The most aggravating factor with the Madoff scandal is that so many banking geniuses fell for it, says Josh Spero. It just goes to show that there’s no fraud like an old fraud
Bernie Madoff may have made off with $50 billion, but would the reaction in the press and throughout finance have been as fierce and wounded if it hadn’t been fifty billion of the smartest dollars in the world?
The Madoff fraud was so simple that – in our modern era of electronic billions appearing and disappearing on and off balance sheets – one is almost tempted to do a double-take. The Ponzi scheme, a pyramid of borrowing from new investors to pay old investors, the sort of thing rife twenty years ago in eastern Europe, could almost be thought unworthy.
When a fraud is being perpetrated on investors, it must be new and complex, perhaps involving new concepts like hedging and securitisation of collateralised debt. But this was really as simple as it seemed, borrowing from Peter to pay Paul – except the one borrowing was a popular country-clubber with a perfect record of modest returns.
These were not ordinary investors, which perhaps makes this more surprising. Whereas the financially naïve have been taken in with promises of limitless returns forever, no-one would reasonably have put Nicola Horlick in that category.
Her Bramdean Asset Management firm had nine per cent of its assets with Madoff. Horlick told the BBC that American regulators “have fallen down on the job,” the antidote to which (some might have suggested) was due diligence, when £21 million is at stake.
The largest of the large banks were not immune either: HSBC have owned up to $1 billion, RBS to $400 million. Nomura have said $300 million, BNP Paribas $460 million. Crowning the losses were hedge fund manager Fairfield Greenwich Group, with $7.5 billion.
Celebrities fell for Bernie’s charms too, which makes the tragedy all the greater – the fallen mighty (and their political allies) can shout much louder than the fallen poor. Steven Spielberg’s Wunderkinder Foundation, a children’s charity, has been badly hit. Media billionaire Mort Zuckerman and clothing tycoon Carl Shapiro are both said to have sustained large losses.
Perhaps this points to a fundamental problem with investment strategies: a base of trust is not sufficient. The trust which led people to invest with Madoff thanks to their social or cultural interactions was evidently misplaced, but how is it to be maintained or restored throughout the rest of the system?
Banks do not lend to one another at the moment (witness Libor) because there is no trust in the integrity of their assets, and no-one now could be blamed for losing what little trust lubricates finance.
The fraud only emerged when investors began to demand redemptions and Madoff admitted to his sons – both senior employees – that there was no money at all to pay out. He had – apparently – been planning to dole out the final $300 million to friends and family, a final feathering of the nest, but until this point, Madoff claims no-one else was aware of the fraud. The use of a three-man upstate New York accounting firm perhaps should have given a clue.
We have not been able to call bankers and hedgies ‘masters of the universe’ for some time now: their figleaves have long blown away and the phrase is only uttered in mockery. Each admission of new quarterly losses – somewhere north of a trillion and climbing still – is thought a final blow to their dignity, but the indignities keep coming. The Madoff scandal denudes them even further, if this were possible.
When a criminal is being sentenced, the judge can consider a range of aggravating factors relating to the crime – was it a racist attack? Was it committed in the course of another crime? The most aggravating factor with the Madoff scandal is that so many banking geniuses fell for it.