Bernie Madoff and Sam Bankman-Fried - and every other Ponzi fraud - are more similar than different
17-Jan-2023 •Dhirendra Kumar
Bernie Madoff's racket is long gone, and now he's been dead for more than a year. It's well-known now that his racket was the largest Ponzi scheme ever, amounting to US $61 billion when it was discovered in December 2008. Of course, those who have read his story in detail - or watched the new Netflix series 'The Monster of Wall Street' - know that his racket was suspected and discovered long before that.
As long ago as 1999, a financial fraud investigator, Harry Markopolos, proved that it was mathematically impossible for Madoff to generate the returns he claimed to be generating. Markopolos complained to the SEC, but no one listened. Markopolos later wrote a book titled 'No One Would Listen'. This is a great mystery to some people, but there is no mystery here to many others. Of course, no one would listen - they did not want to hear. Madoff was a star; he made donations to charities, he was friends with the individuals who were regulatory heads, and he had been a Chairman of NASDAQ - he was a pillar of the financial world.
The Netflix serial - worth watching - tries to delve into the psychological reasons that made him start the scam. Essentially, he began with honest intentions of managing his clients' money well. He did well initially, and then, at some point - which could have been as early as the 1970s - he made some losses. He loathed admitting failure, so he quietly made good the losses out of his personal money. This was it - he never got out of the trap of wanting to be seen as much better than others. Pretty soon, he was running a pure Ponzi scheme. He did not trade and just paid for redemptions out of the general pool of client funds.
A Ponzi scheme is like a runaway train on a track from the first step to the last. It ends only when there's a derailment. The derailment always comes when there's a big dip in the markets, many redemption requests come in, and there isn't enough money to meet the redemptions. Madoff finally had to confess because in December 2008, as the global financial crisis got extended, he got so many redemption requests that there was no other way out. Indian investors will note that although Ramalinga Raju's scam was somewhat different, he too had to confess as a fallout of the global financial crisis.
Ponzi schemes follow a pattern. The kind of people who perpetrate them also follows a pattern. The most recent example of a Madoff-like phenomenon is the former crypto-king Sam Bankman-Fried. He too, started by trying to run a scheme that was going to be the greatest ever. When the crypto markets started crashing, he dipped into customers' funds and transferred them to his trading subsidiary, which had massive losses. Of course, since everything in crypto runs at hyperspeed, Bankman-Fried went through the cycle of becoming crypto-king and having his Ponzi discovered in just months.
There are some other similarities too. Bankman-Fried was hailed as a genius. He gave large donations to politicians and to other recipients, including the media. So far, he has played the game better than Madoff did. The days following the FTX collapse demonstrated this quite clearly. Based on the Madoff affair, one would have expected that someone caught running a Ponzi scheme above ten billion dollars would be universally condemned and would not have anyone to defend him but what is happening to Sam Bankman-Fried was very different. The legacy media in the US carried many articles that tried to minimise the harm that this man did and, in fact, portrayed his actions as mistakes or misjudgements rather than outright theft. Many articles also lamented how his donations supported all kinds of scientific research, and all that will now come to an end. "Before FTX collapsed, the founder poured millions into pandemic prevention. Most of those initiatives have come to a sudden halt," is an actual headline in a very influential American newspaper.
Notably, both Madoff and Bankman-Fried could operate because the actual activity was unregulated (for crypto) or poorly regulated (for Madoff). Handling other people's money is the world's greatest temptation; having too much compliance and auditing is better than too little.
Suggested read: And another one...