Bernie Madoff only has another 144 years left on his prison sentence.
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You see, Madoff is currently in jail for running the biggest fraud in U.S. history. He’s the subject of numerous books, TV shows and movies. A new ABC miniseries starring Oscar winner Richard Dreyfuss aired last week and there’s even a Robert De Niro-powered film in the works about the fraudster and former investment advisor.
But before you switch over to HBO or ABC, take a second to familiarize yourself with the man.
What exactly did he do?
Madoff, a former stockbroker and previously well-respected figure in the financial industry, convinced thousands of investors to give him their money on the promise that he could bring them consistent profits. He was going to make them very wealthy.
He then basically kept the money for himself, conning investors out of $65 billion along the way and operating under the radar for several decades.
How exactly did he do it?
Madoff used the classic fraudster’s trick, the Ponzi scheme, to dupe his unwitting clients.
The Ponzi scheme started with its creator, Charles Ponzi. An Italian immigrant to the U.S., Ponzi came up with a scam in the early 1900’s that promised his clients double their money inside 90 days. His plan for earning that money: buy discounted postal coupons (coupons you can exchange for postage stamps) from other countries and then redeem for their face value in the United States. By buying his postal coupons for cheap in one market and then selling them for higher in another, he’d pocket the difference (pure profit). He’d then use the proceeds to pay his investors. This practice is also known as arbitrage.
Sounds simple enough, and it might have even worked – except Ponzi never bothered to actually create the business. Instead…he took all the money that his investors gave him, deposited it in the bank. Homeboy paid his older investors with the money brought in from new investors. As long as new investors kept coming in, Ponzi could pay off the others.
Fast forward to 2009, and at Bernie Madoff’s trial, the man himself admitted that the essence of his scam was to take his investors’ money and deposit it straight into a Chase bank account rather than invest it to generate steady returns. If someone wanted to take their funds out of Madoff’s investment vehicle then he would, in his own words, use “the money in the Chase Manhattan bank account that belonged to them or other clients to pay the requested funds”.
It was honestly, truly that mind-numbingly simple.
So how exactly did it go wrong?
Ponzi schemes are tough to keep going because they depend so completely on the influx of new investors and capital. At the same time, if too many people want their money back that can cause strain on the Ponzi scheme operator, as there’s only so much money to hand on. Other times people start to look more closely…and the cracks start to appear.
Charles Ponzi had to withstand many of his clients asking for their money back. Each time he would pay them and confidence restored, the scam would continue. Eventually, his fraud was revealed through the investigative actions of a local newspaper. A financial journalist named Clarence Barron was able to show that if Ponzi had actually gone through with his business plan there would be about 160 million postal coupons in circulation. The actual number was around 27,000. That caused a massive panic and in the end, as the truth came out, Ponzi’s investors found just how much they had been taken for. All told, Ponzi’s investors lost $20 million ($225 million today).
Madoff went down in a similar fashion. In 1999, a financial analyst named Harry Markopolos crunched the numbers on Madoff’s storied returns and concluded that they were, mathematically, impossible. Madoff was only indicted in 2009 so it actually took a while for the castle walls to come down.
Even though it took Markopolos 10 years to get the world on his side, many within the investment and financial community already suspected something was fishy with Madoff’s investment fund. Many of Wall Street’s biggest funds and banks refused to invest with him.
It wasn’t until the Great Recession of 2008 that the scam really started to unravel. He was already in a bad way. He had so many investors already, that he had to resort to taking out loans from banks to pay them their returns. As the recession ramped up, people got nervous. They started to ask for their money back. They were scared of losing everything and thought it would be better to just hold their investments as cash. Of course, Madoff didn’t have the money to give them.
In all, Madoff’s clients were requesting $7 billion in redemptions. It’s estimated that he only had somewhere between $200 and $300 million to give back.
The walls were coming down.
How exactly did it end?
Madoff was turned over to the authorities by his own sons, themselves also senior employees at Madoff’s company.
Right after Bernie promised his staff $173 million in bonuses, his sons confronted him. That’s when he confessed that the entire thing had been a huge scam. Two days later he was arrested and charged with fraud.
He would go on to plead guilty to three counts of money laundering and was handed the symbolic sentence of 150 years in prison for his crimes. He was also banned from the securities industry for life, but that almost seems a bit trivial when you line it up against 150 years in jail.
The total damage over many decades worth of deception: he’d made off with $20 billion, left many of his clients penniless, and shamed his family for many years to come. His assets have since been frozen and all efforts are being made to pay back his clients but a lot of the damage is irreversible.
That’s the story of Bernie Madoff. Now you know.
To learn more about Ponzi schemes, check out this course on how to avoid financial scams.