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Sunday, December 14, 2008

Mark Kleiman asks where did the Madoff money go ?

This is the 50 billion Ponzi scheme.

He writes

What isn't clear (to me) is where the $50B went. It must have been some combination of outright theft, trading losses, and expenses (commissions, salaries, etc.). If it was stolen, then it must still be somewhere; Madoff could hardly have spent any noticeable fraction. It's also hard to see how expenses could have accounted for much of that sum. Did he really manage to lose most of 50 gigabucks? Shouldn't that be hard to do? Roughly as hard as making that much? After all, every trade has a counter-party, so what Madoff lost someone else gained.

That's simple. It was a Ponzi scheme. For years Madoff paid investors 8 to 10 % year after year. That's where the money went. In a Ponzi scheme, the money invested by new investors is used to pay the old investors. In this way it seems Madoff's firm managed to build up $ 50 billion in debt mostly by sending money to investors.

Now it seems someone warned the SEC what was going on but couldn't get taken seriously for some reason. He wasn't named Mark-up-a-loss but he is named Markopolos.

update: Thanks for the link prof. Kleiman. Also I notice that lots of people are googling "where did the Madoff money go" so I'm getting a good bit of traffic (by my standards) by quoting him in my title.

One point I was going to add (which I just notice was also noted by anonymous in comments) is that the $ 50 billion figure sure seems to be exagerated since Madoff only claimed to have 17 billion in assets under management. I don't see how if one claims 17 billion one can be overstating by 50 billion. I will just call the amount missing X where X could be $17 billion or $590 billion or something in between.

The other point is that much of the money was never anywhere. Madoff did not collect X from investors. Some of the money he promised them was money he claimed to have made investing. He was claiming 8 to 10 % returns for years. If he was getting average returns of say 5%, there would be a whole lot of made up money which never existed in any way anywhere.

In my original post, I assumed that he sent the fake returns to investors as dividends. It is much more likely that he just added the numbers to their accounts. Of the X which is missing, some would be money paid in by investors, some would be the actual returns that Madoff got and some would neither be nor have been ever.

I'd guess most of the ever really existing money was paid to investors who cashed in their accounts taking their money, the returns on the money and much more out (why is taking money *out* cashing *in* ???). Madoff probably paid a lot to himself. He probably didn't spend all of that, is not personally bankrupt, and will have to give his personal wealth to investors to cover civil fraud liability. Also his accountants probably weren't wasn't cheap given that he too might well end up in the slammer. Plus I would guess a good bit of semi-bribes and quite possibly pure and simple bribes.


Bruce Webb said...

Kleiman seems to be confused by the concepts of 'cash' vs 'wealth'. If everyone in Riverside Ca is convinced that their house is worth $600,000 and the market is clearing at $600,000 then a 1000 houses in the Inland Empire are well and truly worth $600 million. Which back in early 2006 could well and truly be converted into cash up to whatever portion of that $600 million was in excess of outstanding mortgage principle. On the other hand if all of a sudden the market is not clearing at levels above $350,000 those 1000 houses are well and truly worth only $350 million. If each and everyone of those homeowners had extracted each and every dollar of their equity then you could ask "Where is the money" but in the normal course of events this does not happen.

On any given day only a small fraction of a common stock will change hands. But everyone who holds that stock either gains or loses 'wealth' in exact proportion to the movement of the price. In this case it is just not true that every trade has an exact equivalent counter-party, a small tail can end up shaking a large dog to death.

Was that $50 billion dollars real money? Well it was just as real as unsecured deposits in a pre-FDIC bank in the 1920s. It was real until it turned to vapor. And in the end no one gained anything, depositors lost their balances and bankers jumped out the window.

"If it was stolen, then it must still be somewhere"
Well no, this is just to display an extraordinarily naive understanding of the relation of 'wealth' to 'money'. That the former is demoninated in the later does not by that alone give it existential reality.

Anonymous said...

Please see the article, "Who is Bernard Madoff, the man behind the $50 billion fraud?" at if you wish to see where much of the money in all likelihood went. In reading the article you can easily intuit why the question of where the money went is studiously avoided in most of the reporting and commentary by the mainstream media.


Anonymous said...

Still, I have trouble understanding the number $50b. Reports say he had $17b under management. If he had $50b he would have had to find $5b a year to keep the thing going. Also losses (such as Santander's 3b seem to add to nearer to 17 than 50.

Bruce Webb said...

"(why is taking money *out* cashing *in* ???)"

Assuming this is not rhetorical clearly Robert needs to spend more time at Vegas. Or given that he is in Italy maybe up the coast in Monte Carlo.

When playing a table game whether that be cards or roulette you cash your chips by pushing them in or towards the dealer or croupier. The player will announce he is 'cashing in' presumedly so that no one thinks he is betting it all.

Jeseppi Trade Wildfeather said...

In order to understand where the money goes one must first understand "where the money goes" in short selling. That is the stuff hedge funds are made of. That's where. The losses go right back into your pocket. That is called trust and fiduciary self interest. Sheesh!. Dumb money has no idea how the system works or how to make a buck they just lose it. To find out where the money went, grill those individuals he did business with who represented their organizations. Takes two to tango. I think that the organizations took the hit but the agents of doom are skiing Zermatt twice a year.