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

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Comments

[susquehannastudio]

If you add up what Fuld and Paulson "made or earned" and put in their own pockets there must be a billion taken out of the economy right there. How many more did the same? I'm sure they did it honestly but ethically?

Why do American firms need offshore accounts in countries where they have no market?

[sheila]

and here i thought that supply-side economics, coupled with the exploitative "growth at all costs" model was the biggest scam ever. silly me. why would a pyramid scheme involving the entire world, built on exploiting workers and the environment for the benefit of a tiny number of grotesquely rich people, which disenfranchises 99% of us and mires us in debt, misery and disconnection to the real meaning of life be considered a "scam?"

it's called "unchecked capitalism" and it's just as big a scam as "unchecked communism." neither accounts for the (inherent or learned?) greed of humanity, and its desire to cut corners to maximize personal benefit, no matter how much it harms others.

i believe that if kids, starting in middle school, were taught more philosophy, particularly ethics, the world would be a MUCH better place. people don't even realize they are exploiting their planet and their fellow humans by most of their (our) behaviors because the philosophy of greed is indoctrinated into us from birth, but other philosophies (except religion, which also usually highlights the exploitative, rather than the sustainable elements of its creeds) are never even presented.

[Rule Of Law]

You hit the nail--education is the key. And we should find a way to make the dry and dusty topic of economics relevant, alive, and engaging. The Elites depend on us not knowing or caring about the one thing that absolutely affects us All--The Economy and the Financial Markets. Start by teaching kids how to balance a check book, then show them how the history of War and Depressions are always linked to the Banks and the Elite Families that profit from them. Make it pertinent. Give the next generations a least a few tools to protect themselves from this gang rape called Free Market Capitalism.

[kellygrrrl]

The Biggeat Scam of All Time:

convincing Americans that the ReThugs are Compassionate or Conservative

[sushi27]

Thank you!!!

[CAPTAINSKIPPY]

... and, capable of "running the country - like a business!!"

[GrainOSand]

The wolf has been seen, not in the vicinity of the henhouse, but he has been seen in a bulldozer, leveling the hen house. The robber has not left the building, he or she has stole the building and is robbing everyone in the building. America is fast looking like a giant Ponzi scheme, the greatest hoax ever. So many people buy into liberty and justice for all and end up getting the shaft while others drive the shaft home -- for profit. There may be no God or cosmic justice some suggest. If they are right that is a pity, for such corruption, such greed, may well take supernatural force to address because thus far hens have failed to stop the wolf. The best one can do is strengthen the nucleus and be ready (as possible) for all eventualities. Evil -- not freedom -- is on the move.

http://www.economicpolicyjournal.com/2008/09/henry-paulson-american-oligarch.html

"Ellis does point out a fascinating quirk in tax law: wealthy political appointees who put their assets into blind trusts needn’t pay capital gains taxes on any sales. So public service isn’t always a low-paying sacrifice; it can also help outwit the tax man. Ellis estimates Paulson could have saved as much as $200 million this way."
http://www.nytimes.com/2008/10/12/books/review/Anders-t.html

http://www.huffingtonpost.com/david-sirota/the-paulson-payoff-at-the_b_24379.html


http://kunstler.com/Mags_Forecast2009.html

[websmith]

There are many scams that are much larger going on, but the true costs, while in the trillions, are hidden and hard to measure. After stealing Social Security funds, the government is now trying to con everyone into believing that they are blameless and the culprits are baby boomers now asking for their money back.

After destroying themselves with greed and raping the economy, banks are now convincing the public that they are the economy and if they go under, disaster will befall us. The true bailout has been going on for over two years and the cost is quickly passing $7 trillion as they continue to foreclose on our homes and charge us loan shark rates on our credit cards.

http://ewebsmith.com/Finance/7trillion.html

[richardmcnoggin]

Are you kidding; Socialist Security IS the biggest Ponzi ever!!

[waverly]

As stated above:

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.

[Infostream]

It hasn't hit the MSM yet, but people in the financial sector (i,e, people who want to make lots of money without ever actually producing anything of value) are reporting that the vast majority of hedge funds are now refusing their investors requests to take their money out. It's like a run on the banks, but since the funds are unregulated, they can just say "no, we're keeping your money until we're ready to let you have it". It is just part of the crash of the BIGGEST SCAM OF ALL TIME - THE FRACTIONAL RESERVE BANKING SYSTEM which allows banks to create money out of thin air by creating debt. The hedge funds and the banks know that this irrational corrupt system they have profited so obscenely from has now reached a tipping point. Everyone is in debt to one another - governments, banks, consumers, a massive convoluted pyramid scheme of debt, and since they know there's nothing but more debt out there already, why lend money you can't possibly get back?

EDUCATE YOURSELVES, WATCH FOR FREE:
On Google video - find "Money as Debt" (45 min) and "The Money Masters" (3.5 hrs)
Or on YouTube: "Financial Crisis - Why All the Experts Are Wrong & A Too Good to Be True Solution" (17 min)

[Viper]

The biggest scam of all is reagan economics... Voodoo economics, trickle down, supply side, laisez faire capitalism, outsourcing, mindless free trade, the market is always right, governement is the problem and finance is more important than actually making stuff, deficits dont matter, that has been sold for the past 30 some years by Repugs.



All other scams basically arise from this Idealogy .

Happy New Year and regards

[ThirdEye]

But the biggest scam of all is the one the Feds just pulled off on the American public by hiring the people responsible for the whole financial crisis to disperse the hundreds of billions of dollars to all of their friends and associates with practically no oversight, restrictions, or controls.

[AMP43]

Absolutely

[The Hedonistic Pleasureseeker]

http://www.webofdebt.com/articles/ponzi.php

A must read to understand the Mother of All Ponzi Schemes.

[Mnemanth]

The biggest scam lately hasn't been this whole investments business. That's been a scam from the get go. "Give me your money, our business will do better, and you'll get a pittance back on your investment."
No, the biggest scam has been seen in the past couple of months: Trillions given out freely by our own representatives to stave of these rather sudden- and convenient- financial situations. No oversight, no accountability, no records of where the money is going or what it's being used for. And we're being told that it's alright, the grownups are taking care of things for all us stupid tax payers.
We're being robbed by our own leaders. It's clear as day, it's as obvious as the nose on our collective face- and not a d*mn thing is being done about it.
Who feels scammed now?

[Overd0g]

Let the buyer beware.

[Viper]

Said the con man not wanting to take the blame for his own criminal acts....

Reagrds

[jsgaetano]

The Biggest Financial Scam of all time was deregulation and the Credit Default Swap fraud market.

We are talking TRILLIONS of dollars. It may even eclipse Bush/Cheney's Iraq War scams, but the fact that they made plane-loads of pallets stacked with hundred dollar bills just disappear, you just can't beat the theatre of something like that.

[joebanana]

It impressed the hell out of me. I mean, go figure, how the heck could that happen?
Boy, I sure wouldn't want to have to explain that one to the little lady.
The first thing she would say is"WHAT THE HELL WERE YOU THINKING"
Then it would get ugly.

[BobsNotWorking]

Well? Lets talk about scams that outscam "The Scam". None even come close to the Federal Reserve. It is the mother of all scams. Federal Reserve? Clever name isn't it? The Federal Reserve is not an agency of the federal government. It is a private bank owned by the member banks. It exists for the sole purpose of facilitating fractional banking. Fractional banking is the greatest scam ever perpetrated on mankind. Keep asking yourself this one simple question; [Given that the constitution affords the federal government the power to print the currency] Why does the government borrow money at interest when it could simply print all the money it needs and spend it into the economy free of interest? Dig a little deeper folks. When you find the answer to this question you'll start to see the scam. These tabloid scams are nothing more than greedy children at play. The Federal Reserve [or central banking system] is the scam that, when challenged, can buy a president a dirt nap.

[The Hedonistic Pleasureseeker]

You took the words right out of my mouth.

The Babylonian usury/debt/slavery system is the foundation of our so-called "modern" central banking model that we call fractional reserve banking. It's the biggest Ponzi scheme of all, and so long as we are under its thumb it doesn't matter what we call ourselves: Democrats, Republicans, progressives, conservatives. What we are, are slaves.

Wake up, people, and brush up on your math. EIGTH GRADE MATH!!!! Fractional reserve banking is a Ponzi scheme. It is NOT SUSTAINABLE. It must crash, and it WILL crash, probably within the year, unless the central bankers trick or force us into accepting a new currency so they may start the scheme anew.

[ErnestineBass]

Amero, anyone? Heh heh

[Infostream]

Bravo. We need to start a national movement to get rid of the Fed and do what the constitution says we should do: have a democratic government directly control a rational monetary system. Thomas Jefferson warned us that letting private banks control our economy would lead us exactly where we are now.

It is hard to get people to listen on this subject, most just don't want to think about anything that "complicated", and others have been trained to think anyone who mentions the Fed is a conspiracy nut, so we really need to focus on the nuts and bolts of why the Fed doesn't.

It is really pretty simple though when you look at the big picture, the system we have now allows the private banks (the Fed) to create money by creating debt. They profit from this so they create too much debt money, which creates inflation. But worse, when you have a system that only creates money as debt, everyone must inevitably end up in debt, and we have reached the tipping point now, there is just no way to pay anything off and the banks know it, so they freeze credit and a depression is on its way.

[CanuckDemocrat]

very interesting... i have always had an inkling that it's not just greed ruining the system, but the system itself. It never worked, it is just now showing its true colors.

[TeriLyn]

I'm glad you brought this up. One of the most interesting descriptions of the formation of the FED is G. Edward Griffin's "The Creature from Jekyll Island". It's out there in print and on YouTube. Just Google it. It's one of the best descriptions of the inception of the Central Banking system I've come across...., but also one of the most enlightening in regards to the scam that's operating daily right under our noses. It should be must reading/viewing for every school child.

[Rule Of Law]

Great book that All Americans should read!

[Rule Of Law]

Dirt nap! Ah yes. And when you look at those who did challenge it, the result for all of them was either war, attempted assassination, or death.

"Madison and Thomas Jefferson organized what they called the Republican Party (later called the Democratic–Republican Party)[7] in opposition to key policies of the Federalists, especially the national bank!"

Especially the national bank.

Then the war of 1812 occurred.

"During and after the war, Madison reversed many of his positions. By 1815, he supported the creation of the second National Bank,"

And the war magically ended with, "Both the British and American will to continue were exhausted, the causes of the absurd war were forgotten."

Forgotten? No, England and Hamilton (who was English to his core) had won. They had their National (Federal Reserve) Bank based on the Bank of England and run by it.

[Kassandra]

au contraire, mon amie! The biggest scam is TARP and the Fed under Bernanke printing money so fast the presses are smokin'. Madeoff is just the target we've been offered for our hatred; really not worth spit in the larger "scheme" of things.

How many times have they pulled the "look over here!" scam so we didn't watch what is really happening?

[Mnemanth]

Excellent! There's always some big disaster that conveniently pops up, right in time to get the attention turned from the government- which is doing something stupid.