Looking into the grey zone of financial crime
Branko Milanović is an economist specialised in development and inequality. His newest book is “Capitalism, Alone: The Future of the System That Rules the World”
Cross-posted from Branko’s Substack Site
I watched a four-part excellent documentary on Bernie Madoff’s “scam of the century”. (The series is not exactly a documentary because most scenes are re-enacted, but this is done in a very good, and rather discrete, way, combining the actual footage with the enacting, so that we can still call it a documentary). The film has several professors of finance and Wall Stret specialists explaining very clearly the mechanism of the fraud (I liked in particular Diana Henriques who is the author of a book on Madoff).
But the movie never comes close to explaining “the why” of the scheme. We know “the how”, but not “the why”. The banal explanation that Madoff did it in order to steal the money does not work, and the movie—to give the producers credit—never tries to push it. The explanation does not hold for at least two reasons. The outstanding amount of the scheme at the time when Madoff’s was apprehended was $65 billion. His possessions that are highlighted a few times in the four episodes are minute compared to that amount: a penthouse in New York, a villa in Southern France, and a house in Florida. Readers can probably check on the Web the values of these properties but it is unlikely that the are worth more than $20-$30 million all together. Compare $20-30 million to $65 billion. Second, Madoff had all the time run two businesses: a highly successful legitimate business, and two floors below the shadowy Ponzi shame. His legitimate business generated huge income; surely more than enough to buy the three properties. So he did not need the Ponzi scheme to be rich.
The payments to the other people who were involved in the “secret” business on the 17th floor were small too. For example, the pay for one of the assistants in the scam was a paltry $60,000 per year and Madoff was nickel-and-diming her. Thus nothing in the secret scheme smells like big money—for those who did it: for Madoff and his helpers.
But not so for these who invested. There, the movie shows, the four major investors, who each had billions (yes, billions) invested with Madoff, and given that they received steady annual returns of 10%, who, in turn, made billons out of Madoff’s scheme. One of the four big investors, the movie rather persuasively claims, realized that the whole thing was a big scam rather early on, but his interest was that the scam continues as long as possible, that is as long as he continues to receive exorbitant returns. At one point when Madoff is in serious trouble, this big investor deposited billions that Madoff needed to pay off people who, as the stock market tanked, began to withdraw money. The big investor did this to help Madoff survive the panic, and of course, to continue the Ponzi scheme. That investor was later about to be indicted as co-conspirator but rather conveniently was found dead in the pool of his Florida house.
So why did Madoff do it? The reason, just slightly alluded to in the movie, might have to do with Madoff’s need/desire/wish to be loved, even adored and –yes- to achieve that devotion by delivering to his friends incredible presents, in terms of money returns they could never obtain elsewhere. The cause of the fraud thus lies in the psychological domain: it does not need to be studied by financiers or economists. What we need is therapists.
And the light moves from Madoff to his investors. Why did they clamor so much to invest with him?; why did they queue, beg him to take their money, intercept him on the beach to give him millions? The answer is greed. Not only among the top big investors who, as I wrote, might have known what is afoot all along, but also among hundreds of medium and even smaller investors. Why did Elie Wiesel need a special investment opportunity that would generate 10% per year? Aren’t there hundreds of wealth management and investment funds that would take his money? Hasn’t he heard of Fidelity, Vanguard, Chase? And the same is true for many others.
Of course, in the court case, and even to some extent in the movie, the story-tellers insist on “normal” investors, many of them however extremely rich by usual standards even if not billionaires. Even for them, one wonders, why did they do it? Didn’t they have other, more standard, opportunities? I know that many people will argue that this is blaming the victim, and while there is no doubt that legally Madoff was guilty, ethically, one wonders, if the victims’ guilt was not as great. If Madoff was doing all of this in order to be admired and loved, didn’t they exploit his psychological weakness to make money? Wasn’t Madoff used by his “victims”? Was he a victim of his pride and they the victims of their greed?