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Op-Ed: Ponzi, Ponzi Everywhere...

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Madoff merely symptom of broader economic malaise.

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Editor's Note: James Quinn is a senior director of strategic planning for a major university. James has held high level financial positions with a retailer, homebuilder and a university in his 22-year career.

The Great Swindle

The greatest fraud in the history of our country was exposed last week: Bernard Madoff's $50 billion Ponzi scheme. The size of the losses is mind-boggling - 3 times the size of the proposed bailout of the US automakers. The immorality of his actions is incomprehensible. Charities have been wiped out, the life savings of entire families have been lost, and innocent lives have been ruined.

This man was well-respected by the Wall Street investment community, a prominent philanthropist, and part of the wealthy high-society crowd in West Palm Beach. This begs the question: If this scam has been in progress for decades, how many of its kind are still out there? After a year of never-ending tales of scandal, fraud, lies, greed and mismanagement, this episode should finally convince the American public that the investment game is rigged, and they don't stand even the ghost of a chance.

It's too soon to determine what the long-term effects of this scandal will have on our financial system. This tragedy is a failure of morality, a failure of regulation, a failure of unbridled capitalism and a failure of common sense.

What began as a classic American success story is ending as an American tragedy. Bernard L. Madoff Investment Securities started in 1960 with $5000, and became one of the founding members of the NASDAQ. Madoff eventually became Chairman of its board, with an estimated net worth between $200 and $300 million.

The words on Mr. Madoff's website now seem gravely ironic:

"In an era of faceless organizations ... Bernard L. Madoff Investment Securities LLC harks back to an earlier era in the financial world: The owner's name is on the door. Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm's hallmark."

It's doubtful that the words "high ethical standards" will grace Mr. Madoff's gravestone. Even as his Ponzi scheme was unraveling, his "high ethical standards" led him to try to distribute his $200 to $300 million to family, friends and employees before the victims of his crimes could attempt to recover some of their money.

A Ponzi scheme involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from net revenues generated by the business. Mr. Madoff's Ponzi scheme was incredibly unsophisticated. He was spectacularly successful at marketing his fund to the ultra-rich communities he inhabited in New York and Florida, as well as at European ski competitions attended by the ruling elite. His fund generated returns of 12% to 13% per year consistently for decades.

Since 1996, the fund only had 5 losing months. The market has had dramatic monthly moves over this time. It is a virtual statistical impossibility for an investor to have such a consistent record through bull and bear markets.

Madoff refused to provide his clients online access to their accounts. He sent out accounting statements by mail, whereas most hedge funds email statements and allow them to be downloaded via computer for easier investor analysis. His books were audited by a 3-person accounting firm, Friehling & Horowitz, operating out of a 13-by-18 foot location in an office park in New York City's northern suburbs. A $17 billion fund could not possibly be audited by 1 partner and 1 accountant.

These facts had all previously been brought to the attention of the SEC, both by concerned individuals and by Barron's. And yet the SEC investigated Madoff's firm twice in the last 8 years and found nothing. The SEC has an annual budget in excess of $900 million, and has failed miserably in its mission to protect investors. The oversight of hedge funds has been virtually non-existent during the Bush administration.
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No positions in stocks mentioned.

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