Three Things I Think About When I Think About Bernie Madoff

Updated: July 16, 2009

By Peter Passell,
Author of Where to Put Your Money NOW: How to Make Super-Safe Investments and Secure Your Future

The greatest financial fraudster of all time has gone to the slammer, and isn't scheduled to be released until he reaches the age of 221. That's OK by me. Bernie Madoff, after all, was no Robin Hood. Sure, he stole from the rich (the struggling middle-class need not apply). But he stole from the poor, too, slurping up billions from the endowments of charities. And apparently the only beneficiaries of this vast involuntary transfer of wealth were family members struggling to maintain the lifestyles of the rich and infamous.

End of story? Not quite. While it's hard to imagine that anyone else is running a Ponzi scheme on this scale, I would argue the human weaknesses that made it possible for Madoff to keep the scam going for decades -- greed, gullibility, laziness, money-driven politics -- explain why most investors, most of the time get less than their money's worth. At very least, then, the Madoff fiasco should remind us all of some unhappy truths about investing in America.

Government regulation is no substitute for personal vigilance. If you rob a bank, the chances are excellent you'll be caught -- and quickly. Indeed, the clearance rate on bank heists is so high that only unshakably optimistic crooks even try. How, then, was it possible for Madoff to get away with so much bigger a crime and for so long? One important reason is that modern business depends more on cultural constraints (as in, "I'm not a thief") than on regulation (as in, "I'd never get away with the theft") to keep it honest. And, unfortunately, the investment business attracts lots of folks who aren't deterred by the injunctions they heard in Sunday school.

But surely, regulators will now be more vigilant. Don't bet on it. The sort of regulation that could reliably deter the bad guys on Wall Street would be immensely intrusive and costly. And when push comes to shove, it's not likely that either Congress, or regulators appointed with the tacit approval of big political campaign contributors, will have the stomach do what's necessary.

The bottom line: You don't always get what you pay for. If you want to invest in anything other than government-guaranteed CDs and bonds, you've got to stay on top of who's got your money and where.

If it's too good to be true, it isn't. Most investment scams are of the get-rich-quick variety -- as in "I'll double your money in three months." Madoff, by contrast, attracted big sums by offering something that seemed far more reasonable. No secret land deals in Wyoming for the former chairman of the NASDAQ stock exchange, no once-in-a-lifetime opportunities to profit from the coming boom in ruthenium (look it up, yourself . . . ). All he offered were 10-15 percent returns, year after year, regardless of the state of the stock market or the global economy.

You've got to give the devil his due here. The promise of low-double-digit profits without risk was just plausible enough to attract the sort of investment advisors who served clients by dressing well and mixing a terrific martini rather than by providing timely intelligence on matters financial. Meanwhile, Madoff was able to make the cash payouts needed to keep investors believing they were getting what they paid for as he was able to increase funds "under management" by a modest amount each year.

On closer look, though, the promise of a steady 10-15 percent was hardly more plausible than the promises of more conventional investment cons. For while plenty of investors do average annual returns in the low-double-digits, they only manage it by taking substantial risks. And the fact that Madoff never had a losing year should have been a dead giveaway.

How did he get away with it, then? Like all successful scammers, Madoff understood that almost everybody secretly feels entitled to something for nothing -- and many are ready to deny reality to get one. To paraphrase Groucho Marx: Who you gonna believe, me or your lying eyes?

The scandal isn't what's illegal, it's what's legal. Yes, I stole that line from the great pundit Michael Kinsley. And yes, what Madoff did was illegal. But his most excellent adventure should not be allowed to obscure the reality that the $50 billion or so that Madoff lost on behalf of clients over the last few decades was far less than the sums that the financial services industry takes from investors every year for nothing much in return!

How dare I, an economist and (within reason) a believer in free markets, make such an outrageous claim? Try this on for size: In 1997 the after-tax profits of financial services companies was roughly $100 billion (a record high to that date). Over the next ten years it averaged a bit more than $170 billion -- even after adjusting for inflation. So what did we get for the extra $70 billion annually? Wall Street sliced and diced a lot more "product," managing everything from a great wave of corporate mergers to the issuance of hundreds of trillions of dollars worth of old- and new-fangled financial derivatives.

But it's hard to see what extra investors got from the deal. And when you look closely, you can see what they didn't get. Corporations paid hefty fees for securities issues -- fees that never seem to go down in spite of what appears to be heavy competition for their business. Meanwhile fund investors paid humongous sums to shuffle assets in what economists call "zero-sum" games in which the gains of some came out of the pockets of others.

Bernie Madoff is gone, may he rest without peace. But the financial world that spawned Bernie is alive, and will soon be well enough to take your money with gusto.

©2009 Peter Passell, author of Where to Put Your Money NOW: How to Make Super-Safe Investments and Secure Your Future

Author Bio
Peter Passell, author of Where to Put Your Money NOW: How to Make Super-Safe Investments and Secure Your Future, is a senior fellow at the Milken Institute and the editor of the Milken Institute Review, and has been a columnist for the New York Times. He is the author of many guides to personal finance, including Where to Put Your Money, The Money Manual, and How to Read the Financial Pages.

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