I’m slightly over halfway through Too Good To Be True: The Rise and Fall of Bernie Madoff. It’s written by Erin Arvedlund, an investigative journalist who wrote an article for Barron’s about him in 2001. Note: Madoff was not arrested until December 11th, 2008. Had I known about him before reading this book, I would instead have chosen to read the book by Harry Markopolos, No One Would Listen: A True Financial Thriller. Markopolos started trying to prevent the coming tragedy starting in 1998, and he was truly a voice crying in the wilderness.
As I said to Fakesister yesterday in our weekly chat following the NY Times crossword puzzle (P.S., Fakesister, we missed two letters…it was that damn Japanese tourist town that did us in), I wish Ms. Arvedlund had written from more of a “layperson” perspective. She assumes a basic understanding of the terminology of trading and financial management, which I don’t have. I have picked up a few things…in fact, I’ve learned quite a lot…but I’m not reading the book for tips on how the system works, or how to manage money (or steal it). I was interested in the psychological perspective. Like: why did he do it? And how did he get away with it for so long? And his “investors”: what were they thinking? (I put investors in quotes, because Madoff never invested a single dollar he was given.) It seems very unlikely I’ll ever have the real answers to any of those questions, nor will anyone else. You can talk around the edges of the thing, but it turns out to be like the fable of the blindfolded men trying to describe the true appearance of an elephant.
So here’s what I’ve learned so far: Bernie Madoff started his business as a legitimate stockbroker-dealer (i.e., he was licensed), and to do so, he borrowed $50,000 from his father-in-law. He was very successful. So his father-in-law started telling everyone he knew that they should give their money to his genius son-in-law. Only here’s the problem with that: from the minute Madoff accepted any money from anyone that he was holding for longer than it took to execute a trade, he was breaking the law. To accept someone’s money to invest as you see fit, you have to be licensed as a financial advisor…or as a bank. He was neither, and he knew it, so that at least answers the question about whether or not he did this innocently to help out his family and a few friends. There was nothing innocent about it, even from the beginning.
One of the most interesting parts of the book is the historical aspect–how trading used to work, and how it’s changed. The formation of NASDAQ for example. Madoff was one of the first people to use computers, and that’s what initially gave him such an edge. Think about it this way:
You used to get up in the morning and read the Wall Street Journal over coffee. You would say, Hmmm. That looks like a good price for IBM. And prices are quoted only once a day–at closing, I assume. You ring your broker (on the telephone–remember them?) You say, buy me 2,000 shares of IBM. Your broker calls a trader on the floor of the actual NYSE–which is the only way to do it. Sometime that afternoon, your broker calls back to say he got it done, maybe at the price you wanted, or maybe not (although you could instruct him not to buy if the price went above X), because the reality is, the price has fluctuated 782 times during the day. With computers, you could see the price fluctuations in practically real time, and therefore you had a huge advantage and did better for your customers than others doing business the “old” way. I may not have this exactly right, and in fact, I’m simplifying even what I understand.
But the time came when everyone was using computers, and certain practices changed, and the bottom line was that Madoff was no longer on the cutting edge. His profits started to go down. In the beginning, he was making such a killing in his legitimate business that it was no skin off his back to share the 15-20% return he “guaranteed” on his illegitimate “advisory” business with his “investors”. So then, to keep up the “guarantee”, he basically was paying you your “returns” with your own money. That only works, of course, if you never ask for your principle back. Then the money ran out, and in order to pay existing “investors”, he had to get new “investors”, so there seems to have been a progression toward a true Ponzi scheme.
There is much, much more to the situation, but in the end, you can’t help but be fascinated by a story of the greatest thief ever (that we know of, so far). As I said, I haven’t even gotten to the part in the book where Harry Markopolos’ role in the story begins, but my suspicion is that the SEC is going to be a villain at least equal to Madoff himself, and in my worldview…greater than Madoff. Let’s face it–it’s the job of the outlaw to try to avoid capture. It’s the job of the enforcers to catch you anyway. How could they be that stupid for ten years?
Put it this way: if I ever decide to become a criminal, I’ll seriously try to avoid coming to the attention of the FBI. The SEC? I think I’ll just whistle a happy tune.