Posts filed under “Really, really bad calls”
Part of the story about the Madoff Ponzi scheme was that Madoff created this elusive, difficult-to-become-a-member club. The exclusivity and rejections made membership all the more desirable to greedy investors.
That actually is turning out to be somewhat of a myth.
There is much more to his canny trick of rejecting investors than initially meets the eye. In reality, he did not really turn away money from investors. What actually occurred was that he refused to take cash from people whose participation would have easily revealed the fraud.
Allow me to explain:
As we noted earlier this week (Why Might a Madoff Plea Deal Take Place?) there are lots of other parties who might get pulled into this story. But the one that intrigued me most came from Credit Suisse, when that firm and its analysts looked into Madoff’s investments, and came away skeptical or convinced there was a fraud occurring.
In particular, there was something the execs who had met with Madoff said to Bloomberg that got me thinking: They noted his little- known auditor who had just one client, his refusal to reveal AUM, his refusal to charge asset management fees. But what was especially noteworthy was the issue of why Madoff served as the custodian of his clients’ assets.
That turned out to be, IMO, the key to his “turning away investors.” This was the scam within the overall fraud, one that made his Ponzi scheme irresistible to gullible investors.
Why? Consider how Custodial accounts work: Your institutional firm, endowment or trust fund is held at a major bank (as the Prudent Man rule requires). That means outside managers use DVP trades (delivery versus payment), with the clients’ monies staying in their custodial account, and the outside firm trading it.
Here’s how that looks int he real world. Let’s say the XYZ Foundation –10 billion in assets, held (custodial agent) at Goldman Sachs. XYZ wants to give the Ima Scammer Fund 10 million in assets to trade. Ima Scammer trades the $10 million of the account, but the cash and shares all stay at GS on behalf of XYZ.
That’s how a custodial account works. The outside fund manager has control over the money only so far as handling that portion of it. But the assets stay with the custodian.
And all of those clients turned away by Madoff? How much do you want to bet me that the vast majority were custodial accounts? Given the alleged scam, Madoff couldn’t do that, because the ruse would have been revealed almost immediately. The custodial accounts could not have generated his alleged returns.
These monies weren’t turned away by Madoff; they were run away from — by him.
UPDATE: January 15, 2009, 11:47 am
Even more amazing, the Boston Globe is reporting Madoff might not have made any trades
Why Might a Madoff Plea Deal Take Place? (January 2009)
Credit Suisse Urged Clients to Dump Madoff Funds
Cynthia Cotts, Katherine Burton and Elena Logutenkova
Bloomberg, Jan. 7 2009
Last night’s 60 Minutes had a story on Oil Speculation. Its not that they said anything that was factually wrong per se, its more that they told 10% of the story of the rise and fall of energy prices. The entire report was surprisingly thin, and avoided discussing all of the many other factors that…Read More
The Treasury Department TARP/Bailout plan has been an utter disaster. It has been mishandled from day one — poorly planned, poorly executed. Both Hank Paulson and Congress for passing such a shoddy piece of legislation should be ashamed of themselves for their horrific judgment and egregious failures. It is hard to see a single thing…Read More
Over at Marketwatch, Paul Farrell sifts through a book (sitting on my shelf) and pulls out these embarrassing quotes. 15 reminders of how happy talk misled us a decade ago October 1999: James Glassman, author “Dow 36,000.” “What is dangerous is for Americans not to be in the market. We’re going to reach a point…Read More
Alternative Title: David Lereah: Even More Full of Shit Than Previously Believed > Of all the various parties who contributed to the boom and bust in housing and credit, none have escaped more unscathed than the National Association of Realtors, and their former Baghdad-Bob-in-Chief, David Lereah. The NAR turned a blind eye to fraud amongst…Read More
Here is another excerpt — part II — of the all consuming OpEd of the Sunday New York Times by Michael Lewis and David Einhorn: Excerpt: When Bear Stearns failed, the government induced JPMorgan Chase to buy it by offering a knockdown price and guaranteeing Bear Stearns’s shakiest assets. Bear Stearns bondholders were made whole…Read More
The entire OpEd section of the Sunday New York Times has been taken over by an article jointly written by Michael Lewis and David Einhorn, titled The End of the Financial World As We Know It. Its this morning’s must read piece . . . Excerpt: “OUR financial catastrophe, like Bernard Madoff’s pyramid scheme, required…Read More
Terrific l o n g article in the Sunday Times Magazine by Joe Nocera, titled Risk Mismanagement. Its all about how Wall Street developed and still uses VaR — Value at Risk.
The application of VaR remains hotly debated today. Did it contribute to the credit crisis — or was it ignored/misapplied/distorted, and THATS what was a key factor.
Risk managers use VaR to quantify their firm’s risk positions to their board. In the late 1990s, as the use of derivatives was exploding, the Securities and Exchange Commission ruled that firms had to include a quantitative disclosure of market risks in their financial statements for the convenience of investors, and VaR became the main tool for doing so. Around the same time, an important international rule-making body, the Basel Committee on Banking Supervision, went even further to validate VaR by saying that firms and banks could rely on their own internal VaR calculations to set their capital requirements. So long as their VaR was reasonably low, the amount of money they had to set aside to cover risks that might go bad could also be low.
Given the calamity that has since occurred, there has been a great deal of talk, even in quant circles, that this widespread institutional reliance on VaR was a terrible mistake. At the very least, the risks that VaR measured did not include the biggest risk of all: the possibility of a financial meltdown. “Risk modeling didn’t help as much as it should have,” says Aaron Brown, a former risk manager at Morgan Stanley who now works at AQR, a big quant-oriented hedge fund. A risk consultant named Marc Groz says, “VaR is a very limited tool.” David Einhorn, who founded Greenlight Capital, a prominent hedge fund, wrote not long ago that VaR was “relatively useless as a risk-management tool and potentially catastrophic when its use creates a false sense of security among senior managers and watchdogs. This is like an air bag that works all the time, except when you have a car accident.” Nassim Nicholas Taleb, the best-selling author of “The Black Swan,” has crusaded against VaR for more than a decade. He calls it, flatly, “a fraud.” . . .
What will cause you to lose billions instead of millions? Something rare, something you’ve never considered a possibility. Taleb calls these events “fat tails” or “black swans,” and he is convinced that they take place far more frequently than most human beings are willing to contemplate. Groz has his own way of illustrating the problem: he showed me a slide he made of a curve with the letters “T.B.D.” at the extreme ends of the curve. I thought the letters stood for “To Be Determined,” but that wasn’t what Groz meant. “T.B.D. stands for ‘There Be Dragons,’ ” he told me.
Best line in the article: “When Wall Street stopped looking for dragons, nothing was going to save it.”
I particularly loved the graphics and illustrations that were part of it:
Paul Krugman asks: Unusually, I’m having a vocabulary problem. There has to be some word for the kind of person who considers his mild discomfort the equivalent of torture, crippling injury, or death for other people. But I can’t think of it. What brings this to mind is this from Alberto Gonzales: I consider myself…Read More
Special Schadenfreude edition: In case you missed it, here is our updated collections of the worst predictions for how 2008 would turn out: • The 10 Worst Predictions for 2008 (Foreign Policy) • The Worst Predictions About 2008 (Businessweek) • 2008 Investment Guides Are HILARIOUS (New York Magazine) • Famous Last Words (CNBC) • The…Read More