Thoughts on Madoff

Warning: this post is not good for children.

There are things that you may never know.

Madoff, for example. Google Madoff and you get 8 million hits (in comparison, Tom Cruise doesn’t fare too much better at 19 million), but many questions are left unanswered despite of the massive media coverage and public rage.

Let me explain by running an imaginative Ponzi Scheme fund for 10 years.

• Promise 30% return, risk free
• Set the minimum amount at $1 million, and suppose all participants subscribes with that amount
• Assume you get 200 subscription in the first year. The second year growth of subscriber base to be 200%, and reverse (I doubt it will) YoY to 10% in year 10 in a kinda geometrical way.
• Suppose 5% of subscribers quit each year, those who stay reinvest 50% of their interest payment
• The fund operates at a cost of 0.5% of total principle amount. As you will see, this is quite some money to spend.
• At each year end, you pay out 30% interest on principle.

He’s what you can get after 10 years:

• You have 6578 subscribers, owing them $12 billion in total
• You have $5.6 billion in cash for personal spending over the span of 10 years. That’s $5.6 billion, with a “b”.

If you’re interested in numbers, here’s the detail.

Now go back to the Madoff case and try these questions.

1. I guess Madoff had at some point huge trading losses. We don’t know when, but it has to be way before he devotes completely to a Ponzi. There were redemptions and mass redemptions toward the end, but given the alleged $50 billion amount, there must be some (maybe huge) sum left at some corner of the world. What would you do if you have his numbered account at a Swiss bank?

2. Suppose someone put $1 million with Madoff 10 years ago, “gaining” 12% a year, reinvested all, and redeemed right before it imploded. He gets away with over $3 million, a 200% gain. As a benchmark, the S&P 500 gained around 1/3 at peak in the last 10 years. What’s your take?

3. If you know it’s a Ponzi but you’re assured that you will have your redemption, would you invest with him?

4. What’s the difference between Madoff and the stock market, or Madoff and the housing bubble, Madoff and tax/federal budget? A visible hand v. an invisible hand?

5. Who’s to blame for the Madoff case? Who’s to blame for the crisis today?

 

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