Bernie Madoff and Hamlet’s Ghost

“Madoff Securities is the world’s largest Ponzi Scheme.” —Wall Street Journal, quoting Harry Markopolos letter to the U.S. Securities and Exchange Commission, 1999.

Like most people in this business, we here at NotMakingThisUp knew next to nothing about Bernie Madoff or the Madoff Family of So-Called Funds, until, oh, Thursday morning.

That’s when news hit the tape that a guy had been arrested at his home after telling associates that his $50 billion Family of So-Called Funds had been “just one big lie” and “a giant Ponzi scheme.”

Now, you would think that a guy who ran $50 billion would be pretty well known among hedge fund types and other money managers.

You’d think that the head of a firm claiming to handle more money than Mario Gabelli—one of the most relentless stock hounds we’ve ever known (we last saw Mario presenting at a Merrill Lynch conference; before that, he was grilling the locals at the Berkshire Hathaway annual meeting)— would cut a regular figure on the investment circuit.

You’d expect, over the course of a decade or two in the business, to run into somebody from the joint—a marketing guy, an analyst, a portfolio manager—somewhere.

But we never did. Not at a conference, not at the Berkshire Hathaway annual meeting, not even listening in on an earnings call or two.

Of course, Madoff’s methodology was, supposedly, of the “black box” kind—buying stocks and selling options using top secret algorithms—so there was no need to be on an earnings call, let alone schlepping out to Omaha to listen to Warren Buffett.

Still, you might think the general lack of something visible going on behind the curtain at Madoff would have raised some red flags among regulators—i.e. the people who are supposed to protect investors from scams.

You might think a supposed $50 billion fund with audited statements from an unknown accounting firm with no web site might, oh, raise some eyebrows.

And it did.

As the Wall Street Journal has reported, one individual more or less laid out the issue for the regulators in language that does not get much clearer, nor much further from the actual truth:

Harry Markopolos, who years ago worked for a rival firm, researched Mr. Madoff’s stock-options strategy and was convinced the results likely weren’t real.

“Madoff Securities is the world’s largest Ponzi Scheme,” Mr. Markopolos, wrote in a letter to the U.S. Securities and Exchange Commission in 1999. Harry Markopolos may be today’s version of Hamlet’s Ghost.

Recall that as that play, “Hamlet,” opens, Hamlet’s dead father appears as a Ghost, telling Hamlet how his own brother (Hamlet’s uncle) killed him in the garden, took his crown and married his wife (Hamlet’s mother).

Hamlet intuits the Ghost is telling the truth—but then spends then next two hours trying to make up his mind whether the Ghost is the real deal, or just telling Hamlet what he wants to believe.

Like Hamlet’s Ghost, Harry Markopolos tried to tell the right people what happened, as the Journal reports:

Mr. Markopolos pursued his accusations over the past nine years, dealing with both the New York and Boston bureaus of the SEC, according to documents he sent to the SEC reviewed by The Wall Street Journal.

And Markopolos wasn’t the only one to have doubts.

At least one hedge fund advisor, Aksia’s Jim Vos, saw Madoff for the scam it appears to have been by—sacre bleu!—investigating Madoff’s accounting firm and discovering that is was housed in a strip mall…and had just one accountant.

But it was not merely sharp-eyed investigative types who saw what was happening well before the Feds.

A friend and fellow money-manager called us Friday, to gloat. “You see this guy Madoff?” our friend asked, his voice a mixture of outrage and I-told-you-so. “I had a guy who used to beat me up all the time,” our friend said, his voice steadily rising as he recalled the injustice of the thing. [NB: we are leaving out the more colorful nouns and adjectives that punctuated his language; we suggest using your imagination—all of it—to capture the essence]. “He’d say, ‘why can’t you do that? Why can’t you make 8% guaranteed?’”

We turned the volume on our phone down while he went on. “I used to take [insert bad noun here] from this guy all the time. All the time! I told this [extremely bad double-noun] it was too good to be true.”

And of course it was.

Now, we are not writing to dwell on the regulatory bumbling that led to our friend’s client losing whatever he invested in Madoff. Nor do we celebrate the loss of billions by rich numbskulls who got swindled here, for it is not merely rich numbskulls that will lose fortunes on this catastrophe.

We know of a nearby town that is losing $42 million of its police, fire and town employees’ pension money—14% of total assets—to Madoff’s apparent scam.

Instead, we seek to answer the question that has been asked of us over and over again: how did this happen? How is it possible for people to have believed this guy?

The answer is as old as Hamlet. Recall that play’s tortured hero could not believe what his uncle had done, despite the appearance of his dead father’s ghost to tell him so, until Hamlet himself had conducted his own version of our modern due diligence: he forced the new King to watch a play reenacting his own father’s murder (“The play’s the thing/wherein I’ll catch the conscience of the King.”)

People simply want to believe good stuff, not bad stuff. It’s human nature.

Investors wanted to believe Enron’s numbers were legit. They wanted to believe AIG’s earnings were real. They wanted to believe Fannie Mae and Freddie Mac could grow earnings 15% forever. And we don’t mean your average day-trader.

We mean professional investors. Big names with the resources to conduct their own due diligence into Enron and AIG and Fannie Mae, but did not. Famous investors who should have known that a natural gas trader couldn’t deliver consistent earnings without resorting to fraud, as Enron did; or that the U.S. housing market could not compound at 15% a year forever, period, as Fannie Mae’s books seemed to suggest.

So how did Madoff happen? Simple: enough people wanted to believe it that it happened.

And not even Hamlet’s Ghost—or Harry Markopolos, for that matter—could have stopped those people from believing it.

Jeff Matthews I Am Not Making This Up

© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.