Editor's Note: James Quinn is a senior director of strategic planning for a major university. James has held high level financial positions with a retailer, homebuilder and a university in his 22-year career.

The Great Swindle

The greatest fraud in the history of our country was exposed last week: Bernard Madoff’s $50 billion Ponzi scheme. The size of the losses is mind-boggling - 3 times the size of the proposed bailout of the US automakers. The immorality of his actions is incomprehensible. Charities have been wiped out, the life savings of entire families have been lost, and innocent lives have been ruined.

This man was well-respected by the Wall Street investment community, a prominent philanthropist, and part of the wealthy high-society crowd in West Palm Beach. This begs the question: If this scam has been in progress for decades, how many of its kind are still out there? After a year of never-ending tales of scandal, fraud, lies, greed and mismanagement, this episode should finally convince the American public that the investment game is rigged, and they don’t stand even the ghost of a chance.

It’s too soon to determine what the long-term effects of this scandal will have on our financial system. This tragedy is a failure of morality, a failure of regulation, a failure of unbridled capitalism and a failure of common sense.

What began as a classic American success story is ending as an American tragedy. Bernard L. Madoff Investment Securities started in 1960 with $5000, and became one of the founding members of the NASDAQ. Madoff eventually became Chairman of its board, with an estimated net worth between $200 and $300 million.

The words on Mr. Madoff’s website now seem gravely ironic:

"In an era of faceless organizations ... Bernard L. Madoff Investment Securities LLC harks back to an earlier era in the financial world: The owner's name is on the door. Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm's hallmark."

It's doubtful that the words “high ethical standards” will grace Mr. Madoff’s gravestone. Even as his Ponzi scheme was unraveling, his “high ethical standards” led him to try to distribute his $200 to $300 million to family, friends and employees before the victims of his crimes could attempt to recover some of their money.

A Ponzi scheme involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from net revenues generated by the business. Mr. Madoff’s Ponzi scheme was incredibly unsophisticated. He was spectacularly successful at marketing his fund to the ultra-rich communities he inhabited in New York and Florida, as well as at European ski competitions attended by the ruling elite. His fund generated returns of 12% to 13% per year consistently for decades.

Since 1996, the fund only had 5 losing months. The market has had dramatic monthly moves over this time. It is a virtual statistical impossibility for an investor to have such a consistent record through bull and bear markets.

Madoff refused to provide his clients online access to their accounts. He sent out accounting statements by mail, whereas most hedge funds email statements and allow them to be downloaded via computer for easier investor analysis. His books were audited by a 3-person accounting firm, Friehling & Horowitz, operating out of a 13-by-18 foot location in an office park in New York City’s northern suburbs. A $17 billion fund could not possibly be audited by 1 partner and 1 accountant.

These facts had all previously been brought to the attention of the SEC, both by concerned individuals and by Barron’s. And yet the SEC investigated Madoff’s firm twice in the last 8 years and found nothing. The SEC has an annual budget in excess of $900 million, and has failed miserably in its mission to protect investors. The oversight of hedge funds has been virtually non-existent during the Bush administration.

Alan Greenspan, the patron saint of free markets, proved his prescience in 2000 when he campaigned before Congress not to regulate hedge funds. He described hedge funds as “a vibrant trillion-dollar industry dominated by US firms. They are essentially free of government regulation, and I hope they will remain so. Why do we wish to inhibit the pollinating bees of Wall Street?” These killer bees have contributed greatly to the biggest financial destruction of wealth in history. It seems that Mr. Greenspan has been on the wrong side of every financial debacle in the last 10 years; this one is no exception.

What brought down Bernie Madoff wasn’t his guilty conscience, but the redemption of $7 billion by investors, which overwhelmed his ability to pay them from new funds. The story he wants everyone to believe is that he was the only one who knew about the fraud. His brother, 2 sons, his niece and other family members held high-level positions in the firm. It strains credulity past breaking to argue that none of these people knew what was going on. A $50 billion fraud cannot be perpetuated by one man acting alone.

The victims of Mr. Madoff’s crimes are many. The Robert I. Lappin Charitable Foundation has lost its entire $8 million endowment; The North Shore-Long Island Jewish Health System and the Texas-based Julian J. Levitt Foundation have lost millions; the town of Fairfield, Connecticut has seen 15% of its retiree pension fund vanish; Maxam Capital Management has been wiped out; Tremont Capital Management has lost millions; thousands more have lost their life savings. This blackest of marks in investment history will forever alter the faith that investors have in investment managers, financial advisors, mutual funds, and hedge funds.

The Other Ponzi Scheme

A much bigger Ponzi scheme is currently being conducted by the US government: It’s called the national budget. Mandatory spending for agriculture subsidies, unemployment benefits, civilian and military pensions and health benefits continues to grow. The Ponzi aspect of this system lies in the fact that we continue to pay out benefits by printing money. We’re currently obligated to pay $53 trillion that we do not have.

Social Security, for example, has run at a surplus since its inception. But our trustworthy leaders have spent all of those surpluses in order to keep the Ponzi scheme going.



The above charts prove beyond a shadow of a doubt that we cannot use the Republican “strategy” of growing our way out of this problem. As entitlements and net interest grow, discretionary spending gets squeezed. Non-defense programs, which include activities related to children, transportation, infrastructure, education, training and research to promote future economic growth and prosperity are crowded out. We can make no investment in the future because we’re forced to honor commitments made decades ago.

The Government Accountability Office provided a troubling deficit forecast in January 2008 which showed we could reach a fiscal deficit of $1 trillion by 2016. That $1 trillion deficit will be reached 7 years early, in 2009.

Something called shared sacrifice is necessary if we are to avoid yet another American tragedy. Shared sacrifice is something that hasn’t been asked of US citizens since World War II. They are known as the Greatest Generation. Now is time for the Next Great Generation.