To Madoff's Investors: Welcome to Main Street

[On July 1, 2009, seekingalpha.com chose this article as an "Editor's Pick." On July 2, 2009, it became the fourth most popular article on seekingalpha.com's website.]

The WSJ is issuing more Madoff victim propaganda. It is interesting to see the WSJ advocating free markets while slyly supporting special treatment for rich investors who failed to follow basic financial advice. Remember: Madoff's investors only lost their life savings if they chose to violate Investment 101's cardinal rule: diversify, diversify, diversify.

In a free market, the rich must suffer when they violate basic investing rules. Otherwise, you don' t have a free market. Instead, you end up with two separate systems--one where the rich get preferential rules and use Congress and the IRS as their own personal insurance policies, and another where everyone else has to suck it up when things fall apart.

As I wrote before here, people who invested with Madoff thought they were buying membership into an exclusive club shielded from the vagaries of the stock market. Middle-class investors like you and me could not get Madoff as our financial advisor. Most of us did not even hear about him until the scandal broke. We were barred from Madoff's circle because we weren't rich and we weren't connected with the elite. Meanwhile, Madoff's investors lobbied hard to gain entrance into Madoff's circle and did so because they believed returns were practically guaranteed. Well, it was an exclusive group, all right--a group of connected, rich suckers who thought they were getting a sweet deal unavailable to Main Street.

Perhaps you think me coldhearted. Don't be naive. If it wasn't for the stock market's monumental, once-in-a-lifetime bust, Madoff's investors would have continued making good, safe, and illegal returns year after year. Madoff's investors would have continued playing golf, donating millions of dollars to charities, and hanging out on their yachts while Madoff wormed his way higher in the NASD's upper ranks. In short, Madoff's investors would have been seen as pillars of their community because they knew Madoff. Meanwhile, the rest of us--not having access to hedge funds or Madoff's exclusive circle--would have had to make it on our own the old-fashioned way: by saving our pennies and diversifying our investments (otherwise known as Investing 101).

What's that? You say not all of Madoff's investors invested directly with Madoff? And not all of them were rich? Fine. Go after the mutual fund companies that failed to do due diligence and violated their fiduciary duties to their investors. Last time I checked, mutual fund advisors get paid millions of dollars in fees to do research on suitable investments, not to find secret investment clubs and then spend the week playing golf. Main Street investors rely on mutual fund managers to check investments and make sure everything's on the up and up. Many people--not just Harry Markopolos--knew something was wrong.

Remember: not everyone invested with Madoff. Many people questioned his too-consistent returns, noticed his small, little-known auditing firm, and went the other direction. By bailing out Madoff's investors, we're punishing smart, ethical people like Harry Markopolos and rewarding unethical rich people who begged to be a part of Madoff's club precisely because it used techniques unavailable to Main Street.

First, let's put all of this in perspective: according to the NY Times (6/29/09), $1.25 billion has already been recovered for Madoff's investors. The WSJ (6/30/2009, A1) cites a similar figure:

Mr. Madoff's attorney, Ira Sorkin, said that Mr. Madoff was a "deeply flawed individual" but maintained that most of the fraud money went to other investors. He added that the $13 billion figure cited by the government as the net losses suffered by account holders since 1995 was overstated, since at least $1 billion in recovered assets will be returned to investors, and perhaps a lot more.

In addition to the to $1 billion, the SIPC has already approved almost $200 million for Madoff's investors:

SIPC has mailed out about $142 million in checks to eligible claimants, out of a total of $188.4 million that already has been approved. [See WSJ (Jane Kim, 6/29/2009, C1)]

The above figures don't include the special tax breaks Congress pushed through for Madoff's investors. Oh, you didn't forget, did you? Congress changed the tax rules to benefit Madoff's investors. (Don't you wish we could do that?) If the test of fair capitalism is whether the rich have to suffer when they make mistakes, America is getting a "D" grade--and I'm being a generous grader.

On top of the tax breaks given to Madoff's investors because of their losses, millions of dollars of taxpayer money is being spent on what is essentially a civil fraud matter. Many middle class and poor Americans suffer fraud at the hands of scam artists. When was the last time you saw local D.A.s and the DOJ spending this much time and effort recovering money for middle-class and poor victims? Where are the tax breaks for small businesses going bankrupt because of the ripple effects from the big banks and hedge funds? I am disgusted by the attention given to investors who were either too lazy to follow basic investing rules or so sophisticated, they had access to special investment vehicles. I am also sorry the WSJ is ruining its credibility by portraying all of Madoff's investors as poor, impoverished souls who bear no responsibility for what has happened to them.

There are no shortcuts. Madoff's investors forgot about that. Now they want us to cover their hides because their exclusive club didn't pan out? Sorry, I don't do handouts to rich people or negligent investors--especially not investors who knowingly violate basic investing rules and look for shortcuts unavailable to Main Street. Non-rich people who invested with Madoff through mutual and feeder funds need to look to the banks and insurance companies for recourse, not the taxpayer. You have my sympathy, but don't push it. Get a job and start saving your pennies like the rest of us. And welcome to Main Street. It ain't so bad.