Barry Ritholtz on Madoff

As usual, Barry Ritholtz gets it right:

http://www.ritholtz.com/blog/2010/03/what-were-the-actual-losses-in-madoffs-fraud/

Love the example about the trillion dollars. Doesn't it seem that "trillion" will be 2010's word of the year?

Nidal Hasan: What's Religion Got to Do with It?

Quick thought of the day:

People who focus on the Fort Hood shooter's religion are doing themselves as well as future crime prevention a disservice. For instance, what would we learn if we focused on Bernie Madoff's religious background? Nothing. In fact, by focusing on his religious background, we would spend less time on relevant issues, such as how to best prevent fraud for all securities customers. In addition, since we can't change someone's religion or legally discriminate against someone on the basis of religion, we cannot implement effective defenses against criminal activity even if we did find a high correlation between a person's religious background and a particular criminal act.

For instance, continuing the Madoff example, even if we find that high-level financial advisors happen to be Jewish (something I highly doubt), what do we do with such information? If we subject Jewish financial advisors to more scrutiny, all we're doing is making it more expensive for them to serve their clients. We're not actually preventing fraud or helping the general consumer avoid fraud.

In fact, focusing on a perp's religion is a triple-loss--it injects irrelevant data into an analysis, skewering any results; castigates religious practitioners who are innocent of any wrongdoing; and causes us to spend less time focusing on relevant data, which we could then use to create new, effective regulations or new methods.

More on Bernard Madoff

From Reuters: http://news.yahoo.com/s/nm/20090702/bs_nm/us_madoff_sec

Walker-Lightfoot, a lawyer in the SEC's Office of Compliance Inspections and Examinations, sent emails to a supervisor saying information provided by Madoff during her review didn't add up and suggesting a set of questions to ask his firm, the report said. One of Walker-Lightfoot's supervisors on the case was Eric Swanson...Swanson later married Madoff's niece.

My earlier article on Madoff's investors generated numerous comments on Seeking Alpha's website. Here are some quick responses to the comments:

1. Someone wrote, "If you were one of those who lost a lifetime's savings, your article would have a slightly different sentiment." Perhaps you are right; however, I diversify my investments and I buy investments available to the public. I do not and cannot invest in hedge funds or other non-transparent "clubs."

2. Two people have criticized my grammar and spelling--please point out specific mistakes. One person wrote that "investors like you and I could not get Madoff" should have been written as "investors like you and me..." I disagree, but I will check my Strunk and White manual later.

3. An anonymous person implied that I would feel differently had Madoff's investors been of a different religion, more specifically Islam. That's the kind of irrelevant, divergent thinking that Madoff's investors want to avoid if they want any chance of sympathy. People are upset because of perfectly rational factors:

a) Madoff's investors should have diversified their investments;

b) Madoff's investors are receiving special treatment from the government in the form of special tax breaks (paid for by general taxpayers) and more-than-usual government resources;

c) Madoff's investors are seeking to portray themselves as poor widows when most of them are probably still more affluent than 95% of Americans (take a look at Madoff's client list, and you'll see many trusts, private banks, foundations, corporations, and LLCs);

d) most Madoff investors would not have invested heavily with Madoff unless they believed he had an unfair edge or special connections unavailable to the public investor;

e) Madoff's investors believed Madoff was using investment strategies unavailable to the general public (they were right--it just wasn't the strategy they expected);

People are also upset because they see a fundamental shift in values. In the old days, the rich believed they had a duty to the public. They recognized that capitalism necessarily results in winners and losers, and the government could not solve the problems of vast inequality and disparate opportunities by itself. Look at Theodore Roosevelt, John D. Rockefeller, Jr., and John Pierpont Morgan. It's hard to remember now that J.P. Morgan bailed out the federal government, but it really did happen.

I'm not saying all rich persons have lost their moral compasses. Eli Broad, Warren Buffett, Ted Turner, and Bill and Melinda Gates are doing wonderful things, but most of us work hard every single day and will probably never be worth millions of dollars, or even one million dollars.

Most of Madoff's investors got to the financial promised land and squandered their chance at permanent retirement. They did so voluntarily--no one forced them to violate basic investing rules and to invest heavily with Madoff. Thus, it is hard to stomach the general media's sympathetic coverage of Madoff's investors when so many Americans are homeless, out of work, and live paycheck to paycheck.

[The original post is here.]

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.

Mark Cuban is Right about Madoff's Investors

As usual, Mark Cuban makes a fantastic point--this time, about Bernie Madoff and his investors:

http://blogmaverick.com/2009/02/21/was-madoff-a-better-investment-than-your-mutual-fund/

Basically, compared to the average investor, the Madoff investor might end up doing better. In addition, Madoff's investors will be getting tax deductions because of their portfolio "losses." Any way you dice it, Madoff's investors got about the same as the average investor over the last ten years. Yet, no one is trying to bail out the average stock market investor.

I said essentially the same thing here, but Cuban has more stats to support his view.

CS Monitor on Madoff

The CS Monitor has an interesting article on Madoff:

http://www.csmonitor.com/2009/0209/p15s04-wmgn.html

According to the article, Madoff's investors will probably not get a full bailout, but will be able to deduct their losses:

"I've been telling people to renounce their claims," says Robert Willens, a tax attorney in New York. Closing out litigation and other investor-protection claims, he says, opens the door to a "theft-loss" deduction. This lets investors recoup the entire loss minus 10 percent of their gross adjusted income. "Otherwise you'll only get pennies on the dollar," says Mr. Willens.

With the tax deductions, Madoff's investors will be paying fewer or no taxes. That means the Treasury gets less revenue in a year when it desperately needs more. Bailout or no bailout, Madoff has harmed the average taxpayer.

Tragically, some of Madoff's investors have committed suicide. The most publicized suicides during this recession have been rich people (Rene-Thierry Magon de la Villehuchet, William Foxton, et al), not middle class or poor people. That's party because hedge funds and feeder funds relied on a closed circle of affluent investors and connections to supply Madoff with fresh money. Still, it's surprising to see the uber-rich commit suicide, because even without their Madoff investment, they must have property or enough money to be middle class.

Madoff Investors and White Shirts

It's becoming fashionable for Madoff investors to share their stories. One investor, Alexandra Penney, shares her tale of woe here.

For the thousandth time, the lesson is “diversify”:

More than a decade ago, when I was in my late 40s, I handed over my life savings to Madoff’s firm...

It's also clear the elite were the ones connected to Madoff:

I was brought up in very comfortable circumstances in a Waspy Connecticut suburb. My mother was a descendant of Greek royalty, an intellectual grande dame who wore elegant shaded glasses. But my father, a Greek immigrant, was a product of the Depression. He was a smart, strict Harvard lawyer who had seen bad times...I asked around and talked to my smartest friends with Harvard and Wharton MBAs. There appeared to be a secret society of Madoff investors. A friend who was older, wealthier, and more established somehow got me in.

It's still difficult to identify with Madoff investors, partly because there's an element of self-exploitation involved. Ms. Penny, for example, uses her article to promote a sex book she wrote years ago. She also unconsciously reveals how insulated she is when she talks about her forty white shirts, ironed by an immigrant named Yolanda:

I wear a classic clean white shirt every day of the week. I have about 40 white shirts. They make me feel fresh and ready to face whatever battles I may be fighting in the studio to get the best out of my work.

The language is shockingly out-of-touch. "Battles" fought "in the studio"? Is she forgetting that Americans, mostly poor and middle class, are fighting real battles right now? Also, who has 40 white shirts? I'm an attorney, so I actually need white collared shirts. Yet, I own only three--one from Gap (GPS), one from Macy's (M), and another from Nordstrom (JWN). I also specifically look for "wrinkle-resistant" shirts to save money on drycleaning.

Other readers picked up on the "white shirt" phenomenon, too--here's a comment from "Hammett":

Hey, you're worried about clean white shirts. So, you're going to have to learn how to iron and stand there until your back hurts, like most people. That's life. Get off your [arse], and get to work. And stop feeling sorry for yourself.

More on Madoff here and here. Public outrage isn't going to go away anytime soon. Scott Burns, one of my favorite finance writers, received 3,000 emails/letters when he asked readers how Madoff should be punished. What do you think, readers? What would be an appropriate punishment for Madoff?

More on Madoff

A consistent 15% return over 25+ years, without any losses, is impossible without some illegal advantage, such as inside information. Thus, Madoff's investors could not have reasonably believed they were receiving 10 to 15% every year without some insider information. In fact, Madoff's position as Nasdaq chairman probably convinced investors they had access to information no one else did. Click on the link for more.

Madoff's investors should have diversified or at least done more due diligence. Their failure to follow the well-known and cardinal rules of investing--diversify and buy only what you understand--is the sine qua non of their current situation.

Also, most of Madoff's investors were not unsophisticated investors--most were educated, English-speaking, and affluent. This is why Madoff slept soundly at night--in his mind, even if someone invested a million dollars with him, s/he most likely had plenty of money left over. Madoff may have even believed himself to be a modern-day Robin Hood--stealing from the rich to give to the poor and the charities.

At the end of the day, the blame belongs on Madoff and the fiduciaries of charities and other entities who failed to diversify donor and investor money. Rather than excuse negligence, Madoff's investors should serve as an example to those who fail to diversify or who do not question impossible returns. Bailing them out would result in the following:

1. It would tell the world America will print money and devalue the dollar when its citizens--especially the rich and well-connected--make avoidable mistakes. If the Japanese, Chinese, Swiss, and British begin to question the U.S. dollar's integrity, it will be the beginning of the end for our entire country. We have major deficits and are currently dependent on foreign investors to finance our expenditures. When we have a surplus, we can afford to be generous. Right now, we can afford to be sympathetic only with our hearts, not with our wallets.

2. It would weaken faith in our country's sense of fairness. Any time a government gives money away arbitrarily, others not part of the largess rightly cry foul. What about all the other victims of investment fraud, like the Baptist Foundation of Arizona or Sunrise Equities Inc.? What about the mortgage brokers who ripped off ordinary Americans by submitting mortgage applications with false income information? (By the way, where's the perp walk for those people?)

To those of you who say I have no sense of compassion or morality, let me say this: if anyone ought to receive taxpayer money, it should be the families of Americans who were slain in Iraq. They are also victims of government inaction and negligence and have lost more than just money. The list of more deserving victims is endless, but if we go down that path, we will transform America into a land of sympathy-seekers, not strength. For a country that has been the symbol of hope for so many people worldwide, such an image shift is unacceptable.

Although I opposed the auto and bank bailouts, they will help hundreds of thousands of ordinary Americans who had little power to avoid their current situation. Auto workers themselves did not cause their current financial mess--the banks, their unions and the Big Three did. In contrast, Madoff's investors failed to do due diligence, failed to diversify, and/or must have believed Madoff had inside information. As a result, they do not have clean hands.

Regulations resulting from the Madoff scandal, if any, should focus on requiring nonprofits and other charities to publicly disclose (preferably on a website) more than just basic financial information. Even in the absence of a law, donors should ask charities and nonprofits to disclose not only their P&L statements and budgets, but also where they are holding donations, and what specific investments they have bought. As long as taxpayer money is not involved, some good may come of this yet.

More on Madoff here:

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

2. The one that started it all: Madoff the SIPC.

3. NY Times mentions Madoff (1/4/09).