Posts filed under “Mathematics”

What Were the Actual Losses in Madoff’s Fraud?

Here is a deceptively complex and subtle legal question involving Ponzi schemes and fraud: What are “losses” in the legal sense of the word? The question arises in the case of Bernie Madoff, whose offices cranked out account statements like they were junk mail.

As it turns out after the fact, that was all they were — merely junk mail. And that key fact is the major determinant of what the actual losses were.

By the end of his multi-decade fraudulent run, the final account statements (November 30 2008) issued to all his “clients” totalled the sum of $73.1 billion dollars. The people conned by Madoff believed they were worth a collective $65 billion dollars more than their accounts were worth.

The initial amount of cash put up: ~$20 billion dollars, beginning in the early 1960s and continuously from there forward.

The bankruptcy court in this case made the basic determination that the losses were ONLY the cash that was initially given to Madoff & Co. The extra $45-50 billion was a fictitious part of Madoff’s fraud. Therefore, it represents funds that were not actual investment losses, and are not covered by SIPIC insurance:

The key passage the bankruptcy judge issued was:

“Given that in Madoff’s fictional world no trades were actually executed, customer funds were never exposed to the uncertainties of price fluctuation, and account statements bore no relation to the United States securities market at any time. As such, the only verifiable transactions were the customers’ cash deposits into, and cash withdrawals out of, their particular accounts. Ultimately, customer requests for payments exceeded the inflow of new investments, resulting in the Ponzi scheme’s inevitable collapse.”

. . . At bottom, the BLMIS customer statements were bogus and reflected Madoff’s fantasy world of trading activity, replete with fraud and devoid of any connection to market prices, volumes, or other realities.”

Here’s the New York TImes:

“Losses should be defined as the difference between the cash paid into a Madoff account and the amount withdrawn before the fraud collapsed in mid-December 2008 . . .

The total of those account balances — the wealth investors believed they had saved — was nearly $65 billion, by far the largest financial fraud loss in history. But those statements “were bogus and reflected Madoff’s fantasy world of trading activity,” Judge Lifland wrote in his opinion. As such, they cannot reflect legitimate “securities positions” on which claims can be based, he said. As such, they cannot reflect legitimate “securities positions” on which claims can be based, he said.

Judge Lifland endorsed the approach of the Madoff trustee, Irving H. Picard. The differences between how much investors put into their accounts and the amount they took out are “the only verifiable amounts” reflected in the Madoff firm’s records, Judge Lifland said of that method.”

This approach makes sense.

Consider for a moment if some future Madoff wannabe had a Ponzi scheme even bolder, and their final statements were trillions of dollars, on returns of 100% a year — not 12%. The final amount is merely a fantasy number, how much the victim of the fraud erroneously believed they had. Their expectations of riches were the product of the scam, not based on real securities.

Any other decision leads to potential absurdities created by the reliance on entirely fabricated accounting entries. The number based on accounting fraud does not represent an actual loss — only the amount the victim was scammed into believing they actually had.

Its sad, but true . . .  The judge seems to have made the difficult — but correct — call here.


No. 08-01789 (BRL)

Madoff Judge Endorses Trustee’s Rule on Losses
NYT, March 1, 2010

Category: Legal, Mathematics, Psychology

More WSJ Errors: This Time, Its Math

Last week, we discussed a highly politicized, misleading front page article about new bank rules (WSJ Jumps the Shark). If you recall, that story included a large chart showing much various banks declined, in dollar and percentage terms. Turns out the data was wildly wrong. The Journal ran a milquetoast correction, under the heading “Corrections…Read More

Category: Financial Press, Mathematics

How Many Quants Does It Take to Screw in a Lightbulb?

Matthew Greenfield of StoneWork Capital answers the above question thusly: “Using ten racks of co-located blade servers, one quant can detect a janitorial inefficiency, step in between janitor and light fixture, and screw in 49,500 bulbs in less than a millisecond, keeping five hundred lightbulbs of profit. Two quants competing with each other can screw…Read More

Category: Humor, Mathematics, Weekend

Help Wanted: Quant for Model Development

A successful fund manager friend is developing a new Model for running assets. He has a solid math background, but needs a good quant to help him develop and refine his approach. He is looking for two people — a college grad/student, and a PHD mathematician. They run a variety of different types of long…Read More

Category: Mathematics

Statistics: Scientific Consensus on Climate Change?

One of the memes I’ve heard recently in the climate debate is that there is no scientific consensus — that there is actually strong disagreement. The main basis of this argument is that 31,486 dissenting scientists have signed a petition against the belief that Global Warming is man made at the I don’t want…Read More

Category: Mathematics, Really, really bad calls, Science

Fox News (Chicago) Makes the Best. Pie Chart. Ever.

Fair & Balanced? Not exactly. Mathematically competent? Not one tiny bit. > Hat tip Flowing Data ~~~ Update: Here is the Video (Nov 23)

Category: Financial Press, Mathematics, Politics, Really, really bad calls, Television

Site of the Day:

> Some good learnin’ here: This web site stems from a personal interest in critical thinking and is a collection of links to articles and sites pertaining to numeracy and critical thinking. Links should be good for at least the date posted. After the posting date, link reliability depends on the policy of the linked…Read More

Category: Mathematics, Really, really bad calls

The Hubris of Economics

On Tuesday, the 2nd most emailed article on was Crisis Compels Economists To Reach for New Paradigm.

It is an intriguing look at the problems of the the field of economics. It went, however, way too easy on both the profession and its practitioners. The article fails to ask some very basic questions about the soft science, and does not discuss the fundamental incompetency of many economists.

Given the failures of the profession — failing to anticipate the worst recession in decades, missing the warping effect of the housing boom, not recognizing the credit collapse until too late — a damning indictment of the dismal science might have been more appropriate.

Perhaps I can be of assistance.

There are many areas I would have liked to see the Economics Crisis article explore: The lack of Scientific Method, the mostly awful performance of economists, its misunderstanding of the value of modeling, the bias inherent in Wall Street variant of economics, and lastly, the corruption of economics by politics. I will just touch on some of these; you can fill in much of the blanks yourself.

Let’s start with the basics. Hard “science” — Physics, Biology, Chemistry, and all variants thereto — begins humbly. They try to describe the universe around us by creating theories, and then testing them. These theorems are always preliminary. Even when testing validates them, Science is always prepared — even eager — to replace them with newer theories that are proven to be even more valid.

The humility of science begins with an admission: We know nothing. We seek to learn through experiment and logic, and constantly evolve more and more accurate explanations. Scientific belief evolves gradually over time. Nothing is assumed, presumed, or hypothesized as true. Indeed, research is a presumption that current theories are inadequate or incomplete. The practice of science is a an ongoing search for better explanations, more proof, further verification — for Truth.

Science is the ultimate “show me” state.

Economics has a somewhat, shall we call it, less rigorous approach. Indeed, the arrogance of economics is that it is the polar opposite of Science. It begins with a few basic assumptions, many of which are obviously untrue; some are demonstrably false.

No, Mankind is not a rational, profit maximizing actor. No, markets are not perfectly, or even nearly, efficient. No, prices do not reflect the sum total of all that is known about a given market, sector or stock. Those of you who pretend otherwise are fools who deserve to have your 401ks cut in half. That is called just desserts. The problem is that your foolishness helped cut nearly everyone else’s 401ks in half. That is called criminal incompetence.

Where was I?  Ahhh, our sad tale of the practitioners of the dismal arts.

Starting from a false premise that fails to understand the most basic behaviors of the Human animal, economics proceeds to build an edifice of cards on a foundation of sand. (How could that possibly go astray?) Like a moonshot off by a few inches at launch, by the time the we reach further into time and space, the trajectory is off by millions of miles . . .


Economics has had a justifiable inferiority complex versus real sciences the past century. It has attempted to overcome this by throwing lots of smart mathematicians at its practice, in an attempt to make the social art seem more “sciency,” and thus  more credible. This had led to lots and lots of formulas and models. The problems is, Economics places way too much weight on these. It creates an illusion of precision where none exists. The belief in their models led to all manner of mischief, from subprime to derivatives to risk management.

Economics forgot George E. P. Box’s most basic rule:

“Essentially, all models are wrong, but some are useful”

Box was a statistician who recognized the fundamental truth of all attempts to depict the universe mathematically: They are inherently flawed.

He also understood that these flawed attempts can at times have value. His insights contextualize what mathematical modelers do — and fail to achieve.

Economics fails at this often.  The belief in the validity of their models — like the theories they are based upon — is the Achilles heel of the profession.

This is not to say there are not good, even great economists (some are even friends of mine!) who foresaw the coming crisis and warned about it. Many are aghast at the rigor mortis in the academic establishment; some are horrified at how poorly the profession has done. Forget forecasting the future, too many economists cannot accurately describe what happened yesterday.

The Behaviorists have been fighting the mainstream for decades now, trying to correct the errors of the basic building blocks of the dismal science.


Excerpt after the jump.


The Mystery of the Awful Economists, 3/2/2005 3:42 PM EST

(If you cannot access the Real Money piece, click here).

Mystery of the Awful Economists, part II (April 8th, 2005)

Mystery of the Awful Economists part III (April 13th, 2005)

RIP Chicago School of Economics: 1976-2008 (December 23rd, 2008)

Why Economists Missed the Crises (January 5th, 2009)

The Big Picture: On the Efficient Market Hypothesis (2005-09)

The Big Picture: On Prediction Markets (2004-09)

Crisis Compels Economists To Reach for New Paradigm

Read More

Category: Markets, Mathematics, Really, really bad calls

The Cruel Basic Mathethematics of Losses

An odd article in the today’s WSJ laments The Cruel Math of Big Losses. What a terrible misonomer: This article should have been called “The Basic Mathematics of the Stock Market.” Not understanding the simple percentages of losses and gains is a goodly part of the reason so many investors buy into the myth of…Read More

Category: Markets, Mathematics

Bailout Costs Shrink to $11.6 Trillion

I stand before you chastened, a humble man who is must admit the errors of my ways. You see, I thought the bailouts were going to be terribly expensive. Adding up all of the direct cash injections, loans, assumptions of debt, commitments, guarantees, and other obligations, I reached the unimaginable sum total of $14 trillion…Read More

Category: Bailouts, Mathematics