Bernie Madoff's Victims

I’ve been reading a lot about Bernie Madoff in the news recently. Bernie is the Wall Street financier who has owned a securities trading firm for four decades. He was one of the pioneers of electronic trading, and was actually president of the NASDAQ organization for a couple of years. As a market maker, he was one of the most respected members of the Wall Street finance community.

He also ran a money management firm, noted for taking cash from wealthy individuals and other money management firms and producing consistent, steady returns of 1% to 2% a month.

Except that it now appears that Bernie wasn’t actually investing the money he was given. He was making up the posted gains, and using the money new investors gave him to pay cash distributions to older investors. A Ponzi scheme. The biggest, longest lasting Ponzi scheme in history.

So now I am reading stories from people who lost everything from a couple of hundred thousand dollars to a couple of million dollars up to institutions that have lost billions of dollars. Estimates of total losses have run as high as $50 billion dollars.

But here’s what I want to know: Can you truly lose money that you never had? For example, I read one account of an investor who put $25,000 into a fund that invested with Madoff in 1992. Even though the investor pulled out cash distributions every year, his investment had grown to $150,000. In his account, the investor said he had lost all $150,000.

The thing is, the investor never had $150,000. He only thought he had that much because Madoff told him he had that much. The most he ever had at risk was the original $25,000, and he had probably gotten most of that back in distributions over the years. So what is the true loss?

A Ponzi scheme is essentially a zero sum game. A zero sum game is one where the winnings of some of the players are offset by the losses of the other players. The individual running the scheme, in this case, Bernie Madoff, takes a cut off the top. Madoff’s skim, however, appears to be miniscule compared with the sums invested. I mean, the guy lived well, but not that well.

When all the forensic accounting is completed, the losses of later investors are going to be balanced with the gains of the earlier investors. And once that accounting is done, the losers are going to hire lawyers and try and get their money back from the winners.

Thousands of plaintiffs and defendants, all using lawyers to fight over money. Now that’s not a zero sum game. That’s a negative sum game.

Except for the lawyers.