Tags: Madoff | return | lunch | protect

Bernie Madoff's Impossibly Free Lunch

Wednesday, 04 Dec 2013 07:15 AM

By Patrick Watson

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Remember Bernie Madoff? The former Wall Street legend sticks close to home these days. Madoff, presently age 75, retired into a 150-year fraud sentence in 2009. His home is behind bars.

Madoff is in the news again this week. His deputy, Frank DiPascali, testified in a Manhattan federal court against five other colleagues in a deal to reduce his own sentence.

DiPascali told the jury, "It was virtually impossible not to know what was happening."

Before you believe DiPascali, remember he spent his career telling lies. The charities and retirees Madoff preyed upon may have been naive. Does Madoff's staff have that excuse?

These were financial professionals. They passed all the tests and held all the licenses. How could they miss the warning signs of a $17 billion fraud?

The answer, I suspect, is that hope springs eternal. Like Madoff's victims, his colleagues wanted to believe the swindle. They wanted to believe Madoff's astonishingly consistent profits. They wanted to think he was different.

Madoff's scheme lasted longer than others did in part because he kept his claims modest. He told investors his low-risk options strategy produced annual average returns around 10 percent for almost two decades.

In fact, very few managers post double-digit returns without taking significant risks. Records like the one Madoff claimed are astonishingly rare - the statistical equivalent of black swans.

Do black swans exist? Maybe. But you can spend a lifetime in swan country and still never see one.

You can make a lot of money with a good trading strategy. You can keep your capital intact with only minor, short-lived losses, too. Can you consistently do both at the same time with the same money? No, you can't, and neither could Madoff.

Financial markets are efficient. Lunch is never free; someone always picks up the tab. If lunch looks free, you should either dig deeper or ask who else paid for it. You need to know because that person will eventually find you and collect.

Others in the industry knew Madoff's numbers couldn't be true. They assumed he was "front-running" his broker-dealer's trading clients. That's illegal, too, but no one in the business blew the whistle.

You might think it would be in Wall Street's self-interest to police its own ranks. Con artists like Madoff give the "good guys" a bad name. In this case, at least, the Street failed to protect anyone outside its own shadow. Regulators failed, too.

Bernie Madoff's lesson is simple. If a deal sounds too good to be true, it probably isn't true. The fact that seasoned professionals endorse it or regulators allow it to continue does not change reality.

Frank DiPascali is partly right. Plenty of people knew what was happening. They simply failed to act on their suspicions.

Your sixth sense may be all that protects you from the next Madoff. Pay attention to it.

© 2014 Moneynews. All rights reserved.

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