Mad Madoff

Firstly, the relative trivia: have you noticed how the 12 year olds at the BBC are calling this man Bern’ard Madoff as if they were Americans rather than the B’ernard that we know?

 

Secondly, I have just found time to start reading up on some of the technical things that Madoff was or wasn’t doing with the $50 billion that he is supposed to have squandered. He is accused of running a Ponzi Scheme. However, in an article in the FT there is a fascinating piece in which they run through the thought processes of Wall Street wallahs as they studied Madoff and his mad cap work. They ascribed some fancy finance footwork to the man when he was clearly pussyfooting and not cutting a rug at all.

 

For example,

 

Mr Madoff’s returns appeared to many to be too good to be true (see chart below). But advocates claimed they were the result of a “split-strike conversion strategy” that used derivatives to minimise risk, while intelligence from his market-making business allowed him to time investments almost perfectly.

 

The SEC investigated Madoff in 2005 and again in 2007 and found nothing (the chickens in this scenario started to come home to roost this week too! See the whistleblower snippet below) so:

 

Several investors believed he might be front-running – illegally trading ahead of customers of the market-making division – but many stayed with him anyway. “He had a clean record from the SEC and it wasn’t our job to spot this,” says one.

 

Some funds offered a more complex explanation. Split-strike conversion enabled him to profit from periods of rising share prices by setting up what was called a “bull spread”. This involved buying shares in 40-50 companies to mimic the blue chip S&P 100 index, while using put options to protect against falls. The cost of these options was covered by selling call options, limiting the potential upside.

 

My reaction at this point was to think that if only he had been doing this sort of thing, maybe he could really have returned some of the profits that he did pay back albeit within a Ponzi Scheme: a bit like burglars and the like who put huge amounts of effort into their robberies that could just as well be channelled into something legitimate.

 

In a US Congressional hearing this week, a man labelled as a whistleblower in the Madoff case, sorry his name eludes me, made the point that the graph of Madoff’s returns fell on a straight and 45 degree line. This man went on to say that everyone else’s equivalent graph would rise and fall with or against or generally in tune with the market: here’s the link for the kind of graph that gentleman was talking about

 

http://media.ft.com/cms/aa499604-ebd3-11dd-8838-0000779fd2ac.gif You can see what he means and why he said he warned the SEC over a ten year period that there was something rotten in the state of Madoff.

 

There’s a nice time line summary of events here, by the way: http://www.ft.com/cms/s/0/cc1ceb9e-ebd5-11dd-8838-0000779fd2ac,dwp_uuid=b7a8d610-caaf-11dd-87d7-000077b07658.html

 

Regulators, lawyers and Parliamentarians have all tried to make these things impossible to get away with but Madoff is here, Satyam (who??? ... watch this space) surfaced around the new year in a cash reporting scandal in India. The Sarbanes Oxley Act from the US, for example, Corporate Governance rules in the UK for example ...

 

I imagine that a lot of people are wondering how Madoff can still be holding on to his flat in New York, reputedly worth as much as $7 million, when there are probably people who need a mere fraction of that just to live on ... but Madoff stole it from them.

 

Finally for now, you might care to remind yourself of the two basic types of Ponzi scheme I discuss on my web site: http://www.duncanwil.co.uk/ponzi.html Give me time to get back home and put together a summary of what people think they know about Madoff and I will include that on a revised or supplementary Ponzi page.

 

 

DW