Posts filed under “Regulation”
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
January 14, 2009
David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).
What were formerly viewed as wild currency fluctuations are becoming more accepted in this post-Lehman failure period of the global financial crisis. Lately the strength has been in the yen. Many ask why?
We know that the economic situation in Japan is weak and the outlook is poor. We know that the Japanese exporters need a weaker yen not a stronger yen to help their business models. And we know that Japan has been mired in a deflationary recession for over a decade and the outlook for substantive reforms which would enable it to exit this quagmire seems to be elusive.
So why the yen and what will happen next?
We believe that the global mix of assets boils down to just four currencies. Most of the $85 trillion of bonded debt in the world is denominated in these four currencies: euro (30%), dollar (39%), pound (4%), and yen (13%). Most of the other currencies in the world (not all) are managed in one way or another or are tied directly to one of these four. Hong Kong, for example, runs its policy so that the Hong Kong dollar is fixed in a link to the US dollar. In Europe most of the non-euro countries in the European Union are managing their currencies in a narrow band so as to eventually gain entry into the euro system. Freer floating currencies like the Aussie, Kiwi, Krona or Loonie are important but are also relatively small portions of the globe’s total.
Let’s look at the big 4.
The dollar story is widely known. We have a huge developing federal deficit now measured in the trillions. And the Federal Reserve has rapidly expanded its balance sheet to more than triple the size of the pre-Lehman failure period. See www.cumber.com for a graphic illustration of the Fed’s balance sheet. Remember that when the Fed enlarges its holdings of assets (loans in the “lender-of-last-resort” role) it is also expanding the liability side of the balance sheet (printing money electronically) in order to pay for those loans. Many conclude this will lead to a disastrous decline in the value of the dollar and a fierce inflation explosion. We are not as sure about this outcome as are the detractors; readers will see why below.
If they are too big to fail, make them smaller.” -Nixon Treasury Secretary George Shultz about Fannie Mae and Freddie Mac > The operative expression about many of the bailouts we have seen — AIG, JP Morgan (via Bear Stearns), Goldman Sachs, Fannie/Freddie and of course Citibank — is “Too Big To Fail.” Perhaps the…Read More
Fascinating piece you may have overlooked this week in the Boston Globe on Harry Markopolos, the author of the detailed November 2005 memo to the SEC, identifying 29 red flags about Madoff and concluding he was a fraud. Excerpt: “A month ago, Harry Markopolos was an accountant unknown outside Boston’s financial community. Now the slight,…Read More
Today’s must read MSM piece is a brutal Bloomberg column, delineating why the Bailouts have been such a sweet deal for the banks. Despite the gross incompetence and sheer recklessness of Wall Street and the Financial sector, they were handed massive amounts of money with little in the way of returns to the taxpayer, no…Read More
Earlier today, we looked at the NYT interactive graphic that calculates how long it will take to return to breakeven for typical portfolio losses. But what if you were one of 8000 Madoff investors, and your portfolio is now worth zero? For starters, you should get $500k from SIPIC. Then, there is the $830 million…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