“The amazing Madoff clawback”: The surprising silver lining of the Bernie Madoff scandal

Rich Tenorio in the Times of Israel discusses a new book by Jim Campbell about the Bernie Madoff scandal and its somewhat surprising happy ending (Ben Sales’s term). No, this does not refer to the recent death in prison of the disgraced investor, but to the recovery of the lion’s share of the robbed assets.

Madoff came from a middle-class Jewish family. In 1960, with about $5,000 he had saved up working as a lifeguard and sprinkler installer, he started his own brokerage after passing the required licensing exam. He focused on “penny stocks”. As such stocks were not traded on the stock exchange floor, he harnessed computers (still in their infancy in the business world) to keep track fo stock valuayions; his system evolved into what would become NASDAQ. Madoff became both a mainstay of Wall Street and a fixture of the Jewish community’s uppermost reaches.

Madoff’s offices covered three floors of the Lipstick Building on Third Avenue in NYC (across the street from Citigroup Center).

Lipstick Building - Philip Johnson.jpg

His legitimate operation covered the 18th and 19th floors; on the 17th floor was his “other” operation where even his children (who worked for him in the legit op) did not have access. From there, he and a relative handful of employees ran the greatest Ponzi scheme not run by a national government.

Some of the factors that contributed to Madoff’s success:

  • He ran both a completely legitimate operation and his scam at the same time, packaging the latter as an exclusive investor club for “friends of Bernie”
  • Unlike typical confidence tricksters, he was somewhat standoffish and introvert, and relied on his good name, his role
  • He engaged in classic “affinity fraud“, a law enforcement term for when fraudsters recruit “marks” from among their own ethnic, religious,… milieu, leveraging “he’s one of us” trust. 85% of Madoff’s victims were Jewish like himself.
  • In fact, his favorite marks were Jewish private and public charitable foundations — according to US tax law, a private foundation’s annual charitable spending must equal at least 5% of its net worth, hence the annual expenditure (and hence the annual amount they would seek to cash in from their Madoff investments) was relatively small and predictable
  • The returns he offered were large and consistent, but not grossly different (about 1% per month) from the time-averaged performance of more respectable investment funds.

It was the consistency that drew the attention and envy of business rivals. Harry Markopolos, a portfolio manager with Rampart Capital Management, was ordered to try and reverse-engineer Madoff’s investment strategy. When he started analyzing the numbers, he very quicly realized they were too neat to be true. Normally, when plotting the value of investments over time, you would expect some noise on the curve due to market volatility, as well as some longer-term fluctuation due to market “boom and bust” cycles. Instead, Madoff produced straight lines that just couldn’t be real.

Markopolos alerted the SEC (Securities and Exchange Commission) multiple times, but was given the brushoff every time.

Campbell assumes that Madoff’s operation could otherwise have kept growing, and might be around today in 2021 with a book value of about $240 billion (!) if it weren’t for the 2008 subprime mortgage crisis. Beleaguered investors with Madoff accounts found themselves in the position of having to cash in their Madoff investment to plug the holes elsewhere — and try as he might, Madoff simply couldn’t raise new investors (a.k.a. freiereim/suckers) fast enough to raise the required cash. He then confessed to his sons and explained he was going to turn himself in: his sons beat him to it, and the rest is history.

Private fortunes and nonprofit charities were ravaged. Here is a human-interest story of a widow who lost her entire life savings to Madoff — and went from a very comfortable lifestyle to working as a housecleaner to make ends meet.

The Madoff story has a somewhat surprising silver lining though: the amazing Madoff Clawback, as the Wall Street Journal expose about it is titled. Normally, the “clawback” or recovery rate of stolen funds in such cases is about 5-30%; Irving Picard, the court-appointed trustee and his chief counsel David Sheehan achieved an astonishing and unprecendented 75% (yes, three quarters).

First of all: the $65 billion figure quoted is the total on-paper balance of all the Madoff investment accounts: this included the accrued “profits”. As a defrauded investor, you can only put in claims for the money you actually invested, not for the completely bogus “return on investment”. In the end, about $17.5 billion were claimed.

Now not everybody who had invested in Madoff actually lost money: some of his earlier investors had made a hefty profit financed with the deposits from new freierim (suckers), and were smart and/or prescient enough to cash in while the cashing was good. Some were indeed “feeders” who helped Madoff recruit new marks. They (or their estates, if deceased) could be sued for civil forfeiture: in one case, the Picower estate, Picard extracted no less than $7 billion. Even Hadassah, which had invested $40 million and withdrawn a total of $137 million before its supposed remaining balance of $90 million was wiped out, ended up contributing $45 million to a fund for Madoff victims.

I cannot help wondering about two things here:

(a) just how divorced from anything tangible are goings-on in “high finance” really, especially in this economy?

(b) Big as Madoff’s operation was, isn’t it dwarfed by some legally sanctioned Ponzi schemes that are orders of magnitude larger, such as “college for everyone” and the US Social Security system?

On this somewhat dyspeptic note, I wish you all a nice weekend, and my fellow Jews Shabbat shalom.

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