Monday, March 2, 2009

Madoff: Social Security for Fat Cats Goes Bust

HOW MADOFF DID IT AND WHO BENEFITTED

Uncle Bernie Madoff allegedly had a great social security program for the financially well-off. While they were earning the big bucks they'd give millions to him. He'd report growth on these investments of twelve percent a year or more. Every reporting period he'd check which stocks and options went up a lot (or down a lot) and pretend to have bought puts and calls and shares of them. Even a fool can pick the winner after the game! But Madoff was no fool. He had his own brokerage firm and could easily create the trade tickets, after the fact, to document the gains.

If you saw CBS 60 Minutes last evening, you have a better idea of what he did and how.

Madoff and his family, and the network of financial advisors and feeder funds who earned big fees steering eager clients and funneling investment money to him, spent their share of the money on the good life.

Meanwhile, his clients, when they were no longer earning the big bucks, were able to draw whatever money they needed out of their bloated accounts to continue their posh life styles. On their death beds they'd advise their wives (and girlfriends :^) to leave their money with Madoff and draw millions a year for the rest of their lives. The inflow of cash from new investors was more than enough to pay off those who cashed out. Many of the early clients probably received far more from Madoff's social security program than they ever put in. Much more than had they put their money into CDs.

Of course it all came to an end with the recent market crash. Lots of his clients need to cash out and few new ones had the cash to put in. OOPS!

WHAT DOES THIS REMIND YOU OF?

Uncle Sam has a similar program for us ordinary folks. Social Security was great for my grandfather who was near the end of his working career when it started. The rates were low because there were over 150 workers putting in for each beneficiary taking out. He told me he put a few hundred bucks in and collected thousands by the time he passed away at a ripe old age.

My mom and dad also did well. He worked for the post office and, at the time, did not pay into Social Security because the government had their own pension plan. After he retired at an early age and started drawing his post office pension, my dad took a job in the private sector and put enough money into Social Security to qualify as a "double-dipper" when he finally retired for good. My mom worked most of her life "off the books" in my grandma's knitting shop. Then, in her last working years she took a job and paid into the Social Security system to qualify for benefits when she retired for good. During the few years my mom and dad were paying in, the rates were low because there were over ten workers for each beneficiary. Mom and Dad lived long lives and took way more out of Social Security than they ever put in.

My wife and I paid into Social Security our whole working lives. During that period there were a bit over three workers paying in for each person collecting, so the rates paid by us and our employers out of our real earnings were high. We've put over $300,000 into the system. Had that money been invested in CDs they'd be worth about three times as much now. Had we used that money to directly pay our grandparents and parents Social Security benefits the CDs would have still been worth around twice what we and our employers put in.

But, the government took all that money from us and our employers and almost immediately paid it out to beneficiaries. It is unlikely my wife and I will ever break even with Social Security.

Our daughters and sons-in-law, and their employers, have been paying in at high rates since they've been employed. During that time the rates have gone up as has the age to qualify for payouts. I do not think they will ever get their money out. It is a sucker's investment and I doubt anybody in his or her right mind would pay into it if it was voluntary.

WHY DIDN'T THE SEC CATCH MADOFF BEFORE HIS SCHEME WENT BUST?

On the 60 Minutes program last evening, you saw Harry Markopolis recount how he had alerted the SEC multiple times. While working for a competitor firm to Madoff's, he said he figured out Madoff must be a fraud in "five minutes". It only took him a few hours using math models to confirm his hunch. Of course, now -after the game and we know Madoff was a fraud- it is so obvious!

According to the Markopolis 2005 Statement to the SEC, he had alerted the SEC early as 1999 (on Clinton's watch). On the CBS progam, he mentioned alerting them several times between 2000 and 2007 (on Bush's watch). I am no financial wizard, but, as I read the Markopolis statement, all he had was something called Mosaic Theory. In his SEC statement he raises a bunch of what he calls "Red Flags". I read through the Red Flags and none provide any evidence beyond statistical math model generalizations and speculation. Markopolis says (unnamed) senior managers and heads of Wall Street equity derivative trading desks privately agreed with him that Madoff was a fraud. However, Markopolis admits he has no "whistleblower or insider" contacts who would know exactly what was going on or have any documentary proof. He also gave his information to a reporter for the Wall Street Journal but his proof was not good enough for them either.

Of course, in retrospect, he turned out to be totally correct. Had someone at the SEC or WSJ followed through, they could have become famous and saved a lot of people lots of money, but they did not.

LET'S INVESTIGATE !

Imagine you are a civil service lawyer or accountant working for the SEC and you are put on the Madoff case after several tips come in that "it is too good to be true". (Remember you are a civil servant -your main job is to show up every working day and not make waves- if you were highly competent and aggressive you'd probably be working for more bucks in the private sector :^)

OK, so you go to investigate. You are welcomed into opulent headquarters and shown reams of (fake) data that looks good because Madoff has his own brokerage firm. You are shown audit reports from Friehling & Horowitz, a small CPA firm -not one of the big ones- but they have a good record, and, after all Enron was audited by big Arthur Anderson and look what happened with them! Madoff tells you he makes money when the market goes up and when it goes down, but he can't make money when it stays flat. Sounds like a good story.

You are shown a list of big time financial advisors, feeder funds and clients from the New York City area, Palm Beach Florida, Greenwich Connecticut; and all over Europe who vouch for Madoff. None of Madoff's clients have complained -not a single one- they are all deleriously happy with their investment results.

Look, there are nine accounts held by men named "Ira":


IRA LEE SORKIN 10 VANAD DRIVE EAST HILLS, NY 11576
IRA M RUBENSTEIN CPA MANAGING PARTNER ERE 5TH FL 440 PARK AVENUE SOUTH NEW YORK, NY 10016 08012
IRA PITTELMAN 1385 YORK AVENUE APT 29-B NEW YORK, NY 10021
IRA S SKLADER 6600 LYNDALE AVENUE SO #1307 RICHFIELD, MN 55423
IRA S SKLADER 8143 RHODE ISLAND CIRCLE BLOOMINGTON, MN 55438 01152
IRA SCHWARTZ C/O HAROLD SCHWARTZ 989 SIXTH AVENUE 7TH FL NEW YORK, NY 10018
IRA SCHY OR ROSE SCHY J/T WROS GUILDFORD E #3073 BOCA RATON, FL 33434
IRA SIFF 211 EAST 11TH STREET APT 9 NEW YORK, NY 10003
IRA SKLADER GAIL SKLADER JT WROS 6600 LYNDALE AVENUE SO #1307 RICHFIELD, MN 55423
One client even has a home in The Villages, FL, the retirement community where my wife and I live and that is well known for attracting the best and the brightest:


JOHN FOGELMAN AND ROSALIE FOGELMAN TTEES, JOHN & ROSALIE FOGELMAN RV LV TST 1556 LYMAN WAY THE VILLAGES, FL 32162
Fortunately, Uncle Bernie has not Madoff with any of my money, though I wish I had enough to have qualified!

And, what a list of clients! The cream of the crop of the rich, many are famous, and most of them are Jewish. Markopolis said Madoff was running an "affinity scam", preying on his own kind.(Archie Bunker famously said "Them people really know how to handle money." Well, he was wrong about some of us, at least :^)

You show the information about Madoff and the client list to your superior at the SEC. He checks and Madoff is a big time political contributor, as are many of his clients. Most to Democrats but a bit to Republicans as well. If we go after him will it look like we are on a political mission? And, he is well respected among business associates. For God's sake, he was formerly Chairman of the NASDAQ. The National Association of Securities Dealers Automated Quotations is an American stock exchange, the largest electronic screen-based equity securities trading market in the United States.

So, what would you do if you were at the SEC? (Or the WSJ?) I think I'd put the tips down to jealous competitors and apply manpower to more pressing matters. That is exactly what they did.

BOTTOM LINE

The government cannot do much right. I'm not sure I'd want to live in a country where the government had access to the internal data of every company that might be planning or executing a scheme. Even if they had access to all that information, I don't think the kind of people who tend to work as civil servants would recognize such a scheme even if it fell on their heads.

So, Madoff and probably some of his relatives and/or others who can be proven to have known they were running a Ponzi scheme will spend some time in jail and lose most of their wealth. Clients who lost big bucks in the scheme will sue the financial advisers and feeder fund managers for lack of due dilligence, gross negligence, failure of proper risk management, and so on, and some of them will probably have to pay up, at least a bit.

I have trouble feeling sorry for most of the rich victim clients and financial advisers and feeder fund managers. My sympathy is with the poor folks who depended upon the mainly Jewish charities that invested heavily with Madoff. Those charities have lost much of their money and their poor clients will have to do without, through no fault of their own.



Ira Glickstein

9 comments:

JohnS said...

I am reading a book, Life Without Lawyers by Philip K. Howard. The book is not what the title implies, rather it discusses how th threat of a law suit has stiffled our freedom to act. One chapter discusses responsibility in Washington in which he discusses Washington beaurcracy. His point is beaucracy prefers the status quo. Inovation is frowned upon. Thus Washington will never catch a Madoff.

Ira Glickstein said...

AMAZING: Do a Google on "Markopolis 60 minutes" and our TVPClub Blog comes up on the first page. (At least around noon today.)

I discovered this by clicking on "Watch In Real Time" in the "Live Traffic Feed" gadget. Someone in the United Kingdom did a Google search on "markopolis 60 minutes" and found us and landed here this morning.

This reinforces my hopes the biosphere (and associated Internet) has some sort of Global "Consciousness". CBS 60 Minutes features Markopolis last night, I post a Topic on it this morning, and someone in England Googles and locates my posting. WOW! The World is really Wired!

Ira Glickstein

PS: Though only a few of us post Topics and Comments here (I wish more did) we are generating about a dozen visits a day from all over the US and the World. We have lots of "Lurkers". If you have the time and inclination, try clicking on "Watch In Real Time" in the "Live Traffic Feed" gadget. You should see yourself on top or nearby. I find it interesting to see how people find us, what they are searching for, what Topics attract them (emulation vs simulation is popular - go figure! Also the global warming and arctic sea ice stuff).

Violet Glickstein said...

Ira - Some problems with what you have said. First of all you say we (Vi) contributed $300k to SS which we could have put into CDs and would have doubled. Well what if we had put it into stocks instead, where would we have been? Or G-d forbid with someone like Madoff (BTW I would never have let that happen). SS seems like a much better investment to me.

Second the so-called trading tickets which Madoff supplied when asked should have been checked by the SEC to an actual trade with the company listed on the trade! Every buy/sell of stock has a basis in the company that generated that stock. Apparently nobody at the SEC had enough knowledge or desire to check this based on Markopolis' info. But then we know that appointees and those hired for govt agencies had their ideologies checked more than their CVs. So not a big surprise.

Somebody at the SEC should have been qualified to understand what Markopolis had worked on.

Ira Glickstein said...

Good question: "...you say we ... contributed $300k to SS which we could have put into CDs and would have doubled. Well what if we had put it into stocks instead, where would we have been?..."

Well, the Dow Jones average was around $700 in 1960 when I started my professional career, ~ $750 in 1970, ~ $850 in 1980, ~ $2700 in 1990, ~ $11000 in 2000, and is ~ $6700 now. So, had we and our employers invested our Social Security in the Dow Jones average (rather than CDs as I suggested in my original Topic) , a lot of it would have grown by a factor of 9 to today, some by a factor of 3, and some would have lost nearly half. I haven't run the numbers, but I think now, even at what we hope is the bottom in the stock market, the average growth would have been more than the rates paid on CDs over that period. So, we would have had more than three times what we put in.

Ira Glickstein

Ira Glickstein said...

Does Madoff have a deal with prosecutors to spare his family jail time and keep all or part of their fortunes? He will spend the rest of his life under house arrest in his expensive apartment and then in one of the country club jails reserved for non-violent inmates - but what about his wife and sons who were in the business?

I think it would be a "moral hazard" for the prosecutors to allow Madoff's family to retain the rewards of his Ponzi scheme in return for his guilty plea and cooperation in recovering assets that are probably squirreled away all over the world. I am all but certain they did know, but, where is the proof? Absent an insider's testimony, only Madoff knows for sure and he has no reason to tell.

Did some of his employees know? He claims he hired low-level clerical workers unfamiliar with financial matters to do the back office work. They will claim they just logged investments, added the supposed profits as Madoff instructed, and made payouts. Why would any of those employees confess to knowledge of the scheme?

So where does that leave the investors who had around $64B in their bloated accounts last November? Well, only about $25B was actually invested over the years, and many billions were paid out to early investors. Still more went as fees to the feeder funds and financial advisors who induced the clients to invest. Can some of this money be recovered and divided among cheated investors?

Probably not from the clients who may have profited, but I think some feeder fund managers will be sucesfully sued for lack of due dilligence.

Prediction: Madoff's family will give up some of their fortune but will remain out of jail. Some feeder fund managers will make deals with their clients to avoid being sued. Government prosecutors will recover a couple billion in Madoff assets for distribution to cheated clients. Madoff will write a successful book about his scheme and smile about it all as he is interviewed in jail on 60 Minutes.

Ira Glickstein

Paul T Horgan said...

You make good points. However this does mean that in addition to having companies that are 'too big to fail', the USA has companies that are 'too big to be dishonest', well Worldcom and Enron have disproved that.

The clearest alarm bell should have been the Auditor, as they were effectively the first line of defence for the investor. If the SEC had determined that the auditor was a one-man-band with no peer-review and had stated that it did not conduct audits, then the rest would have quickly followed.

Given that Enron's fraud was allegedly sustained by the Auditors (where are Andersen now?), the first port of call for this and all future investigations *must* be the conduct of the auditors.

Ira Glickstein said...

Welcome Paul, and it appears you are posting from Salisbury, Wiltshire in the UK. Thanks for your comments.

Perhaps auditors should be paid in stock of the company they are auditing with a proviso they can't sell the stock for five years. With some of their own "flesh in the game" they might be more careful about the job they do!

Back last November I proposed some Changes that included paying high execs and stock rating companies in the stock and financial instruments of the companies they were managing or rating with a similar hold for five years proviso. With the Madoff scandal, lets add the auditors!

Ira Glickstein

Ira Glickstein said...

The just-announced 150-year sentence for Madoff is mostly-symbolic, but well-deserved. I wonder what sentence will be appropriate for "Uncle Sam" when the Social Security ponzi-scheme goes bust?

In addition to Madoff, I hope the financial advisors who funneled money into his scheme -and got rich on commissions- also end up in jail. They had a fiduciary interest and should have known it was all "too good to be true".

Special punishment is due the financial advisors for the many (mostly Jewish) charities that lost millions. The poor folks dependent upon the charities are helpless through no fault of their own. The poor who depend upon charity have no other assets, unlike Madoff's rich victims.

Ira Glickstein

Ira Glickstein said...

Mark Madoff, Bernie's older son, committed suicide today, two years to the minute and hour of his father's denouement.

Bernie Madoff, from jail, will probably fault his son for being weak.

Perhaps Mark Madoff is the only one who has any shame in that family. It gauls me that Bernie Madoff's wife and brother and remaining son, who almost certainly knew of the scam, or should have known, are still living at a high level of luxury.

Ira Glickstein