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A ``person who did not live especially lavishly''? A $7M apartment in NY, a $9M mansion in Palm Beach, a $3M beach house in Montauk, a 55 foot fishing boat, a yacht moored in the south of France, and half ownership of a $28M private plane?


see Battle for Investment Survival (book by Loeb) or something similar

I agree with diversification in general, with the addition of not letting diversification becoming substitute for spending some time and effort trying to understand each investment.


Dear Gary, if it turns out to be true, that on November 7th, 2005 the SEC has received a very detailed complaint about what is going on I think the SEC is liable for the scam. I do not expect investors to continue to have any faith in US capital markets and their regulators if us government turns away investors with their claims by saying it is your fold. Not acting on such a detailed complaint is a crime.


An innate proclivity to commit the "denial of the antecedent" fallacy on a regular basis pragmatically requires education to tame.

The media, an instrument of education for the masses, unfortunately isn't interested in spreading the wisdom of efficient market theory. "Mad Money" and trading tool infomercials spouting technical analysis nonsense are the ruling religion of the day.

Keep the good faith. Fight the good fight. Your blog is a step in the right direction.


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James N. Markels

I think a lot of investors are willing to outsource their investment decisions and not ask questions so long as the returns are good. And even when the returns are good, investors will push their managers if they discover that their neighbor is somehow doing even better. The good news is that the current economic situation and the Madoff revelations will compel people to act more responsibly. Investors must always be active and involved in their own investments. And investors need to make sure that their own greed does not overpower their need for security.

As for Madoff, what interests me is not that he ran a Ponzi scheme, but rather how he ended up running a Ponzi scheme. Coming from his background, I have a hard time believing that he decided from the start to create a massive Ponzi scheme that he knew would eventually blow up and ruin his good name. I think he started off doing a typical hedge fund. When times weren't so good, he sold some of the invested assets to fund overinflated returns to his investors, expecting that to attract new investors whose money he could use to reconstitute the sold assets. In other words, he may have been borrowing a page from Keynes -- when times are tough, sell assets and pay out good returns; when times are good, pay out lower returns and use the remainder to repurchase the assets.

Looks good on paper, except we all know that it just doesn't work. Selling assets when times are bad and buying assets when times are good is generally a losing "sell low, buy high" strategy to begin with. And investors don't stop demanding high returns just because the market improves.

Of course, it may be that Madoff intended to start a Ponzi scheme from the start, thinking that he had found a way to create one that would not crash and burn like all those before it. But he just doesn't seem to fit that profile to me. We shall see.


This will undoubtedly prompt a new outcry for heavier regulation of Wall Street. Maybe some of that is necessary. But as I see it, what’s mainly needed is a heavy dose of caveat emptor. As Dr. Becker points out, the warning signs were there. I think that there’s a limit on how far government can go in preventing people from doing stupid things (or making stupid omissions).

Media reports indicate that the auditing of the fund was inadequate. Adequate auditing seems to me to be the best way to ensure that funds are going to investments, rather than to a Ponzi scheme. I’m not sure what regulations are in place to see to it that an auditor is up to the job on the scale required, but perhaps they need to be augmented (or put in place, if they don’t already exist).

Terry Johnson

The knee-jerk reaction to this scandal along with all the others will be to add layer upon layer of new regulation.

While the new regulation may do an adequate job of correcting prior problems there will always be guys just a little smarter (maybe) and a little more dishonest (always) than the next guy.

The fact that wealthy individuals lost money is not a shock. Making money and keeping money are two different skills.

Georg Kober

The most obvious or at least the most interesting question to me is that:
Did Madoff really think he would get away with that? I mean, he must have known that one day, sooner or later, or even very later, people would find out and send him to jail. If I devised a Ponzi scheme, I would try to get as much money as possible in a short period and then travel to a sunny country without extraditon to the US or elsewhere. But living in New York for years, knowing that every minute someone could find out, that you would go to jail for the rest of your life and lose all what you have?
I admit, that is psychology, not economics; but for me this remains the real enigma.


The market IS NOT efficient. Example: well published results (see, most recently, Andrew Lo's book 'Hedge Funds') show the very simple technical strategy of longing each day's biggest positive movers and shorting the biggest decliners would have delivered SPECTACULAR returns in the 80's and 90's accounting for transaction costs and risk. And that the opportunity declined to zero in the late 90's and 00's. This is one of many technical strategies with similar return behavior in recent decades. There was an inefficiency in the market, and investors gradually discovered it and exploited it away. But over decades, not the much shorter timescales needed to justify idiotic and poorly informed 'the market is efficient!' statements that regularly spout from academic mouths. Is any of this ever acknowledged? What about strong return performance of funds like Renaissance and Goldman's Global Alpha (which, even including recent terrible performance, still destroys the market even on a risk-adjusted basis)? The market is in a state of some inefficiency, enough so that a number of investors (not just Buffet) can regularly beat it, but not enough that the average investor can. Agreed that it takes years of investment performance (and details beyond just yearly return) to tell the difference between luck and skill in investment success - this central fact is the reason swindlers can succeed, and that is what should be emphasized to investors if one wants to capture the real truth of the situation. Saying 'the market is efficient!' as well just spreads poor understanding and suggests those who work at generating returns in the market are all swindlers. They're not.

Tom K

I agree with James Markels above. Although it's just a hunch, I'm guessing that Madoff probably ran an ordinary business for quite some time, and then only needed to start scheming when things went bad. I wouldn't be surprised if he told himself that when he turned things around, he'd make up the money he lost. Typical gambler mentality - need more money to win back what you lost already.


Diversification wouldn't have protected an investor from grievous declines this year. The only strategy that would have done that (other than staying in cash) is hedging. John Hussman, Ph.D., of Hussman funds hedged his Strategic Growth Fund, and so shielded his investors from the worst of the market declines.


Under your theory that anybody who consistently beats the market must be a scam artist, how do you know that Warren Buffet or any other money manager with consistent good results is not scamming?

Madoff was in business for almost 50 years and for most of it he was managing other people's money and providing good but not spectacular returns. For a great many investors, those facts alone would have provided a great deal of comfort.The huge amount of 20-20 hindsight being exhibited now by many is totally unconvincing.

It is also not clear what exactly would have been discovered by an SEC investigation. He clearly had money under management. The question is whether he had sufficient funds to cover all the amounts reported in the statements he issued to his investors. If he had enough funds to cover the amounts he reported he was managing, how would the SEC or nay other investigator have discovered that he was telling his investors (collectively) that he was managing a much larger amount than the amount he was reporting?


"Ponzi Schemes", in the heart of the legitimate financial world? Looks like someone has taken a page from the "American Gospel of Success" - "There's a sucker born every minute" and why do you think it's called "SPECULATION".

The problem is clearly a lack of transparency that the SEC was supposed to provide.

And now the Financial Investment Banks that have taken money from the Nationally sponsored Bailout do not wish to report how that money is being used.

When are we going to learn and force these guys to toe the line and operate in the National Interest?


Aaah yes......... "transparency". And to think I used to read CPA generated 10Q and K's.......... what are those worth today????????? In an "efficient market?"


innocent until proven guilty

some people benefit from concentrated positions and specialization

not exactly frugal lifestyle


Anon., Guilt and Innocence has nothing to do with it. A few need to be tarred and feathered and run out of town on a rail as a warning to others. Justice works in strange ways at times.


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This is not the largest Ponzi scheme. That title would have to go to Social Security.


There are two posts above that deserve some translation......

On a separate note, for smaller than Madoff investors I recommend Bernstein's book, "The Intelligent Asset Allocator". Pretty much agrees with Prof Becker.

Brokers are not your friend.......


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Not to excuse Madoff but it is interesting to consider what constitutes a Ponzi scheme; is it intent?

Consider Amazon operated at a loss for years, ostensibly plowing all of its revenue into buying market share and striving to preempt competition while its stock rose on expectations of profits certain to come as its founder indicated would be the case. But suppose his model was flawed and Amazon went down as did so many other dot coms?

Then with the dot com frenzy in full swing, WERE there hucksters who had no intent of ever being profitable and intentionally just sold a story, churned some dollars for a while (as was, apparently, part of AOL's "business plan" for a while) go public and "diversify" the capital raised.

Or, more topically, did very savvy investment bankers REALLY think that they HAD invented something that made the "old" 5 : 1 lending ratio obsolete and that going out to 30 : 1 was a viable business practice?

Or? By offering returns far above the historical norm to their investors for selling what MANY insiders MUST have KNOWN was junk also guilty of running illegal Ponzi schemes? Or where they just frisky young capitalists willing to take just a bit more risk in order to maximize returns for their stockholders? Did they think they could reduce their exposure to risk, IF, or before asset prices flattened or fell?

By comparison, did Madoff, think, or hope that after "buying customers" with high returns and getting his fund to some size that he could catch up by lowering returns while maintaining most of his client base? Probably not, and I assume there are some rules against running funds in a manner that returns more than was earned in a given year.

But what of those lending at 30 : 1? That would make 5% loans yield something like 150% on equity. Would a CPA using generally accepted principles endorse such returns as "earnings?" or denounce them as lucky winnings from wild-azzed gambling? or outright fraud?


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