Madoff: Symbol of the Age of Deregulation

More details have been coming out about the role that giant-scale Ponzi artist Bernie Madoff played in the whole Age of Financial Deregulation (a.k.a. casino capitalism), here in the US.
On Thursday, Madoff was indicted in federal court in New York for having committed securities fraud regarding the $50 billion of other people’s money he lost by running his Ponzi scheme.
Notable among Madoff’s affiliations is that he was a past Chairman of the board of the Nasdaq stock exchange, and treasurer and board member of Yeshiva University in New York. Among the investors whose money he lost were Jewish philanthropic organizations, some of them with strong interests in Israel. (Recently Sheldon Adelson and Sam Zell, who have both been large-scale supporters of Israel’s settler movement, have also lost huge amounts of money. I can’t find out yet whether Madoff supported pro-settler or pro-withdrawal movements in Israel.)
The Seeking Alpha blog had a fascinating post about Madoff yesterday, written by someone described only as “fund manager ‘Cassandra'”.
Cassandra wrote that he (or just possibly she) could never figure out what it was that Madoff had been doing all these years to generate a steady stream of income for his investors. She– yes, thanks to commenter Larry I’ve discovered she is a she— also had never met anyone who had formerly worked as a trader for Madoff, which she found strange.
My understanding is that because Madoff was supposedly executing his own trades, rather than running them through an outside institution, he was able to hide what he was doing– or, as it may turn out, not doing at all– from the scrutiny of everyone except his auditor. And crucially, the auditor used by Bernard L. Madoff Investment Securities LLC was listed as Friehling & Horowitz, who was described in this Bloomberg piece as, “an auditor operating out of a 13-by-18 foot location in an office park in New York City’s northern suburbs.”
The Bloomberg piece noted that investment adviser Jim Vos of Aksia investigated Madoff Securities intensively in 2006 and identified a number of red flags:

Among the … “red flags” cited by Aksia was the “high degree of secrecy” surrounding the trading of the feeder fund accounts, which provided capital to Madoff Securities, and its use of a trading strategy that appeared “remarkably simple,” yet “could not be nearly replicated by our quant analyst.”
Friehling & Horowitz operates from a storefront office in the Georgetown Office Plaza in New City, sandwiched between a pediatrician’s office and another medical office…
A woman who works in a nearby office, who didn’t want to be identified, said Friehling doesn’t come to the office regularly. When he does, he is the only person there…

Not exactly the kind of auditorial capacity one needs, to be able to keep track of $50 billion worth of investments…
Back to Cassandra. She wrote at length about his own, apparently longstanding mystification about the source of Madoff’s presumed ‘success’ as an investor:

Is he arbing the exchange fee structure? Is he algorithmically scalping cause he’s seeing the order flow before it gets to the exchange? Maybe. Profitably? Who knows? But I didn’t have a problem with an old Jewish guy making markets. This is what we DO. But there are these investment funds – Fairfield Sentry and Kingate, and these are the issue. They are Madoff-only feeders reputed to be $7bn each. Are they funding his market-making? Why does he need so much capital? What the f*ck f*ck f*cking f*ck could he be doing in the equity markets with that much capital and still keep it a secret AND deliver returns? They say they are doing these split strike conversions but I can’t see how the numbers work. Nor can anyone else. The Wall Street Journal raises the red flags in an article, but it’s dismissed as hyperbole disseminated by jealous competitors…
In 2000, I advised a family-office on their alternative investments and constructed a portfolio on their behalf. I had free rein (thanks! anon). Included in their legacy portfolio was a sizable Madoff position. As a fiduciary – and a conservative one – coming on the heels of LTCM which also lacked transparency and which made it hard for me to raise capital – I dug, asked every well-connected equity-finance, prime-broker, electronic trader and HF allocator type I knew and it still didn’t add up. The best and brightest still had no more insight than I, though the skeptical shared my suspicions. So, I strongly suggested they “dump it”. “One isn’t being compensated sufficiently for not knowing, and something just isn’t right here. Yeah maybe it’s OK, but I think it’s not”. But they liked “it” and they liked “him”. “He’s always paid”, they said. “We’ve been with him a long time”. Old school they were. Trusting. What the f*ck did I know anyway?
Well it seemed to me that the “split-strike conversions” were profit shifting bookkeeping tools. Money invested in the feeders did obtain split-strike conversion positions on their books that had an implied “yield” equal to their return but it seemed these were pre-arranged combinations that shifted return back to the investment vehicles and were “phantom” positions vs. Madoff securities. In the interim, Madoff presumably has use of the entire pool of capital, to do what he pleased, plus whatever that pool could command in terms of leverage from bank lines and financing sources. It could be in anything and everything. He could be doing mutual fund timing, or mutual fund market impact trades. Credit arbitrage. Funding coup d’etats in Africa. Or buying GSCI commodity swaps. More plausibly, he could be doing option and index-option market impact trades since he was ostensibly at the center of market flow, or he could be at the center of a loan-sharking network across America earning 50%pa, and here he was passing a paltry 9% back to investors. Either he was crooked beyond belief or he was an evil contrapreneurial genius. Who would have have thought he was both??!!
Some crimes are too perfect. Some facades too well-painted to be original or convincing. A good hustler knows he must lose sometimes in order to win. THAT is the reflection of reality that makes it believable, and gives confidence to the punter who will shortly be taken out. THAT was what was wrong with Bernie Madoff’s Ponzi. The people who were taken – like the Family Office and many other investors who in time will go public on their fleecing – wanted badly to believe they were onto something that was so good that they ignored the most obvious signs of bogusness. It just didn’t make sense. It just didn’t add up. Even Jim Simons earns it. There is no free lunch.
There is something fitting and just in the timing of this. It is emblematic of America since Reagan and the Great Leveraging. Something for nothing. Thank you Mr Laffer. But as a philosophy and modus operandi it is quite literally, bankrupt and without merit. And Laffer has since been proven to be full of sh*t. Now, Americans will have to confront this, the premise that greed is good and self-guiding and somehow omnisciently beneficial for it has had repercussions down to the core of our society and values. “Sorry everyone….what you’ve been pursuing has all been a lie, a big Ponzi, a rat-hole to nowhere….”. Re-boot.

Well, I almost couldn’t have put it better myself. Except I’d have likely used fewer expletives.
… Earlier today, I was trying to think through how Madoff and his top employees (all or most of whom were, it turns out, his close relatives) got started on his life of crime.
Wow, this would certainly make a great movie.
I’m thinking maybe the guy started out straight… But then at some point maybe he found himself short and he thought, Oh, I’ll just this one time use this new bit of investment to cover my problematic positions in the market and do a bit of creative book-keeping to cover that up… And it worked. So he went on doing it. And he was (obviously) very attentive to his new investors, and potential investors, and their needs… And he had great networking skills… And Ponzi-ing became more than just a habit, it became his SOP, and perhaps the thrill and excitement of deceiving so many people also became more than a little addictive…
And the regulators were nowhere in sight; he was able to keep the financial journalists and other investigators at bay; and his ‘auditor’ had been bought and paid for a long time ago…
And so long as there was plenty of excess money washing around in the New York-based financial system Bernie was just fine.
In a Ponzi scheme, as I understand it, you do generally need to keep on growing in order to cover your commitments.
But the day came there were no new investors. And many of the existing investors needed to liquidate their investment with him to cover positions elsewhere in the troubled markets of 2008… And this time, suddenly, unlike every time in the past, Bernie was unable to give them back their deposits when asked… Enter FBI Special Agent Ted Cacioppi and his sad little account of Madoff’s demise.
Truly an apt story of the Great Age of Financial Deregulation.