Thursday, March 12, 2009

Finally a key answer about Madoff: it started with the 1991 recession

For almost three months now I have been patiently waiting for the answer to one important, key question about Bernie Madoff's Ponzi scheme, as I wrote on December 16, 2008 in a post entitled "When did Bernie Madoff initiate his fraud?":

The main question I have about the Madoff scandal is when did Bernie Madoff initiate his fraud? Has he been doing it all along, or was he on the up-and-up originally and only decide to "go Ponzi" when he started having trouble achieving decent returns in recent years? In other words, what was the real turning point? Was he always a crook, or did he just get into a bind and pride and ego led him to "cheat"?

Today, as Bernie pleaded "guilty" (eleven times), he disclosed that it all started with the recession of the early 1990's. According to a Bloomberg article by Jeremy Gerard entitled "Madoff Exits in Cuffs, 'Law and Order' Cameras Roll: Commentary":

He started bilking his clients during the recession of the early 1990s, he said. Once he had a taste of it -- by neglecting to buy securities his clients paid him for, for example -- he just couldn't stop himself.

Associated Press has the "Text of Bernard Madoff's court statement", in which Bernie tells us:

... for many years up until my arrest on December 11, 2008, I operated a Ponzi scheme through the investment advisory side of my business, Bernard L. Madoff Securities LLC ...

... When I began the Ponzi scheme I believed it would end shortly and I would be able to extricate myself and my clients from the scheme. However, this proved difficult, and ultimately impossible, and as the years went by I realized that my arrest and this day would inevitably come. ...

... I never invested those funds in the securities, as I had promised. Instead, those funds were deposited in a bank account at Chase Manhattan Bank. When clients wished to receive the profits they believed they had earned with me or to redeem their principal, I used the money in the Chase Manhattan bank account that belonged to them or other clients to pay the requested funds. ...

... I want to emphasize today that while my investment advisory business -- the vehicle of my wrongdoing -- was part of my firm Bernard L. Madoff Securities, the other businesses my firm engaged in, proprietary trading and market making, were legitimate, profitable and successful in all respects. ...

Then Bernie comes to the key fact:

... To the best of my recollection, my fraud began in the early 1990s. ...

He goes on to tell us what motivated his decision to commit fraud:

... At that time, the country was in a recession and this posed a problem for investments in the securities markets. Nevertheless, I had received investment commitments from certain institutional clients and understood that those clients, like all professional investors, expected to see their investments out-perform the market. While I never promised a specific rate of return to any client, I felt compelled to satisfy my clients' expectations, at any cost. I therefore claimed that I employed an investment strategy I had developed, called a "split strike conversion strategy," to falsely give the appearance to clients that I had achieved the results I believed they expected. ...

This does not us an exact date, but close enough. According to NBER, the recession started in July 1990 and ended in March 1991. So, it seems to seem safe to conclude that his Ponzi scheme started in 1990 or 1991. His overall firm was founded in 1960, but I am not sure when he started taking client money and acting as an investment advisor.

In short, he did not plan a Ponzi scheme from the beginning. Originally his investments were all on the up-and-up, but then he found himself in a bind and decided to try to take an "easy shortcut" and we now know how that movie ended.

Reuters also has the PDF file for the actual Madoff Allocution Statement that was submitted to the court. It appears to have the same text as the AP article, as far as I can tell.

-- Jack Krupansky

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