Sunday, December 14, 2008

Bernard L. Madoff and his Ponzi scheme

Bernard Madoff market maker and hedge fund manager was charged with securities fraud last week taking investors for as much as 50 billion dollars according to reports.  Investors in his fund use to state they do not know how he does it but his fund consistently returned 9-10% a year.  We now know how he did it, with a giant ponzi scheme. 

Ponzi schemes work by creating the illusion of profits by taking the funds of new investors and putting them into the accounts of current investors. Eventually new money stops coming in and original investors start asking for their money back and the whole things collapses.  People will want to assign blame for this whole thing. Clearly Madoff himself is to blame. He has been around Wall Street for 50 years and with his connections and reputation he did not need to defraud investors to make a living.  He got greedy and I hope he spends the rest of his days on this planet in a jail cell. 

I do not think we should over look the investors in Madoff’s fund. His list of investors is a who’s who of the world's rich. These were not your average 401K type of investors.  They were people with millions and billions to invest and should have known better.    The fund seemed to defy logic and Madoff gave very little explanation of how he made his returns.  Investors also got greedy and took an attitude of as long as I keep making money whatever he is doing is ok with me.  Investors long for the ideology that a money manager can continue to make money in equities no matter what the market is doing.  The investors in Madoff’s fund broke a fundamental rule; if it sounds too good to be true it probably is. 

The regulators are to blame also, but remember hedge funds have fought regulation and won time and time again.  They have basically operated outside the regulator environment.  So I will not blame the regulator as much as those in congress who fought against the regulation of hedge funds. 

No matter who we blame it will not get back the 50 billion dollars of losses for investors.  I just hope some investors will learn from this. There are certain principals of investing that no fund manager can get around.  One of those principals is that there will be periods of loss and if your fund never losses money be suspicious and get your money out while you can. 


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