The Madoff Affair
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Bernie Madoff was a popular investor who was well respected and had several high positions including the highest position on the nasdaq
He ran his own fund and for the first couple of years – he was making tons of money for his investors by legitimate means. Month after month they were making huge profits, although they were often unrealized gains. *(meaning the money was still in their account and not actually withdrawn)
Eventually he became very popular and everyone wanted to invest in his funds and try to make the same huge profits as his early investors. But Bernie realized it is much harder to make those same huge profits when you are trading hundreds of millions of dollars and he could not continue to make huge profits to satisfy investors at the same pace.
So he started making fake receipts to make it look like the profits were still coming in at a high rate…..and when investors asked to cash out he paid them their requested cash outs. This went on for years. He made fake receipts, and made it look like everyone was making tons of profits, and he kept thinking any day now he would have huge profits again and no one would ever find out the profits were all fake. Until more and more people started asking questions and suddenly the new investors stopped coming in and he started running out of money to pay off the investors asking to cash out. He did a lot of tricks to keep the trick going as long as he could but eventually he got caught and went to jail.
Madoff was a well established and respect financier who engaged in a Ponzi Scheme, an extremely large one. That means that he promised investors a large return (although not so large to immediately raise suspicions). The “profits” he showed his clients were actually money given to him by other clients, so continuing the scheme required him to keep getting new clients. That’s why Ponzi Schemes have no out. Eventually you run out of new clients.
The more interesting thing is how Madoff was able to keep this going so long. Madoff was highly respected in the community, with a long track record, so the thought that it was all a big scam didn’t cross most people’s mind. Madoff claimed that he was using a proprietary, secret model. This is not especially unusual in the field, so it wasn’t that weird. On the other hand, financial analyst Harry Markopolos claimed he was able to mathematically prove Madoff was a fraud with a few hours of work as early of 1999, but that he was ignored when he reported it.
So it seems that it was a combination of his reputation, the unwillingness of people who were theoretically making money from this to question it, and warning about it falling through the cracks.
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