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FOLLOWERS of the past year and a half’s financial misadventures have become inured to bucketfuls of red ink. Even so, the potential losses from the scam perpetrated by Bernie Madoff, a Wall Street veteran, are jaw-dropping. The $17 billion of investors’ funds that his firm supposedly held earlier this year have all but evaporated and the hole could be as big as $50 billion. That would make it the biggest financial fraud in history.
Details are still emerging, but Mr Madoff has himself described it as a giant Ponzi scheme. For years, it seems, the returns paid to investors came, in part at least, not from real investment gains but from inflows from new clients. It might still have been going on, were it not for the global financial crisis. Redemption requests for $7 billion, by investors looking to pull back from turbulent stockmarkets, forced Mr Madoff to admit that his coffers were empty—bearing out Warren Buffett’s adage that only when the tide goes out is it clear who was swimming naked.
The affair has robbed an embarrassingly long list of supposedly sophisticated investors of their swimwear. Hundreds of banks, hedge funds and wealthy individuals parked money with Mr Madoff, impressed by the steady returns on offer: 10-15% a year, even in rough times, with barely a down month. Global banks such as Banco Santander, BNP Paribas and HSBC, all three of which had until now survived the credit crisis relatively unscathed, are among those reported to be heavily exposed. So too is Bramdean Alternatives, a fund run by Nicola “Superwoman” Horlick, a celebrated British money manager. Others had most or even all of their eggs in the Madoff basket. Several well-heeled Americans have reportedly lost everything but their properties.
Why were they not suspicious of the unnaturally consistent returns? Mr Madoff’s pedigree may have played a part. A former chairman of the NASDAQ stockmarket, he has long been a fixture on Wall Street. He even has an exemption (to the former “uptick rule” for short-selling) named after him. He has served on an advisory committee assembled by the Securities and Exchange Commission (SEC), America’s main market watchdog. Savvy marketing was another factor. Investors had to be invited, lending his operation an air of exclusivity. This went down well in the country clubs of Florida, Minnesota and other states, where the firm’s unofficial agents told of Bernie’s magic touch, explaining that not anyone could get in, yet always somehow finding space for those who fancied a piece.
According to reports, some of those who put their faith in Mr Madoff suspected that he was engaged in wrongdoing, but not the sort that would endanger their money. They thought he might be trading illegally for their benefit on information gleaned by a separate business within his group, which made a market in shares. The firm had been investigated for “front-running”, using information about client orders to trade for its own account before filling those orders.
Even so, the affair has—like the subprime-mortgage debacle—exposed a stunning lack of due diligence. Droves of investors who should have known better tossed in billions, preferring to keep their fingers crossed rather than ask awkward questions of a firm whose investment strategy was vague and opaque. Even within his own group, Mr Madoff’s money-management business was a black box: no one but he had full access to the accounts. As a broker-dealer, it was able to clear its own trades, a privilege that should give pause for thought. Worse, questions had been hanging over the operation since the mid-1990s. Some institutional investors have long steered clear of Mr Madoff, unable to understand how he spun his gold, or uneasy that his books were audited by a tiny, three-person accounting firm…
