The fraud perpetrated by Bernard Madoff may well be the greatest investment swindle in U.S. history, and unfortunately, it is a sign of the times.
Exposed earlier this month, Madoff confessed and estimated the devastating deception at $50 billion. A full and final accounting is still a long way off, but it’s clear that major banks, hedge funds, foundations and individual investors were badly shaken if not wiped out.
His scheme lasted for decades — much longer than the typical Ponzi scheme — for two reasons: regulators at the Securities and Exchange Commission were not up to the task of performing their duties with diligence, and in our era of cheap borrowed money, new investors continued to line up for fleecing.
Over the years, there were a number of whistleblowers and red flags.
But in the end, it wasn’t Madoff’s conscience or a tough regulator that brought the fraud down. It was a simple cash-flow problem. When investors, frightened by the economic downturn this fall, asked to redeem billions of dollars in investments, he could no longer find enough new investors to cash them out.
In the classic Ponzi scheme, early investors get paid unrealistically high returns from money collected from wide-eyed new investors. When the supply of new investors runs out, the scheme collapses like a house of cards.
The Madoff fraud was large enough to rock the investing public’s faith in the concept of the trusted financial advisor. On a more immediate level, it ruined a number of foundations and charities and wiped out the life savings of families and individuals who’d put their trust in him.
In strict dollar terms — an inadequate measure, given the life-changing toll on many individuals — the largest victim was the Fairfield Greenwich Group, which has admitted investing $7.5 billion with Madoff. According to The Wall Street Journal, Tremont Group Holdings was next in line at $3.3 billion, followed by Spain’s Banco Santander at $2.9 billion.
Tremont, which is based in Rye, N.Y., is affiliated with Springfield-based Massachusetts Mutual Life Insurance Co. According to published reports, a MassMutual spokesman said the impact on MassMutual itself is “minimal.”
Banco Santander is the parent of Sovereign Bank, Connecticut’s sixth largest out-of-state bank with more than 30 branch offices and deposits of $1.7 billion in the state in 2007.
Local nonprofits have evidently escaped the disaster, according to Susan Dunn, president and CEO of United Way of Central and Northeastern Connecticut. “I asked our CFO just to be sure that we were not implicated here, and we got a clean bill of health,” Dunn said.
While that’s reassuring, the immediate toll of the fraud and its implications for our society are deeply troubling.
The fact is that U.S. fiscal policy today has a Ponzi-like character to it.
We are printing money at a breakneck pace to keep up with entitlement spending programs that most experts say will grow faster than our gross national product. Our federal budget deficit this year could top $1 trillion. And government spending for Social Security, Medicare, Medicaid and interest payments on our debt will rise steeply as more baby boomers retire.
President-elect Barack Obama’s challenge is to adopt policies that allow GNP growth to keep pace with the growth of those obligations.
But if those policies don’t achieve that ambitious goal, we are in same boat Madoff sailed for years before finally going under.
