Madoff's old-time ripoff
AMID A global financial crisis caused by the evaporation of exotic mortgage-backed securities, the scandal surrounding Wall Street trader Bernard Madoff seems decidedly old-school. Ponzi schemes are a classic form of financial fraud, in which returns to would-be investors are paid with money contributed by new victims. Until his arrest last week, Madoff perpetrated such a scheme on a vast scale, authorities say - to the tune of perhaps $50 billion.
But if Madoff's conduct was old-fashioned, his arrest late last week still cast light on some of the broader problems afflicting the financial-services sector: One is the ability of under- and unregulated investment vehicles to grow to enormous size. Another is the way overconfidence in trusted investment houses leads to financial disaster.
These problems were on display on Wall Street long before Madoff's downfall. The current financial crisis grew out of elaborate securities based on questionable mortgages; investment firms bought up those mortgages and sliced and diced the financial risk to the point that no one could say what the resulting securities were really worth. Bullish investors bought them anyway.
Madoff's approach, it seems, was much more low-tech. His firm engaged in some legitimate businesses, but what was ostensibly a hedge fund now appears to be an elaborate fraud. Madoff won fans by promising not exponential growth but steady returns. He gained the confidence of investors in New York, Massachusetts, Florida, and elsewhere through financial-planning firms and through his memberships in golf clubs and charitable boards. Madoff, it seems, cultivated an image of exclusivity and even rejected some investors.
There were some signs of trouble - inquiries by the Securities and Exchange Commission investigation over the years; financial statements that, according to experts, were unusually vague. But the fraud evaded detection until Madoff's sons turned him in last week.
Locally, the impact of the Madoff scandal is dramatic: One philanthropic foundation in Salem has already shut down. Another foundation lost about $145 million - half its value. Even now, victims are incredulous: "You wouldn't imagine," one Boston businessman told the Globe, "Ponzi artists would make it so hard to invest."
Authorities say Madoff admitted to fraud after his arrest. Fortunately, there are laws on the books to prosecute such offenses. But outright fraud now seems to be less of a threat to the US economy than mass delusion - most recently in the form of securities that made sense only if housing prices could go up forever, and that investors bought and sold because everyone else was doing it. 