By Kevin Connolly
BBC News, Washington
If I had a dollar for every news story in which the golden rule of
investment has been dusted off and repeated over the last five days,
I would be able to pay back Bernie Madoff's investors myself.
If something sounds too good to be true, I keep reading, that must be
because it is too good to be true.
It is good advice as far as it goes and it raises the question of why
so many wealthy, sophisticated savers were apparently conned into
believing that Mr Madoff had come up with an investment strategy that
allowed him to pay handsome returns even when the stock market was
falling.
I asked a very senior regulator about this, a man who has been
involved in formulating public policy for many years, and he said the
answer was depressingly simple.
People are prone to believe what they want to believe, he said, and
in rising markets a kind of irrational euphoria takes hold in which
we are not inclined to ask difficult questions.
Human psychology
The point about Bernie Madoff was not so much what he was selling, it
was how he sold it.
On offer was a fairly standard hedge fund arrangement in which the
Madoff firm bought stock in a company and then hedged against the
risk by striking contracts to both buy and sell shares in the company
at agreed dates in the future.
In the jargon of Wall Street that is a "collar". It is perfectly
legal, but it requires endless resources of luck, judgement, money
and timing.
What made Mr Madoff unusual was the manner in which he recruited his
investors.
For that he relied on a powerful but elementary piece of human
psychology: the more someone tells you that you cannot have
something, the more you want it.
Membership of the Madoff fund was very strictly by invitation only -
merely being rich was not enough in itself.
Clients were recruited through the social networks of which Mr Madoff
and his wife were themselves members - many were Jewish New Yorkers
who spent part of the year in Florida.
Others came across the charming, wealthy, discreet giant of Wall
Street at the golf club or the yachting marina.
The very respectability of the clientele helped with further
recruitment.
Madoff customers were directors of charities and managers of
investment funds as well as wealthy business people and pensioners.
They were mainly, in other words, people who should have known better
and they fell for one of the oldest illusions in the book: that there
is an inside track in the world of investment.
Mr Madoff fed that illusion, and offered himself as the man who could
offer you access to that magic, secret circle.
Too respectable
The giant bailout of the American financial system earlier this year
introduced the concept of the bank that is "too big to fail", in
other words, is of such importance to the world's financial system
that governments decide that propping it up with public money is
better than allowing it to suffer the consequences of its own greed
or incompetence.
In his own way, Mr Madoff was something similar - an investment
adviser who was too respectable to scrutinise.
As former chairman of the Nasdaq stock exchange, Mr Madoff was a huge
figure on Wall Street - his thoughtful analysis of how modern
regulatory systems made cheating virtually impossible has been one of
the most-viewed clips on YouTube in the last few days.
The regulatory authorities, now that they have finally woken up, are
now assessing how much of Mr Madoff's clients' money has actually
been lost and how much if any might be recovered.
The particular nature of the alleged fraud means, however, that
existing clients seem to have been paid out of money taken from new
customers as they joined the scheme. That probably means that if Mr
Madoff owes you money at the moment, the chances are that you will
not be getting back.
It is not clear how many people working for Mr Madoff knew what he
was really up to with the funds collected from wealthy investors.
It has been widely reported that he operated this side of his
business on a separate floor of the Manhattan skyscraper where his
main company was based and it is even possible that he did not tell
anyone else what was really going on until he explained it to his
sons last week.
The court proceedings that grow out of all of this are likely to be
complex and highly technical, but a friend of mine who works in the
banking sector says the best way of understanding Mr Madoff is to
compare him to the kind of racing tipsters who advertise their
services in the back of sporting newspapers.
They too offer inside knowledge in return for a fee and should be
asked the same question that more people should have asked Mr Madoff -
if this scheme for making money is really so good, why sell it at
all?
Why not simply use the technique to make money yourself?
I asked the regulator if the world would learn a lesson from the
Madoff case and, depressingly, he was doubtful that it would.
These kind of schemes are only possible in a rising market and the
next time the market is rising strongly - as it surely will one day -
that old feeling of irrational euphoria will take over.
The reason we are easy to fool in the end, is because we are so good
at fooling ourselves.
Story from BBC NEWS:
http://news.bbc.co.uk/go/pr/fr/-/2/hi/business/7786813.stm
Published: 2008/12/17 07:51:32 GMT
BBC News, Washington
If I had a dollar for every news story in which the golden rule of
investment has been dusted off and repeated over the last five days,
I would be able to pay back Bernie Madoff's investors myself.
If something sounds too good to be true, I keep reading, that must be
because it is too good to be true.
It is good advice as far as it goes and it raises the question of why
so many wealthy, sophisticated savers were apparently conned into
believing that Mr Madoff had come up with an investment strategy that
allowed him to pay handsome returns even when the stock market was
falling.
I asked a very senior regulator about this, a man who has been
involved in formulating public policy for many years, and he said the
answer was depressingly simple.
People are prone to believe what they want to believe, he said, and
in rising markets a kind of irrational euphoria takes hold in which
we are not inclined to ask difficult questions.
Human psychology
The point about Bernie Madoff was not so much what he was selling, it
was how he sold it.
On offer was a fairly standard hedge fund arrangement in which the
Madoff firm bought stock in a company and then hedged against the
risk by striking contracts to both buy and sell shares in the company
at agreed dates in the future.
In the jargon of Wall Street that is a "collar". It is perfectly
legal, but it requires endless resources of luck, judgement, money
and timing.
What made Mr Madoff unusual was the manner in which he recruited his
investors.
For that he relied on a powerful but elementary piece of human
psychology: the more someone tells you that you cannot have
something, the more you want it.
Membership of the Madoff fund was very strictly by invitation only -
merely being rich was not enough in itself.
Clients were recruited through the social networks of which Mr Madoff
and his wife were themselves members - many were Jewish New Yorkers
who spent part of the year in Florida.
Others came across the charming, wealthy, discreet giant of Wall
Street at the golf club or the yachting marina.
The very respectability of the clientele helped with further
recruitment.
Madoff customers were directors of charities and managers of
investment funds as well as wealthy business people and pensioners.
They were mainly, in other words, people who should have known better
and they fell for one of the oldest illusions in the book: that there
is an inside track in the world of investment.
Mr Madoff fed that illusion, and offered himself as the man who could
offer you access to that magic, secret circle.
Too respectable
The giant bailout of the American financial system earlier this year
introduced the concept of the bank that is "too big to fail", in
other words, is of such importance to the world's financial system
that governments decide that propping it up with public money is
better than allowing it to suffer the consequences of its own greed
or incompetence.
In his own way, Mr Madoff was something similar - an investment
adviser who was too respectable to scrutinise.
As former chairman of the Nasdaq stock exchange, Mr Madoff was a huge
figure on Wall Street - his thoughtful analysis of how modern
regulatory systems made cheating virtually impossible has been one of
the most-viewed clips on YouTube in the last few days.
The regulatory authorities, now that they have finally woken up, are
now assessing how much of Mr Madoff's clients' money has actually
been lost and how much if any might be recovered.
The particular nature of the alleged fraud means, however, that
existing clients seem to have been paid out of money taken from new
customers as they joined the scheme. That probably means that if Mr
Madoff owes you money at the moment, the chances are that you will
not be getting back.
It is not clear how many people working for Mr Madoff knew what he
was really up to with the funds collected from wealthy investors.
It has been widely reported that he operated this side of his
business on a separate floor of the Manhattan skyscraper where his
main company was based and it is even possible that he did not tell
anyone else what was really going on until he explained it to his
sons last week.
The court proceedings that grow out of all of this are likely to be
complex and highly technical, but a friend of mine who works in the
banking sector says the best way of understanding Mr Madoff is to
compare him to the kind of racing tipsters who advertise their
services in the back of sporting newspapers.
They too offer inside knowledge in return for a fee and should be
asked the same question that more people should have asked Mr Madoff -
if this scheme for making money is really so good, why sell it at
all?
Why not simply use the technique to make money yourself?
I asked the regulator if the world would learn a lesson from the
Madoff case and, depressingly, he was doubtful that it would.
These kind of schemes are only possible in a rising market and the
next time the market is rising strongly - as it surely will one day -
that old feeling of irrational euphoria will take over.
The reason we are easy to fool in the end, is because we are so good
at fooling ourselves.
Story from BBC NEWS:
http://news.bbc.co.uk/go/pr/fr/-/2/hi/business/7786813.stm
Published: 2008/12/17 07:51:32 GMT
