THE BOOK--Playing The Percentages In Baseball

That’s a good way of looking at it tango, but there’s just one point I’d like to make.

The people at the bottom of the pyramid (the ones who just recently invested with Madoff) are the ones who are screwed. If you just put your money in a few months ago, chances are you didn’t get anything and you lost your entire investment.

In fact, you don’t even have to be among the most recent investors. Let’s say two years ago you invested $1 million with Madoff. In each of those two years you earned a 15% return. You would have made $150,000 in year 1, then $172,500 in year 2 (assuming dividends reinvested at the same 15% rate). That’s $322,500 earned on a now worthless $1 million initial investment, for a net loss of $677,500, or 32%. In fact, if it paid out 15% annually, you would have had to have invested at least 5 years ago to break even.

I read somewhere that the fund returned something like 8% annually the last few years, so it would have taken even longer to break even, probably closer to 10 years ago

There’s no question that the newer investors get killed because they simply didn’t earn to even match their principal.  But, that MUST be the question to ask.  How long has Wilpon and Speilberg et al been doing this?

I heard from one of the Madoff investors on the radio (NPR) saying he was earning 15% a year.  I haven’t kept up with this in detail, and I don’t know if he fluctuated the returns based on the market. 

Nonetheless, before talking about “losing” money, you have to ask how much they earned too!  There are two equivalents:
1. “I won 10,000$ in Vegas last month!”
Yeah, but didn’t you lose 20K last year?

2. “We’re losing money!”, Bulls owner to Michael Jordan.
“But, what about the capital appreciation?”, Jordan’s reply.

If you only tell half the story, then of course it’ll look lopsided.

Ponzi schemes like this one remind me a little bit of our social security system, where those that get in early reap the benefits of those that come in later.  The structure is that of a pyramid, but when the top gets too fat the whole thing eventually collapses.  On the way to to collapsing, payouts for those at the top get lowered and buy in fees from those at the bottom get larger.  Hmmm.
vr, Xei

But isn’t it true that in ANY Ponzi scheme, the early arrivers make money, having been paid out of the capital of the late arrivers?

Still, I get your point about the early arrivers ... they didn’t necessarily lose money—they might have profited, or broke even.  They just didn’t make the 15% they thought they did, and all the disappointment came at the end when it was revealed that the excess returns over the years was just the return of their original investment.

Right, exactly.  The media isn’t reporting it right.  They are talking about “losses”, when they really don’t know how much each investor gained or lost.  And, the totality of all the investors only lost an amount that matches whatever Madoff claimed in compensation and expenses.  Whatever amount that is, I’m sure it’s not “billions”.

tango, re: your #2 post, one other thing to keep in mind is that the reachback period for fraudulent conveyances - which is what those redemptions or, as you say, dividends were since this was a ponzi scheme - is four years in new york state (iirc). and you can bet a bankruptcy trustee is going after them.

#3 Social Security in the US is only partially an investment system because it has (thank goodness) a strong redistributive element—high income participants put in much more than low income participants but each will receive similar benefits if they have been employed over a similar age span. Plus, the huge number of participants and the long investment time frame (I may start paying in at 20, but won’t be entitled to receive anything until I’m 65) means that relatively small adjustments to the pay in and pay out formulas if established far enough in advance can dramatically improve the long term viability of the system.

Tango, your first paragraph might be better worded as a comparison of the respective values of a package of diversified bonds offering a 15% interest rate and a package of diversified bonds offering a 7.5% interest rate. Your answer is a bit clearer stated that way.

Your basic point that evaluating any particular “investor” (or “patsy” as the case may be) losses from this scheme needs to take into account actual amounts they received back over the years is unquestionably true.  Although it raises an interesting question about how we regard “the investment principal” here.

I tell you I am going to invest your $50 for you and each year for 5 years I pay you $10, describing it as investment earnings on your money (a miraculous 20% rate of return) while in fact I am simply paying you out of your own principal.  At the end of the five years your actual account is empty at which point I fess up.  You had expected that your $50 principal is still sitting in the account but in fact I used it up paying you $50 over five years.  What is your loss?  I guess it is at least your opportunity loss of having been unable to put the money in a real investment for 5 years.  I put your $50 in an FDIC-insured savings account, and spent the interest on baseball cards for myself.  At the least I ought to owe you my interest earned, which I did effectively steal from you, given that you handed me the money in the first place on the pretext that I was investing it for you.  Indeed the interest earned and that I spent on baseball cards was really your money, the investment return that I promised you but that I stole.

Funny, I was thinking of starting a thread on Madoff.

The media has been reporting this as a “scam” and a Ponzi scheme.  I don’t think that is true.

A Ponzi scheme is typically something where the person who starts or operates it does no investing whatsoever.  He simply pays off people at the top with money invested at the bottom.  Either he is one of the top members or he takes money as a “commission” or he skims money, unbeknownst to anyone.  Eventually the “pyramid” collapses of course, and the guy skips town or goes to jail (or whatever).

This is a criminal enterprise perpetrated by someone who set out to deceive and defraud the “investors” from the outset.

(There are also “semi-Ponzi schemes” that are difficult to prosecute sometimes, like a lot of multi-level marketing schemes.)

This is what the media is making this Madoff thing out to be.

The reason that the words “Ponzi scheme” is all over the papers and the internet is because Madoff himself allegedly (according to the deposition supporting the arrest warrant) used those words when the FBI came to his apartment.  I don’t think he meant, however, that he purposefully started a phony investment company so that he could defraud investors and make money himself (which is what Ponzi scheme operators do).

I think that he was a legitimate hedge fund manager (if there is even such a thing) and this particular fund went bad because his investments started to lose money at some point because of the bad world-wide economy, the stock markets, etc.

For whatever reasons, he didn’t want to admit to his investors that their investments, that he was in charge of, were losing money, so he continued to tell them that they were making money, he phonied up statements, and he paid them their dividends.  I don’t think he intended to steal any money and I don’t think that he did.

Now, he may have still been taking a commission or paying himself a salary, which is essentially the same thing as operating a Ponzi scheme for the purpose of making money for yourself while the “investors” eventually lose their money.

But I think that he operated a legitimate investment group or hedge fund for a while, it went bad, and he didn’t have the guts or whatever you want to call it, to tell the investors that the fund was losing money.

The media is portraying this as a “scam” and a “Ponzi scheme” as if it was set up like that, and I think that this is simply not true.

I’m not making excuses for the guy or even claiming that he did not do something criminal.  It looks like he did.  I am just saying that the way all of the media is portraying this thing is misleading at best and flat out wrong at worst.

I don’t know whether he set it up to be a scam, but the accounting discrepancies evidently are egregious enough that the label isn’t misleading.

The fraudulent conveyance issue could get pretty ugly. If X pulled a million dollars out of Madoff’s fund in April and then puts it in Lehman Brothers, then X has the pleasure of losing a million dollars twice. Further with recent market events some of Madoff’s losses were legitimate, so figuring out an allocation of losses between legit and illegit will be necessary, and that could be a nightmare that makes Win Shares a walk in the park.

I still don’t see where the “cheating” is.  Last night on CNN, one of their financial commentators said something like, “No one knows how long this cheating has been going on for.” That is a typical media comment.

If I run a hedge fund and for whatever reason the investments are bad in any time period, but I tell you that you are still making money, where is the “cheating” and theft?  There is fraud and criminal activity there, especially since I am probably doctoring the books and statements, but I have not stolen any money from anyone.  You, as an investor, lost money legitimately, and I just didn’t tell you about it.

The media is NOT making that clear to the public or they don’t get it themselves, or both.

Now…

It also looks like in order to hide the fact that the fund was losing money, he was actually paying investors dividends and even cashing out some investors, all with money that they did not actually have at that point or earn.  So, from that standpoint, he was stealing and cheating from some investors (the one at the “bottom"), and giving that money to the investors at the top.

There really weren’t “top” and “bottom” investors, I don’t think.  Whoever wanted to remove their money probably got their entire principle back and everyone probably was receiving dividends, or they were re-investing these “phony” dividends.  And of course, what was happening was that the withdrawals and all the dividends were actually coming from everyone else’s principal.  So for anyone who had money in the fund, their principal was shrinking a lot, due to legitimate losses AND due to the fact that Madoff was using principal to pay investors their dividends and to pay them their entire principle when they cashed out.

So again, I say, unless Madoff was siphoning off money for himself and spending it, all the feds have to do is to find out who was collecting dividends and who cashed out, and how much of that cash out and those dividends were phony, get the money back, and redistribute whatever is left (which should be everything that was invested minus legitimate losses and expenses).

No one should be out any money that was not legitimately lost in “bad” trades or positions.

Again, this is NOT the classic for-profit (for the guy that starts and runs it) Ponzi scheme.  Not even close.

MGL,

first, since we’re talking about accuracy here, madoff was not running a hedge fund. second, while it’s nice to say “all the feds have to do is to find out who was collecting dividends...and get the money back”, the problem is that it seems pretty likely, based upon questions about the legitimacy of his reported earnings going back to at least 1999, that a good portion of these questionable “dividends” were distributed prior to the reachback of the statute of limitations (which, as i previously posted, i believe to be four year in NY). there are some people who probably made out like bandits in this and are legally untouchable.

I don’t really expect them to be able to “take back” money that has been paid out to investors.  For one thing, they would have to show in court that they were not entitled to that money.  And someone with standing (like any of the investors who lost money) would have to sue.

No doubt it is a quagmire which will take years to clean up, and I doubt that it will ever be fully “cleaned up,” whatever that even means.

But my point remains the same no matter how I or anyone couches it or argues the nuances.  The media is clearly making this out to be an “intentional” Ponzi scheme by a scam artist.  In fact, the media appears to have no idea what actually happended.  They all hear the words “Ponzi scheme” and “scam” and “cheat” and they run with it without actually bothering to find out what allegedly happened.  The media in general knows as much about finance and investments as they do about sabermetrics.  That is true of many of the so-called financial experts for the various media outlets, like CNN and Fox.  Those people are like the Steve Phillips and Buster Olney’s of sports. They have lots of “knowledge” but little idea how to apply it.

Anyway, that is all I have been hearing and reading.  How Madoff operated a “Ponzi scheme” and “scam” for 10 years.  There is no evidence that I have seen or heard that indicates this was an intentional scam or Ponzi scheme.  As I said, it appears to be something completely different, even though the end result is similar.  It appears to be a legitimate “fund” (and BTW, I am not aware that there is any technical definition of “hedge fund” other than a bunch of money that someone collects from investors and uses to invest in or buy and sell all kinds of securities, which is largely unregulated, and which usually requires a large investment and usually has a limited number of investors) that did poorly and the person who ran the fund concealed that from the investors for some time (for whatever personal reasons), by phonying up records and statements and paying out dividends and cashing people out, using monies that those people did not actually earn (the money came from other investors’ principles).

Here is a typical quote from an AP ESPN article about Madoff and Wilpon, the Mets owner:

Bernard Madoff may have stolen $50 billion from clients

Talk about irresponsible journalism…

Larry, I am not suggesting that anyone who was paid or withdrew their money did anything criminal and that is why they might have to give it back.  There are no allegations that I am aware of that anyone other than Madoff did anything wrong.  The investors who lost money would presumably be able to sue those investors who received undeserved dividends or withdrawals, based on the theory of “unjust enrichment.”

As far as a SOL (statue of limitations), I don’t know about federally, but in some jurisdictions, the SOL is tolled (does not run) until the crime is discovered.  Otherwise embezzlement or fraud that is not likely to be discovered for many years would be an attractive crime…

you don’t seem to be that familiar with the applicable law here. the theory would be fraudulent conveyance, not unjust enrichment. and, yeah, someone with standing would have to sue. like the court-appointed trustee. the bayou case, while a little different and (apparently) on a much smaller scale, is the general template for what will happen.

they’ll run into a slight problem with tolling the fraudulent conveyance reachback considering the standard is due dilligence would have revealed the fraud and there have been published articles questioning the stated returns dating back to at least 2001 and some institutions who did do due dilligence chose not to invest because of the innumerable red flags. the basic point is that you’re incorrect that no one will have gotten “cheated” - those who pulled out years ago (sources are now saying that the fraud dates back twenty, not ten, years) will have made out and those who didn’t will be cheated. as happened in the bayou case, some even had to return “principal” that was returned to them. and that’s not even getting into all the fun fees they’ll be paying to lawyers and accountants for the wrangling with the government, trustees, madoff, third parties, etc. to get “their” money back. nothing like trying to get the IRS to return taxes you paid in the 1980s - good luck with that!

this holman jenkins column does a pretty good job of putting the Madoff “ponzi scheme” in perspective.

http://online.wsj.com/article/SB122947442947812429.html

Yup, #16, thanks for the link. That is literally the first article I have read or heard of that seems to be speculating (on what actually happened) correctly. In fact, the author says exactly what I have been saying in this thread.

The other thing that is annoying about the media (and the talk show hosts), is their indictment of the SEC for “not doing anything about this for years.” Perhaps they can do a little research on this before they declare that the SEC “failed the investors” by abdicating some kind of oversight that they were supposed to be doing with respect to this “fund.” I don’t know whether they did or did not (abdicate responsibility), but I think neither do these media people.  This was obviously not a mutual fund or something like that, which should and does (presumably) get maximum scrutiny by the SEC.  I don’t even know whether this kind of fund (I called it and heard it being called a “hedge fund” but someone above disputed that notion) is registered with the SEC, and even if it is, clearly it did not get the kind of scrutiny and regulation that a more mainstream fund (like a mutual fund) would get, right or wrong.  In fact, isn’t that one of the characteristics of a “hedge fund” and something that investors know or should know going in (less regulation and scrutiny)?

And let’s not lose sight of Tango’s original point, which was a good one.  Lots of people are complaining about how much money they lost (some people are claiming that they lost everything).  What about all the people over these 20 years who got high dividends and/or withdrew all or part of their money?  Have some of these people who are complaining that they “lost everything” already received 100 or 200% return over the years, but their original principle is now gone?  If I were them, I would not be complaining too much…

Another one from Ken:

http://online.wsj.com/article/SB123128761903059219.html

I have no idea what this guy is talking about (the above article).

As usual, they are a little on the slow side, but the AP is finally realizing what was obvious to Tango from the start.
http://finance.yahoo.com/news/Doubt-cast-on-50-billion-apf-14563063.html

Instead of talking about baseball, maybe Tango, MGL, and some of the prominent commenters here should be running a hedge fund.  Or in charge of the SEC.

Nah, baseball is more fun.