The Lesson of Bernie Madoff, Investing and the Markets

This post was originally published on this site

I had the Trammps running through my head yesterday, as the “sad” news broke. I heard somebody say burn, baby, burn!

Yes, Bernie Madoff died Wednesday at his home away from home, a federal correctional facility in Butner, NC. I prepared myself for the normal deluge of self-righteous pap from the mainstream financial media… and then I realized I stopped reading those media years ago, so I wouldn’t be bothered by idiocy. Madoff was a crook, pure and simple. He was a fraudster running a large — but not particularly sophisticated — Ponzi scheme. Pure and simple.

It is no coincidence that Madoff’s empire crumbled in December 2008, right in the middle of the crisis sparked by Lehman’s bankruptcy. The out-of-the-money puts that formed one part of Madoff’s claimed split-strike conversion strategy SHOULD have been going bananas in that market as price levels continued to fall and the VIX hit never-before-seen levels. But they didn’t, because Madoff was not investing the money. In short, he was stealing it.

Ponzi schemes work as long as there are more inputs than outputs, and after decades, that situation had reversed on Madoff by late 2008. So, he gave up. What followed was a passion play about greed and the inevitable victims of such avarice including tortured cries of “why” from Madoff’s wife and his sons. Nobody (should have) cared then and I hope nobody does now. These people led lives of status and privilege fed by Bernie’s fraud. I don’t really care what happened to them.

But what does this say about the markets? Madoff WAS running a Ponzi scheme. This is not debatable. Does that mean there are Ponzi schemes everywhere? Is bitcoin a Ponzi scheme? Is Elon running an elaborate Ponzi scheme by pumping bitcoin into his chronically money-losing (excluding profits from ZEV credit sales), quality-poor car maker, Tesla (TSLA) . No. No. No. When you overuse a phrase it loses its meaning. The world is not awash in Ponzi schemes, and the SEC, as pathetic as it is — Madoff’s niece, Shana, was also his compliance officer and also was married to (and still is) former SEC enforcement lawyer Eric Swanson — at least offers some protection to investors.

But the real lesson of the Madoff affair is to DIY. Do it yourself. Madoff’s empire was tallied at over $64 billion of assets “under management” — they were liquid assets, but nobody was managing them — as of December 2018. The network of feeder funds that aped Madoff’s supposed strategies accounted for the vast majority of this total, and that was the existential problem, and still is.

This market is ruled by derivatives. Not just listed ones like options and futures, but other ones like ETFs that derive their underlying value from an index or group stocks. That’s the correlation with Madoff in today’s markets, and that’s what would be hard to kill… if anyone were trying. But no one is.

So, funds like Cathie Wood’s ARK (ARKK) drive huge gains in assets under management. Unlike Madoff, she actually does manage the ARK funds, but does so in the least fiduciarily responsible way possible, which is by crowding into a few assets that are in the same class. It’s a classic mistake, and one that Bernie couldn’t make, because he was never putting the money to work, anyway.

But Cathie Wood never started a company or disrupted anything. As someone who busted his hump studying for the CFA while working full-time in Wall Street firms, I can attest that ARK’s “research” ranges from misleading to pointless to just plain stupid. It’s all just a big con intended to inflate asset values in the face of the most inflationary stock market conditions seen for five decades.

So, the lesson here is to be careful. If you have a company that you want to be part of, buy stock in it directly. Lose the middleman or middlewoman and take control of your portfolio. Knowledge is power and knowledge is the best protection against any type of fraud especially Madoff’s insidious brand of affinity fraud.

Do your homework!