Undone, but still not understood

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One lesson of recent events is that there seem to be no limits to the greed of the greedy. But perhaps the explanation is simply the one Madoff gave to the judge who sentenced him: “I made a mistake.”

What did he do? Why did he do it? Why did so many people give him so much money? How did he get away with it for so long? Erin Arvedlund’s book on Bernard Madoff does not fully answer these questions. But it helps to frame them.

The basic elements of the fraud are well understood. Madoff was engaged in a crude and simple Ponzi scheme. The trades from which he claimed to obtain an astonishingly reliable series of monthly returns never took place, and evidence of them was fabricated after the event.

Arvedlund is not able to tell us whether there had ever been any genuine trading. Nor is it clear how much was actually stolen. The headline figure of $65bn is an estimate of the amount people believed they had invested with Madoff at the moment of collapse. That sum is made up of the original investments of the victims – much of which went to pay off earlier investors – and the accumulated returns on those investments, which existed only in Madoff’s imagination and the reports he issued to investors. So much of the $65bn was never there and much of the rest was spent by innocent beneficiaries.

The attempt to identify the amount stolen leads into perhaps the most puzzling aspect of the Madoff affair. Why did he do it? Madoff appears to have had a highly successful legitimate business. His lifestyle was extravagant, but not extraordinarily so by the standards of modern financial titans. Why did he embark on a course that was bound eventually to lead to disgrace and imprisonment?

One lesson of recent events is that there seem to be no limits to the greed of the greedy. But perhaps the explanation is simply the one Madoff gave to the judge who sentenced him: “I made a mistake.” Arvedlund suggests that the scheme may have begun as a mechanism for funding Madoff’s legitimate business. The trouble with a Ponzi scheme is that once begun, there is no going back. Repentant or fearful bank robbers can stop robbing banks. But the only way the perpetrator of a Ponzi fraud can avoid exposure is to continue the crime on an ever increasing scale – to rob bigger and bigger banks until he is caught. Madoff remained free until he robbed a very big bank indeed.

Investors were persuaded with some of the classic ruses of the confidence trickster. An exclusive opportunity might be forfeited if too many questions were asked. Returns were paid promptly – until the last one was not paid at all.

One of the most shameful elements in the Madoff story is the role of intermediaries in procuring funds for the scam. It is evident from Arvedlund’s account that little diligence was required to become suspicious of Madoff’s claims. The split-strike strategy he claimed to use is not really very complicated, but the man who was making billions by using it stumbled when asked to explain it. The typical operators of Madoff feeder funds appear to have been the well-connected but dim individuals who prey on the wealthy but poorly connected. This is a recurrent phenomenon, true at Lloyd’s during the 1980s and in the New Economy bubble a decade later, and then for Madoff in New York and Florida and, finally, Europe. The time is overdue for the imposition of exemplary civil and criminal penalties to keep ignorant but well-bred sales people away from financial services.

And this raises the most shaming question of all: where was the Securities and Exchange Commission? Quite apart from the substance, the formalities of Madoff’s operation had probably been illegal for two decades. Major Wall Street institutions had known for many years to steer well clear of Madoff. Harry Makropoulos, who at some personal risk gave the SEC extended briefings on Madoff’s activities over several years, was virtually ignored. Arvedlund had herself raised disturbing questions about Madoff in an article for the investment magazine Barron’s. Elementary probing by regulators would have revealed the fraud.

The SEC, Arvedlund suggests, is populated by box-tickers whose job is to assess procedure, not to raise queries. Most importantly, the downside for junior SEC officials from annoying rich and powerful Wall Street figures was far greater than the upside in exposing the fraud of the century. Until that changes, there will be little to prevent another Bernie Madoff.

The book is evidently written in haste. The structure is neither historical nor thematic, the evidence relies too much on hearsay and on tertiary or even more remote sources. But the story is sufficiently rich to provide a gripping read. There will be a better book on Madoff, even if the full story may never emerge. But Arvedlund’s account, tantalising and entertaining, will do for the time being.

Madoff: The Man Who Stole $65 Billion

By Erin Arvedlund

Portfolio ($25.95)

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