When the wind blows, the house of cards will fall

Regulators say Mr. Madoff himself estimated that $50 billion in personal and institutional wealth from around the world was gone……

Even though Enron was a legitimate business, its finances were all a scam. Many of its financial workarounds were legal, but all had the intention to make assets appear on the balance sheet or debt to disappear off the books. When Enron finally crashed in December 2001, the world was shocked that such a large corporation could fail so quickly. A house of cards can only get so big before a gust wind blows it over. Just like Enron, Bernie Madoff was managing a $50 billion house of cards that fell down hard and fast.

As many who have watched the news over the past months know, Bernie Madoff ran his own investment firm or scam, whatever you would like to call it. Called a Ponzi scheme (after an immigrant con man named Charles Ponzi who ran a similar scam in 1919) , Madoff took money from investors all over the world and promised a fixed return, in some cases as high as 20%.

Madoff received billions of dollars from his clients and did pay them back with high return, yet the money was not really being invested. Instead, he would pay previous owners back with the principal of new investors. Like Enron, Madoff’s financial web was wound around and around the world. Madoff used “feeder funds,” or other investment organizations that would send money back to Madoff. Apparently, most members of the feeder funds did not know that the money was going back to Madoff. This allowed the scheme to grow huge, while affecting the money of thousands and thousands of people.  Below is a graph of the feeder fund network, which gives you a sense of how encompassing this scheme was.

Madoff Feeder Funds

Madoff Feeder Funds

The list of people that lost money is just as spectacular. In February, this list was released to the public and had 13,000+ names on it. I am sure the impact reached farther than this list, as I believe the feeder funds were listed, instead of the clients of those particular scammed funds.Many organization’s that invested with Madoff were philanthropic trusts and even some universities like Tufts.

Here is just an excerpt of the Madoff’s clients from the New York Times.

“While many of the known victims of Bernard L. Madoff Investment Securities are prominent Jewish executives and organizations — Jeffrey Katzenberg, the Spitzers, Yeshiva University, the Elie Wiesel Foundation and charities set up by the publisher Mortimer B. Zuckerman and the Hollywood director Steven Spielberg — it now appears that anyone with money was a potential target. Indeed, at one point, the Abu Dhabi Investment Authority, a large sovereign wealth fund in the Middle East, had entrusted some $400 million to Mr. Madoff’s firm.”

In December, as the economy was free falling, Madoff’s clients started pulling out its investments. Madoff then did not have enough to cover these withdraws and his scheme was revealed, but not before Madoff owned:

“a Manhattan apartment, a beachfront mansion in the Hamptons, a small villa overlooking Cap d’Antibes on the French Riviera, a Mayfair office in London and yachts in New York, Florida and the Mediterranean.”

So like Enron, Madoff fell hard and fast, hurting thousands of people along the way. The maximum sentence for security for fraud is 20 years in prison and and 70, that may be a life senetence for Madoff. Though twenty years for $50 billion stolen moneys seems petty. As for the $50 billion, where is it? Investigators actually do not know. Some theories point that Madoff may have paid some back to investors as well as probable kickbacks to people who must have been on the inside of such a large scheme. Money was also probably lost in the finincial crisis as well. One lesson that can be learned from both Madoff and Enron is that if a deal seems to good to be true, it probably is. And as for Charles Ponzi, the originator of this scheme, he was found out and deported, where he eventually died broke and was buried in a pauper’s cementary in Brazil. Fitting.

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11 Responses

  1. Hi,

    I’ve read a lot of your Enron posts and they all seem to be based on Smartest Guys In The Room.

    You realize that book is basically a novel, right?

    I’ve actually written a post called Everything Wrong With Smartest Guys In The Room. Google if it you like. But meanwhile, the fact is, that book is not the complete (or even partial) story of Enron.

    Since you deal with organizations, I was hoping for a little better, deeper understanding of this company, since despite the reputation, and the willingness for people like yourself to read the book and think that’s the gospel, it was a great place and full of great people.

  2. Can you put the link to your post? We are reading the book for a class. Other materials have been made available including the Powers Report, Enron year End Statements, and some business school cases.

    Thank you for commenting on the blog!

  3. Sure, here you go:

    http://caraellison.wordpress.com/2008/06/05/everything-wrong-with-the-smartest-guys-in-the-room/

    Also on my blog, you’ll find an entire Enron Index of material.

    Thanks for being open-minded!

  4. I asked in my blog if these kinds of horrific incidents ever teach lessons? It’s sad but when one Madoff dies another one is probably just being born….

  5. Very informative. Nice work.

  6. I read that he actually was not buying any assets. If that is so, how could any have been lost in recession?

    This article describes the lack of actual assets.

    I know Valdis Krebs from whom you borrowed the graph! orgnet.com his site is his site.

  7. It’s just amazing how people come up with these bold ideas, and then manage to go so far before getting caught. Pretty slick.

  8. Yet again thousands are left without money. What I don’t understand is how faults remain to be uncovered until the last second. As Evan said, some 13,000 people lost money because of Madoff, yet he was able to slide under the radar. To me this just seems like one more red flag that the government should pick up on. Sure they have created guidelines to prevent problems on as large of a scale as Enron’s, but then we turn around and someone on a PERSONAL level was able to attribute a huge amount of damage. So many companies push for deregulation, but look what happens when the control is released and people are left to fend for themselves.

  9. […] Quality of Writing: Evan’s When the wind blows, the house of cards will fall, Leah’s The Enron Elixir, Dave’s Enron […]

  10. I was having a discussion with some friends the other night, and the argument came up about who was “worse” or more unethical…Madoff or the guys at Enron. Some people seem to think that Enron’s reporting style, though ridiculous and convoluted, was not illegal. What was illegal was their choice to not disclose the kind of accounting methods they were using. Madoff, however, flat out stole from charities and engaged in activities that were unquestionably illegal. I’m just wondering if anyone has any insight into who they think probably lost sleep at night thinking about what they were doing to people.

  11. I think Madoff was probably worse as he set out from the beginning (or at least at some point as some theories think that he began as a legitimate fund but he couldn’t follow through with his claims) to scam people. Enron started out as a good company that turned down a dangerous road that it could not recover or want to recover from.

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