The Bernard Madoff Ponzi Scheme

Ron Berger —


amd-bernard-madoff-courtLast month ABC aired Madoff, a four-part television miniseries starring Richard Dreyfus in the leading role as Bernard Madoff, former chairman of the NASDAQ Stock Market and founder of Bernard L. Madoff Investment Securities. Like The Big Short feature film (see my March 9, 2016, Wise Guys article), Madoff offers a glimpse into the corruption endemic to the world of finance capitalism. It does not have the humor of The Big Short, but it is an entertaining dramatization that is worth watching.

The financial crime perpetrated by Madoff is known as a Ponzi scheme, a term that originated with Charles Ponzi, a young immigrant from Italy, who opened the Financial Exchange Company of Boston in 1919 while guaranteeing investors a 50 percent rate of return within 45 days. According to criminologist Stephen Rosoff and colleagues, Ponzi ostensibly planned “to purchase international postage coupons in countries where the exchange rate was low and then re-sell them in countries with higher rates. Within six months, [he] had persuaded 20,000 investors to give him nearly $10 million.” The secret of Ponzi’s success was to pay “early investors with new investors’ money, thereby attracting more and investors. At its height, his company had a daily clash flow of $250,000.”

Thus a Ponzi scheme, as this type of financial fraud became known, is dependent upon an ever increasing supply of investors. But at some point the offender’s greed outstrips his luck and the “house of cards” inevitably falls out. After an exposé in the Boston Globe revealed Ponzi’s fraud in 1920, he was arrested, convicted, and sentenced to four years in prison (and later deported).

In the contemporary era, Bernard Madoff has become the “poster boy” for Ponzi-scheme criminals. Indeed, his criminality constituted the most serious Ponzi scheme ever perpetrated in the history of finance capitalism, costing investors $17 to $18 billion, with fabricated gains of about $65 billion.

Madoff began his fraud in the early 1990s, and regulatory authorities at the Securities and Exchange Commission had been suspicious of his investments for some time, because the gains he claimed to deliver to clients were unrealistic. But no one did anything about it about it. Neither did investors complain, because they believed they were privy to an insider “sweet deal,” which included no investment fees. No one bothered to ask or find out how Madoff racked up his incredible returns or request statements from a reputable accounting firm.

Madoff’s victims included a number of high-profile people—among them, Kevin Bacon, Zsa Zsa Gabor, Jeffrey Kaztenberg, Larry King, Sandy Koufax, John Malkovich, Kyra Sedgwick, Steven Spielberg, Eliot Spitzer, Elie Wiesel, and more generally, people who knew him through their common membership in the exclusive Palm Beach Country Club in Florida. Madoff’s investors also included a number of major banks, corporations, charities, and university endowments in the United States and abroad—among them, Bank Austria, Hadassah, Mitsubishi, Royal Bank of Canada, Royal Bank of Scotland, Royal Dutch Shell, Stony Brook University Foundation, and Yeshiva University.

In December 2008, in the immediate aftermath of the stock market crash of that year, Madoff was indicted for his crimes. He pled guilty to multiple charges and was sentenced to 150 years in prison. But lest the public think that Madoff was an isolated case, between 2003 and 2015, government regulators and law enforcement officials also initiated or completed about 30 other Ponzi scheme cases.

At the end of the Madoff miniseries, Madoff (i.e., Dreyfus) says that the entire stock market can be viewed as a Ponzi scheme of sorts. This claim is inaccurate, as a Ponzi scheme refers to a particular type of financial fraud. Nonetheless, it remains true that the stock market is riddled with other illegal investment strategies, as well as strategies that straddle the line between illegality and legality or in other ways disadvantage the average investor.

Take the case of insider trading, which occurs when some investors take advantage of privileged information other investors do not have in order to gain an unfair advantage.  The logic behind the criminal prohibition of insider trading is that the moral legitimacy of the capitalist system depends upon the expectation of a positive association between the economic risk taken by an investor and the potential return. But with insider trading, in the words of Stephen Rosoff and colleagues, the insider investor “collects the highest returns with little risk at all, while the ordinary investor, who assumes most of the risk, is exploited like some naive bumpkin lured into a rigged game of chance.”

Or take the case of pump and dump schemes, whereby con artists or corrupt stock brokers recommend stocks or issue fraudulent information to drive up their value and then sell their own shares before the stock price collapses.

Lastly, in the practice high-frequency trading, even legitimate financial firms use complex computer algorithms to exploit minute short-term fluctuations in stock value. As journalist Nick Baumann observes, we now live in “a world where investing—if that’s what you call buying and selling a company’s stock within a matter of seconds—often comes down to how fast you can purchase or offload it, not how much the company is actually worth.”

Sources

Nick Bauman. 2013. “Too Fast to Fail: Is High-Speed Trading the Next Wall Street Disaster?” Mother Jones (Feb.), http://www.motherjones.com.

Ronald J. Berger. 2011. White-Collar Crime: The Abuse of Corporate and Government Power. Lynne Rienner Publishers.

Stephen Rosoff, Henry Pontell & Robert Tillman. 2009. Profit Without Honor: White-Collar Crime and the Looting of America. Prentice-Hall.

 

 

 

 

About Ron Berger (27 Articles)
I am a professor emeritus of sociology and criminology from the University of Wisconsin-Whitewater. In my retirement, I write primarily about politics, economics, and social issues.

2 Comments on The Bernard Madoff Ponzi Scheme

  1. mrichardson14 // March 15, 2016 at 2:48 pm // Reply

    I have always wondered how people think they can get away with Ponzi schemes for any length of time. Logic says that there has to be a saturation point, when investors run out while the dividends are still owed the earlier investors. One would think that the schemer would realize that the day of reckoning is coming. Seems like a complete failure to see the big picture.

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  2. Ron Berger // March 15, 2016 at 3:08 pm // Reply

    People’s capacity for denial—both the Ponzi scheme perpetrator and his victims—runs deep in the human psyche. Madoff said, “When I began the Ponzi scheme, I believed it would end shortly and I would be able to extricate myself and my clients from [it]. However, that proved difficult and ultimately impossible.” David Shapiro, a professor of economics and former FBI agent, observed that Madoff, like other offenders of his ilk, seem to be able to divorce themselves from the human impact of their actions: “When you’re making all this money and you realize nobody’s really checking on you, the temptations become too great.”

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