Monday, February 17, 2014

Markopolos and "Our System"

Starz has a story on Harry Markopolos, an accountant turned fraud investigator, who did years of research trying to expose Madoff and his Ponzi scheme. It is much too long with annoying diversions into Markopolos' growing--and seemingly merit-less--paranoia but it is unforgettable in several areas and is important in what it reveals about what we believe is "our system."

Markopolos started as an accountant working for Ramparts, an investment company in Boston. The company was trying to break into the options market and were stymied by Madoff's success. No one wanted to shift money from Madoff to Ramparts. Markopolos was assigned the task of evaluating Madoff's performance so Ramparts could compete with them. 

Marlopolos says that in five minutes he knew it was a fraud. Why? Because he never lost money. The hallmark of investing is that you can not plan on every contingency and sooner or later you will be wrong and will lose money. Madoff never did. So investing guarantees you will, at some point, lose money. There are no exceptions that are real.

With this insight, Markopolos moved deeper. Soon it became clear to him that Madoff was not investing anything, he was just pretending he was and recorded pretend profits. That lured more investors in and, with the new money from new investors, he paid the earlier investors. When Markopolos started looking at this, Madoff had a fund of 3 billion dollars. When Madoff was exposed the fund had a paper value of 50 billion.

More, it became apparent that Madoff was not alone. He required a complex of many "feeder funds" who had investment money to place and chose to place it with him. These funds received much more money for placing the money than the fees Madoff himself demanded in his scam. Indeed, Madoff's take was a relatively small percentage (but of a considerably larger pie.) Markopolos realized that most of the feeder funds were involved, at least passively, in the fraud. (It was similar to the Jasmine character in "Blue Jasmine.)

Markopolos went to the SEC. Every time he showed them his figures they said they were impressed. Every time they did nothing. It is important to note that Ponzi schemes are fragile. As they have no real investments, they are easy for a regulator to spot. All you have to do is say, "Who sold this IBM stock for you and who bought it?" Checkmate, because no stock was bought or sold. This simple check was never done. More, at some point in the middle of Markopolos' campaign, the SEC's  main overseer of this area married Madoff's niece. Married his niece!

Markopolos went to the press. Our guardians of last resort. A story was put together by Forbes. It was never run. He went to the WSJ, to their top investigative reporter, in 2006. He was impressed. The story never ran. Markopolos implies there were simply too many opposing forces at work, the elites too close, too many people with a lot to lose, for the press to reveal the scam.

In 2008, eight years after Markopolos started his campaign, the credit crunch began. Fearful people wanted to pull their money out of the exposure in markets and everyone began requesting their money. Madoff's client/victims too. But there was no money, only fraudulent paper transactions. So Madoff fell. It is important to realize there was not a single agency or news release that stimulated the failure; the failure was generated by market dynamics. Like the ill child of cultist parents, Madoff succumbed to natural forces.

Of the 300 firms, 300, implicated in the fraud, there have been less than a dozen individual arrests.

This is a grim story with grim lessons. First, the characteristic of a real investment is that it will lose money. That should never be forgotten. Two, the investment arena is huge and complex. But it is also motivated by greed and, if possible, corruption. No one's better nature will shield you. Nor is reputation much help. (Madoff was a past president of NASDAQ.) Three, success in this area occurs but it is similar to knocking down all three bottles with a ball at the county fair: The contest is designed to beat you. Four, the government oversight is a sham bigger than Madoff himself. What this means in other areas of the government I tremble to think. Five, the watchdog press has more interests and concerns than truth. When they are placed in an awkward position, they will sacrifice us.

God help us all.

No comments: