If it’s too good to be true…maybe it isn’t. Part of the wholesale abandonment of risk management in the current financial environment includes ignoring risk, whether risk is clearly evident or what should be at least a healthy sense of skepticism, and the growing lust for reward beyond the reasonable or traditional – despite the risks.
It once was that bankers followed simpler rules – say, having their own borrowing or capital costs at three percent, such as the bank-to-bank overnight lending rate or the intermediate and longer-term rates and then charging six percent or so to the borrower. A slower way to make money, for sure, but “safer” compared to what’s been going on in this century on Wall Street and in banking circles. Since the 1999 repeal of the Depression-era banking laws separating Wall Street brokerage and Main Street banking, this was looked on as a sort of Fuddy Duddy banking.
What was promised through securitizing of home mortgages, credit card outstandings (consumer-owed debt), auto loans, and a variety of commercial real estate loans – hey, that was the new road to riches. The old ways belonged to George Bailey in that 1940 movie shown on Christmas Eve. Or the silly old E.F. Hutton ads – We make money the old-fashioned way – we earn it!
And there is now the strange case of Bernard Madoff and his billions of dollars assumed to be held in fiduciary trust – and that has that disappeared. We watch in fascination (and too many in horror) the continuing fallout of the scandal that almost perfectly has been summing up the recent fear-greed equation so prevalent in the 2008 capital markets. (As one expert said, Abandon ye all fear / pursue [we must] those outsized rewards based on personal and institutional greed.)
Bernard Madoff was a tower of the securities industry, as they said in the downtown Manhattan canyons, as well as in too many other locations where money was entrusted to Madoff Securities. He was known as a very smart money manager who knew how to create solid returns in good times and bad – you could really count on Mr. Madoff to earn money on your money when all your friends were losing theirs in the market. At heart, it was really the simplest of financial schemes.
A Simple System
You get people to trust you and then to entrust their money to you to invest on their behalf. The money comes in, and as trust (and referrals) build, you get more money, which you use to pay the early folks who have money in the pot. Those early “winners” tell everyone how smart they are (for investing with you) and how smart you are (bragging rights for entrusting their money to you), and the game goes on. If it goes on long enough, in theory, you will run out of people to bring new money in, but, hey, it’s a great game for a time.
In some ways this sounds like the some of the recent events in banking and the capital markets on a grand scale. In some ways / some events, like the great collater-ized mortgage, asset and debt schemes, or the marketing of complex and exotic derivatives based on real or theoretical values from which the value of the derivative is said to be determined. Too much confusion for you? Then focus on one man’s role in all this – Bernard Madoff, the man at the center of the scandalous headlines of today.
He’s the go-to Man
He is the central figure in a $50 billion (“b,” that is) of an alleged grand investment fraud that involves wealthy individuals, family trusts, foundations, endowments, banks, not-for-profits, charities, hedge funds, the grandkids’ inheritances – did we leave anyone out? Oh, he was such a good guy to know, according to those who knew him and some who knew of him. Or people who knew people who knew him. Trust, in tight circle at first that ever broadened. And brought in new money.
New money and old money people got caught up the net. The fall out continues – we like the quote from PR man Gary Lewi speaking to Newsday about one of his clients: Much like an atomic detonation off on the horizon, the shock wave takes a bit of time to get to you. But get to you it does, for a growing list of investors.
Let’s start with the professionals – those with fiduciary responsibilities to others, who pursued reward with Mr. Madoff: Fairfield Greenwich Advisors, an investment management firm; losses are $7.5 billion. Tremont Capital Management, a fund-of-funds investor; losses $3+ billion. Access International Advisors, a NY investment advisory firm; $1.4 billion. Note the irony: advisors and investment management. Banco Santander, a Spanish bank which own Sovereign Bank here in the New York area; just under $3 billion lost. A private Swiss bank (Union Bancaire Privee), a billion dollars gone.
Bankers are a conservative lot, no? Well, yes, when you are asking for a loan or a mortgage, in the past and much more recently. But when chasing rewards in the New Era financial marketplace, maybe not. Ask the professional bankers who gambled and lost: Royal Bank of Scotland. BNP Paribas. Nordea Bank of Sweden. Credit Agricole of France. Banco Populare of Italy. Or other investors (or trustees) who should be taking risk into consideration along with reward: The Korea Teachers Pension fund. RAD Capital, a hedge fund. Man Group of Britain, a hedge fund. And a long roster of social sector organizations.
Bloomberg News is reporting now that 400 US-based non-profits lost collective billions in the scheme. These US foundations fund a variety of causes and activities and in 2007 they provided $73 million in funding. With their investments vanished, what will 2009 look like for their recipients? Well the JEHT Foundation, which gave away $24 million last year, to advance criminal justice reform, is going out of business now. So is the Picower Foundation, which has given away $268 million since 1989 and is now forced to close. The list of social sector organizations who entrusted their investments Bernard Madoff fills almost 40 pages now.
Another “Ponzi Scheme?”
“A Ponzi Scheme,” the journalists trumpet. Well, if the facts are as stated in the torrent of stories that followed the news break – that the $50 billion wasn’t there – it is way beyond the original Ponzi. When all the facts are known and the losses tallied, and the fallout winds down at some point, this may well be the events referred to in the future as the “Madoff Scheme.” Ponzi was a piker in comparison.
The original Ponzi was an Italian immigrant (arriving in the US in 1903), Charles Ponzi, who set up the Securities Exchange Company (great name), in downtown Boston to wheel and deal with investors’ money. There were few securities regulations in that day, and theWonderful Era of Nonsensewas getting underway. This was what columnist Westbrook Pegler dubbed the speculative financial contagion of the 1920s. The good times did last until October 1929, and the last great crash that the 2008 events are being compared to. Mr. Ponzi’s schemes unraveled well before those October-November 1929 Black Days on Wall Street and on many Main Streets in America. As with the current New Era of Financial Contagion and Epidemics, the mass media helped to fuel the scheme. Consider the headline of the Boston Post,
“Doubles the Money Within Three Months”
…in a profile of Charles Ponzi’s operation on School Street. After that story appeared $1 million a week of new money flowed into the nondescript offices of his firm (multiply that times 10 for an approximation in today’s dollars, at least while the 2008 dollar is still worth that). The gullible were lined up at the door when Ponzi arrived in his splendid Locomobile auto and strode confidently up the staircase to his lair.
At the heart of his scheming was something no one today probably heard of, an International Reply Coupon issued by governments (especially the government of Italy) under the Universal Postal Union for trans-border mail. This was a paper of fixed value that could be redeemed for stamps in other countries. Watching other get-rich-quick operators, Charles Ponzi went to work gathering dollars to build his pot, promising fantastic returns…especially compared to the paltry sums offered by the US Postal Savings Plan, or local banks. This was real money! You know, the kind ofreal money made in this 21s Century by real men!
Also – did we tell you he was charming?
Charles Ponzi was charming and dynamic and so smart – he was smart, wasn’t he, making all that money for investors? The dollars flowed in. The press clippings helped. Word of mouth was the clincher for new investors. This was all so complicated no one really asked about “how” – like the way investors poured money into the Madoff coffers in recent years.
Money came in buckets, briefcases, pocketbooks, clenched in the hands of hopefuls-to-be-in-the-middle class or those who were really rich. And the early investors made a ton of money when the payments were due; of course, most of them plowed money back in to make more. More, more! For a time. And then the unraveling came. In less than two years the scheme collapsed; he was accused of fraud; he went to jail, and after a few years was deported to his native Italy. The Massachusetts attorney general got him; he was indicted many times over on federal fraud charges; and he had no money at all in the end. He moved to Brazil in the 1930s, but never returned to America. He died in Brazil in 1949. His name had entered the realm of legend – financial legends, especially! – but he was broke and had hidden no money away from prying eyes. (The authorities are trying to figure out as 2008 ends how much money Mr. Madoff and his firm actually have on hand.)
A Drama Worth Reading About
There’s a marvelous book about all this – a really good read while we await the outcome of the Madoff media drama – by author Michael Zuckoff: “Ponzi’s Scheme – the True Story of a Financial Legend.” As Zuckoff writes, “with a maestros’ touch, Ponzi had struck a perfect balance among the forces competing to control the new America identity [in 1920] – altruism and avarice…” (published in paperback by Random House Trade, 2006)
Sounds like 2008, doesn’t it? If all that we read is only half true in the Madoff drama, this is (as the famed Yogi Berra was said to say) deja vu all over again!
The final word for now of things Madoff is that of actor-commentator-author Ben Stein, in the December 28, 2008 issue ofThe New York Times: He writes that two years ago a little delegation from a major investment bank came to his house to sell him their “wealth management” services. A large chunk of the money would be invested with a “money manager of stupendous acumen” whose genius was never losing money. Up and down markets didn’t matter. Ben Stein said he didn’t think so; he argued that a perfect hedge fund wouldn’t work the way they described. And the money genius charged 2 percent on the money invested. They went away without Ben’s money. Guess who the investor was? Correct – Bernard Madoff (who Stein had never heard of until then).
Oh, did I mention who lost money in the original Ponzi Scheme? Among the little people there were big fish: Hanover Trust, a bank that earlier had turned down the once-broke schemer for financing, in effect swooned and became the de facto Bank of Charles Ponzi (writes Zuckoff), after the executive committee – throwing risk to the winds – elected him a director and sold him new stock for controlling interest. Hmmmm….
This, after all, was a unique time in America – in the 1920s, writes Mitchell Zuckoff, a new ethos was emerging, and a new definition of what it meant to be an American. No more pennies saved and pennies earned, money was best when it arrived fast, easy and in large quantities…if wealth didn’t come knocking, go and get it yourself. Charles Ponzi was the first roar of the 1920s, the author notes, and today his name lives on it infamy. Until this year. We don’t know yet how far the Madoff unraveling will go, who all will be swept up in the drama, how much money was lost, and how many people will really be hurt. But this situation seems to be an apt metaphor for this year’s financial meltdown, abandonment of risk, chasing outsized rewards, and financial gimmickry, as we stumble toward 2009.
No doubt we’ll be reading all about it in a few books to come. Hey, the book publishing business needs a lift!