Sunday, December 21, 2008

Madoff and SIPC

When you click on the SIPC website, you will see a pop-up screen for "Madoff claims." I've been reading stories about the hard-luck investors and charities that invested with Madoff everywhere. In fact, Saturday's WSJ could almost be called propaganda designed to convince readers to feel sympathy for Madoff investors (thank God for the James Grant article, which salvaged the issue). Don't fall for it. Most of these investors knew what they were getting themselves into when they invested with a hedge fund. As for the people who invested through a "feeder fund," they should blame their well-connected managers and leave Main Street taxpayers alone.

First, only sophisticated individual investors can invest with hedge funds. A hedge fund is a private investment fund open to a limited range of investors. Such a fund is less regulated and allowed to undertake a wider range of activities than other investment funds. Basically, the rich have created a separate avenue of investment designed to make them even more rich--or, in some cases, less rich. Hedge funds come with unique risks--and individual investors knew that going in. That's partly why few of Madoff's investors asked questions--a hedge fund is designed to be less regulated, so there's more allowances made for secrecy. Madoff operated as a hedge fund until 2006, when the SEC finally forced him to operate solely as a broker-dealer.

Second, you should always be wary when the government or the media says Wall Street should have more protection or attention than Main Street. Investors like you and me are limited to KKR Financial (KFN) or Blackstone (BX) if we want a piece of the hedge fund mystique. How are those stocks doing? Well, KFN is around 57 cents per share. BX is about $6/share, with a 52 week high of $23.87/share. In short, Main Street investors didn't do much better than Madoff's investors--and the SIPC isn't going to help us. Why should Madoff's investors--who already had access to a special fund--get special help or special sympathy? I don't see sob stories featuring Blackstone or KKR investors.

I am deeply concerned that taxpayer monies may be used to reimburse Bernie's rich investors more than the usual $500,000 SIPC coverage. Bernie's investors should receive half a million dollars each. I fear that Congress will increase or finance SIPC insurance, purportedly as a populist move (I can already hear the words, "For our protection")--and then make the increased limits retroactive. If that happens, taxpayers will be paying more bailout money, this time to sophisticated, rich investors.

Don't be scammed. Most Madoff investors were doing fine before Madoff, and they are still better off than 99% of the American population today. If they convince you otherwise, perhaps they really do deserve to be called sophisticated investors--after all, if Madoff's rich investors are smart enough to get reimbursed for 100% of their losses when they knowingly invested in a less regulated fund, the American taxpayer is indeed unsophisticated.

Update: Kathleen Pender of the SF Chronicle had a very comprehensive article about Madoff in the Chronicle's December 21, 2008 issue (page C1).

Update: Madoff's investors are already asking for a taxpayer bailout:

"There's no doubt that hearings will be held on this, and some government aid is a very logical request," said Robert Schachter, an attorney with New York-based Zwerling, Schachter & Zwerling, which is representing several Madoff victims. "If we're bailing out Wall Street and the auto industry, maybe these individuals should be bailed out too."

[Additional cite, Joe Bel Bruno, AP Business Writer]

More on Madoff here:

1. "Capitalism without Failure is like Religion without Sin"

2. Clark Winter on hedge funds, in The Either/Or Investor, page 88: (although the book was pre-Madoff scandal, it still has relevance to Madoff):

Hedge funds are basically nondirectional investments designed to take advantage of the indecision of markets. Once upon a time, you needed to be a millionaire in order to be qualified to invest in hedge funds--they are loosely regulated, and it is possible for investors to lose all of their money quickly if a manager's strategy goes only wealthy investors are allowed to use hedge funds as investment vehicles. But increasingly, institutional investors such as universities and mutual funds have placed a portion of their money with hedge fund managers, to their customers' benefit.

[on page 105] Wall Street's performance demands had gotten so out of line that some corporate chieftains could only make their numbers by faking them.

Update: It was only a matter of time--Madoff's investors have asked the 111th Congress for a bailout. The House of Representatives has obliged, and the House Committee on Financial Services is currently reviewing H.R. 2798. As of July 10, 2009, H.R. 2798 has not been submitted for a vote. You may write to the House Financial Committee using the following link:

Here is my letter, which you are welcome to copy:

Dear House members:

I am asking that you vote against H.R. 2798 or decline to submit the bill for a full House vote. The proposed bill seeks to bail out Madoff's investors under the guise of shoring up the SIPC. For example, SIPC members will only be expected to pay $1000 annually (up from $150 annually) into the SIPC fund. This amount is stunningly low, given that credit unions have had to pay millions of dollars to shore up their own version of SIPC, called the National Credit Union Share Insurance Fund (NCUSIF). Star One Credit Union, for example, will be assessed a $44.2 million charge to maintain adequate member protection. Thus, a revised annual SIPC fee of $1000 is laughable if consumer protection is the goal.

H.R. 2798 would be even more comedic if the money to expand SIPC protection wasn't coming from taxpayers. Unfortunately, because the SIPC has been woefully underfunded, if Congress passes H.R. 2798, the U.S. Treasury must issue loans to raise the SIPC fund's available credit from one billion dollars to $2.5 billion. As you know, the U.S. Treasury is basically the American taxpayer, so ordinary Americans and their children will be on the hook for this proposed bailout.

Most tragically, H.R. 2798's proposed penalties for white collar crime are too low at five years' jail time and a $250K fine. Such minimal deterrence will not protect the public against a future Madoff. Approving such low penalties post-Madoff may cause voters to wonder if white collar criminals have lobbyists. I would not want my name associated with H.R. 2798 in its current form.


Update: Click here for more on Madoff's investors.  It's titled, "To Madoff's Investors: Welcome to Main Street."

1 comment:

tfg said...

Excellent post, I've been thinking along the same lines. However, I'd wager that many of Madoff's investors were well aware that it was Ponzi and were anticipating a bailout. It's not exactly a novel concept.

BTW, I went to the SIPC site and saw the pop-up for Madoff victim claims. Where can I find the application for Bernanke and Paulson victim claims, becasue as a taxpayer, I'm in dire need of relief.