The Scam That Outscams "The Scam"
The Bernie Madoff Ponzi scheme is generally regarded as the biggest financial scam of all time. I don't agree.
Hedge funds, and particularly "fund of funds," make Bernie's despicable conduct look like small potatoes.
The underlying premise of hedge funds -- outsized returns with no increase in risk--is fatally flawed. Numerous studies have demonstrated the vast majority of these funds do not beat the returns investors could obtain for themselves, by investing in a simple S&P 500 index fund.
It was only a matter of time before these funds started to implode. According to a web site that tracks hedge fund failures, 108 funds at 66 firms have gone of business since 2006. Many more are sure to follow.
While the pitch of hedge funds is a scam standing alone, the "fund of funds" embellished the con. These funds charged 1% or more for selecting and monitoring the performance of "the best" managers.
This scam relied on the gullibility of investors who believe "best managers" is not an oxymoron. The data clearly indicates that it is. If you own an actively managed fund, the odds of it beating its benchmark over 1 year is 1 in 3, over 5 years it's 1 in 5, over ten years it's 3 in 100 and over 25 years it's essentially zero!
How anyone can claim to be able to beat these odds and convince so many sophisticated investors they should pay them to do so, is the poster child for a combination of greed and cognitive dissonance.
Enter the track record of Bernie Madoff. Fifteen years with steady returns of 11%. This was something fund of funds could really sell -- and they did. Some funds reaped hundreds of millions of dollars of fees for simply forwarding billions of dollars of assets to Madoff. These investors felt privileged to gain access to him and were happy to pay the fund fee, secure in the knowledge that Madoff was being closely monitored.
You know what happened next.
Here's the real scam: How motivated were these "fund of funds" to carefully monitor Madoff's performance? Did they really want to kill the golden goose? Or is it likely they either knew his returns were too good to be true or engaged in "willful blindness" to his fraud?
It would not have been difficult to detect his misconduct. He used an obscure accounting firm. He had no independent custodian. These are major red flags.
Or, they could simply have read a 2001 story about Madoff written by Erin E. Arvedlund in Barron's.
The article was skeptical of Madoff's track record and noted "[T]hree option strategists for major investment banks told Barron's they couldn't understand how Madoff churns out such numbers using this strategy."
Of course, real monitoring would have included replicating Madoff's results. No one has been able to do so....and with good reason.
The real beneficiaries of the scam are these funds. Their rewards dwarfed those received by Madoff.
They are the ones who engaged in the scam that outscams "The Scam."
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein
Follow Dan Solin on Twitter: www.twitter.com/DanSolin
Loading comments…
Want to reply to a comment? Hint: Click "Reply" at the bottom of the comment; after being approved your comment will appear directly underneath the comment you replied to
I would like to vote for Health Insurance in the US as a big scam ( not the biggest ). Back breaking monthly fees, huge deductibles, the weak denied coverage, most procedures not covered, coverage cancelled when ill, damaging most US corporations ( see GM ) and hundreds of millions in corporate pay to the top execs. The Wall Street crisis has made us take our eyes off this industry that is causing damage to our economy. What if these families had 500 to a 1000 extra to spend each month instead of putting it into the hands of the con artists of health insurance ? That would stimulate the economy.
Health insurance is expensive because too many people seek too many expensive treatments. How much money do you think people spend just on anti-depressants and erectile dysfunction drugs? If people payed completely out of pocket for those things themselves, insurance costs for the rest of us would go down a fairly good amount. There are a lot of other things I believe people should pay for themselves too, rather than the rest of us who don't use such drugs subsidizing them who do.
Anti-depressants could be considered an economic boost. It is beacuse of ADs that I work much more than I used to, own real estate, and also invest in the stock market.
ok, there are many, many, many more reasons healthcare is expensive. try a car accident, complicated childbirth or, um, cancer
SS would not be in trouble if those who made over 100k+ paid a share of that money into the fund. There would be no shortage and it would continue to work. I guess we could get rid of it and go to strickly 401k programs which have lost all gains in the past few years. The corporations are now refusing to match 401k contributions as a way to keep paying the stockholders. Anything the neocons can do to screw the workers they will. The top 2% keeps sucking more and more from the other 90%.
It would also help if the SS trust fund was not siphoned off for personal pork projects like the two wars we have going.
I am now on SSD due to illness, it ruined me financially right off the bat. SSD is less than half of what I had been making working. Due to situation beyond my control it was not like I was making all that much, and could not even afford to go to school. Thanks RonnyRaygun and those who voted for him.
It is too long to go into here, but I was a trained air traffic controller............
I count myself lucky that I not longer homeless, and that there is still Medicare and Medicaid however long that will last.
Thanks Dan for bringing this to our attention. To be sure, hedge funds are a scam, i.e., a confidence scheme which you define as the belief in "outsized returns with no increase in risk". The only people who actually win are the guys who set up these scams. But given the credulity and greed of many Americans hedge funds, I am sure, will not be the last fraudulent enterprise that Wall Street comes up with.
LIFE is the biggest scam of all. No matter what you do, or how you act, you end up 6 feet under.
AMEN, brother.
The greatest financial swindle in human history, which is politely called "financial scam," was the selling of mortgages to unsophisticated Americans of houses and other real estate inflated by speculators and easy money. Then to market them to trusting foreigners and governments.
This swindle kept Americans able to maintain a standard of living unwarranted by the declining employment,manufacturing and technological competence, accelerating wars and lowered taxation on the upper echlons of society.
The repercussions of this swindle on American self determination is yet to play out. But foreign drumbeats are becoming increasingly louder among damaged economies in a wide variety of countries to exact revenge and recompense for the damage of our financial institutions to the world's prosperty. Our Nation is becoming the scapegoat for the looming world wide depression.
One fact is clear: We will be damaged most grieviously by this depression. We will be the last to recover, if ever we shall. And we most likely will be ostracized from major decision making as our debt paralyzes our capacity to shape our own future.
Not very optimistic today, are we TML? As the reelection of Bush showed, people have short memories. Most won't learn a thing from this. Thus, we can stumble forward with our leadership renewed, because, Yes, we can.
The biggest scam is the bank bailout and the no-bid contracts and trillions spent on Iraq!
Just want the government to have some connected bike lanes, high speed trains (220 mph) and a bicycle for every family and a refund check to insulate and modernize each American home.
Forget Detroit, Forget Wall Street....
No bid contracts in Iraq have not been a problem. FDR started no bid contracts in 193901949 by the way because he understood that future costs are often very difficult to even impossible to determine. How can you bid on something you don't know the scope of and don't have any more of a guess of what the costs will be? Plus, there are often no competitors in many of these spaces anyway. What other company besides Halliburton could have done the oil servicing over there? Schlumberger is technically a French company so should we have let them bid?
were the food service contracts for the troops bid?
Did you hear that now we are going to now bailout the Detroit suppliers. This crap is never to end. This country is going down the toliet.
Mr. Solin is wrong: the biggest scam of all is capitalism -- the ultimate pyramid scheme.
right on!!!!!!!!!
Right on. AND we actually don't need it.
Cuba is waiting for you.
Funny how people here keep saying that but they can never give me proof of it. Every first world country is capitalist and always has been.
Every first world country -- except the USA -- has nationalized health care. Nobody -- except Americans -- have to worry about health care for themselves, their children, their parents. Nobody goes into debt to pay for higher education or even medical school -- except Americans. Also, first world countries -- everywhere except in USA -- have first-rate public transportation systems, high - speed trains -- subsidized.
The biggest financial (Ponzi) scam of all time is SOCIAL SECURITY.
It is time to recognize that social security was to be a backstop to failed retirement benefits not the sole retirement benefit for Americans.
Americans who do not save should not be rewarded with a sufficiently comfortable social security retirement benefit paid for by all workers.
We, as a society, guarantee that Social Security will be there when you need it. No individual or corporation can give you that security. It is not a scam, because:
a. the rules are known,
b. most of the participants benefit from it,
c. most of the participants can change the rules through their elected representatives.
It would be interesting to see how wealthy this fund would now be had Reagan not robbed it.
Maybe it would only be more depressing.
It IS a scam because it relies on the people paying FICA taxes now to cut checks for recipients. All the money taken in is used to pay out and not invested. Thats why SS is in trouble, in a few years there'll be more people taking than paying
Interesting that you would call Social Security a Ponzi scheme. The reason it's not a Ponzi scheme is that it isn't being sold as an investment program. Right from the start it has been described as a program whereby current contributions fund current benefits. No one ever claimed that current benefits are funded by saved and invested contributions.
If you had understood otherwise, it's understandable why you would think of Social Security as a Ponzi scheme once you understood how it really operates. But now that you know, I hope you will not refer to it that way again. Doing so will only confuse others.
So your answer is to privatize Social Security? Forced to contribute your savings into Wall Street just like 401K's, feeding the market into even bigger bubbles which burst only to gobble up your savings. Is that your answer?....To lose all your retirement savings. Most people are smarter than that.
Social Security is the greatest government program ever conceived and executed. You are welcome, however, to forgo your share, if you really feel that way, somehow I doubt you will.
You are absolutely correct. SS was never meant to be a retirement/savings plan. It was meant to be an insurance policy. That's it. Too bad we had idiots running the government back in the 50s and 60s who didn't have the courage to make sure all Americans understood this. Now we have this retirement welfare system that will absolutely be restructured. If anyone thinks they will live off this, they will be eating dog food. Take responsibility for your own life and stop asking hard working people like to support your lazy, ignorant butt. You should have learned a trade or spent more time in the engineering books. Live with Your decisions. It’s never too late to fix your life.
An even bigger scam, perhaps the biggest, is that an economic system cam be based on perpetual growth. You can't have unlimited growth in a limited system (Earth). But, you go to hell in the handbasket you have, to paraphrase Rummy.
The fundamentals of the economy are insane.
Indeed, that notion just feels wrong, particularly because our planet has limits and has not grown to match our appetites. What is the alternative, is the greatest question of our times
Banks, corporations, advertisers, investment firms, are Enemies of The People. The real sad thing is that our so called leaders have conspired with them instead of protecting us from them
The biggest scheme in U.S. history will be the upcoming "stimulus" plan which will consist of nothing but pork projects on crack and handouts to political organizations to grease the wheels of the stimulus bill through congress.
Agreed. God help us with the three amigos, Pelosi, Reid, and Barney Fife/Frank.
The Scam of Scams is Wall Street. Unregulated CMBS, CDO's and CDS - Trillions of dollars of lost investor’s money. Senior Management taking multi-million dollar salaries and bonuses in a 2-3 year time frame and then saying oops- I guess I was wrong - sorry- I will just move on now. In the 80's it was the S&L scandals, in the 90's it was Tech and insider trading and now it’s the financial services.
What's next?
B"H
Dan - great article!! You are 100% right - the whole fund of funds pitch is a gross misrepresentation on its own. I share more thoughts on how Madoff pulled it off at www.davidportnoy.blogspot.com.
What about the US government?
That is the ultimate ponzi scheme and will be in high gear with the trillion dollar pork plan known as stimulus about to be rolled out.
Lifeline = Stimulus = Bail Out = Pork
I disagree. The biggest scam is Social Security... the governments illegal legalized Ponzi scheme.
Get your facts straight. Stop falling for GOP drivel. This nonsense created 401K plans handed to Wall Street to replace insured pension plans. It is greed. They want our money.
The government has been using our surplus payments into Social Security for decades to fund their wars and pork. The surplus that the boomers have paid over the past 35 years would cover their benefits. Don't let them deceive you.
Get your facts straight.....anyone that works is not forced to invest in a 401K plan. We are forced to "invest" in Social Security.
It's the same scam the auto industries played on their employees. Instead of taking the money paid in for retirement and creating a trust fund for future payments, the money was basically used to pay for other things. Now that there are retirees looking for their benefits the industry tries to say they are broke and can't pay, meaning the money has been legally stolen.
Hope you're independently wealthy. Social Security is pay back to the people who worked all their lives and supported this government. If you don't agree with it , don't accept it when you become eligible.
Your statement to not accept SS when one becomes eligible is a bit reactive. Wouldn't it be nice if we could be proactive and decide we didn't want to pay into it in the first place?
Proactive works better for me than reactive.
I really disagree! Social Security is NOT payback for anything! I paid into the Social Security system in every paycheck for 47 years and what I paid in was a hefty amount. I now collect a Social Security check every month and that is the money I paid in all those years. This isn't a reward. It's MY money!
There are millions of Americans that spend their lives treading water, living from paycheck to paycheck. You would prefer to see these people, in their old age, living under highway overpasses?
Nice straw man you have there. Why do you presume how s/he feels?
We can't have a sane conversation about Social Security until everyone participating in the conversation fully understands the true nature of fractional reserve banking and fiat monies, and the horrendous inflation built into the system. Seniors are screwed. We are ALL screwed by this massive Ponzi scheme called central banking.
Getting rid of Social Security while stupidly hanging on to our present form of Central Banking (Federal Reserve) would be a disaster for everyone. No doubt. HOWEVER, if we got rid of the Federal Reserve bank in favor of a Treasury-issued commodity currency (minimally inflating) we could THEN (maybe after a generation has passed) have a rational discussion about social programs like social security, medicare, etc., and come to a consensus of what kind of "floor" we wanted to create vis-a-vis standards of living for all citizens. By then we might conclude we don't need them.
The key is to make participation in any system voluntary. For instance, the Amish don't pay into the system, and lo and behold! The space-time-continuum has not ripped apart!
I expect them to work they way through college or a trade school like I did, instead of making babies or feeling sorry for themselves.
You must be logged in to comment. Log in or connect with
