I can just picture the due diligence meeting. “Bernie? Bernie Madoff? I’ve known the guy for years. We take steam together down at the club. Twice a week, regular as clockwork. He says he needs another billion? So send him a check. Electronic transfer would be even better.”

Then again, these were some of the same sharp guys who were buying subprime mortgages up until a year ago, so I guess we shouldn’t be too surprised that they got taken.

I’m sure that the “Law and Order” screenwriters are already working on a “ripped from the headlines” story.