The Madoff Miracle

If you live in the United States and haven’t heard the name Bernard Lawrence “Bernie” Madoff, you either just arrived by hitching a ride on a cargo ship after thirty years in Malaysian jungle or you were born yesterday…in reality. Bernie and his clan pulled of perhaps the greatest Ponzi scheme ever, so big that any multi-level marketing company must be green with envy. On June 26, 2009, Judge Denny Chin ordered Madoff to forfeit $170 billion in assets and prosecutors asked Chin to sentence him to the maximum 150 years in prison, which Chin ultimately did. Should you wish to contact good ole Bernie for financial advice, he is Prisoner #61727-054 and receives his mail at the Federal Correctional Institution Butner Medium near Butner, North Carolina, about 45 miles (72 km) northwest of Raleigh.

What earned Bernie such a long stay in one of our finer Federal institutions? It was fraud on a massive scale. The magnitude of which was estimated by former SEC Chairman Harvey Pitt to be between 10 and 17 billion dollars.

For those who don’t know what a Ponzi scheme is, the Securities and Exchange Commission defines it this way:

“A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.

The schemes are named after Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. At a time when the annual interest rate for bank accounts was five percent, Ponzi promised investors that he could provide a 50% return in just 90 days. Ponzi initially bought a small number of international mail coupons in support of his scheme, but quickly switched to using incoming funds to pay off earlier investors.”

Ponzi schemes are also called “pyramid schemes” because a few people at the top depend on a broad base of investors at the bottom.

Ponzi schemes collapse because, with little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue. In other words, “income” must continuously and forever exceed “outgo”. They tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out, because they are a cash flow game – chasing old money with new. Early participants can usually get in and out without getting hurt because there is a rush of capital from those who desire to capture the promised returns – it’s the folks late to the party that get left holding the bag. That is why Ponzi schemes are illegal and Ole Bernie is doing 150 years in the clink.

So what, you may ask? I went through all of that because last week, on August 14th, we celebrated the 75th anniversary of a Ponzi scheme of such a magnitude that it makes Bernie look like a piker. By the end of 2010, this “fund” will need to pay its existing investors 41 billion dollars more than it will take in. A reasonable question might be that if Bernie has to avoid dropping the soap in the shower for 17B, who is going to go to the Big House for this one? The sad answer is nobody – this one is legal. If you have a job, you are one of the poor suckers holding the top of the pyramid up.

Happy birthday to the Social Security Act of 1935!

In a politically calculated speech designed to scare retirees and to try to put the Republicans on the defensive prior to the November mid-terms, President Obama was quoted in his weekly national address by the New York Times:

“President Barack Obama has taken the lead in a Democratic offensive on Social Security, warning that Republicans will revive efforts to privatize what is perhaps the government’s most popular program if they seize control of Congress in the November elections.

“I’ll fight with everything I’ve got to stop those who would gamble your Social Security on Wall Street,” Obama said on Saturday in his weekly national address. “Because you shouldn’t be worried that a sudden downturn in the stock market will put all you’ve worked so hard for — all you’ve earned — at risk.”

The remarkable aspect of the President’s address is that we have everything at risk now. There is no Social Security reserve, no account filled with money, no “lock box”. There is nothing but a line item in the Federal ledger that indicates how much the government owes the Social Security Administration out of the General Fund. You see, the government takes the money that gets deducted from your paycheck in that little FICA box and mixes that sweet, sweet cash right in the General Fund to be spent anywhere and everywhere they choose.

You own nothing but a promise; there is no tangible asset that you can control – nothing that can be cashed out upon your death for the benefit of your kids – your survivors may be eligible for benefits but these are just based on a promise as well…and even those aren’t looking like a sure thing since we are at record budget deficits and debt (13.3 trillion and climbing).

On the flip side, a private investment in stocks and bonds is yours – you own it. In 1995, when the Dow-Jones Index was around 4,000 (today it is over 10,000), the CATO Institute found that “assuming historical rates of return, if individuals born in 1970 were allowed to invest in stocks the amount they currently pay in Social Security taxes, those individuals could receive nearly six times the benefits that they are scheduled to receive under Social Security, as much as $11,729 per month. Even a low-wage earner would receive nearly three times the return on Social Security.” Even with the fluctuations in the markets, the equations are still roughly the same – Social Security: around 4%, mutual funds: around 8%.

Folks, now is the time for us to have honest and difficult discussions about Social Security. We have to discuss asset based retirement planning and the freedom to independently invest at least a percentage our money as we wish and reap the benefits or suffer the consequences. The political class does not want to have that conversation with us due to all that they have done to pervert the system, to use it as a slush fund. They don’t want you to make the IOU’s in the General Fund payable immediately and they need you to keep paying in to stop the collapse of the pyramid. If they won’t have this discussion, they need to have their career options freed up for them, starting in November.

Let’s stop supporting all the little Bernie’s in Washington.


One thought on “The Madoff Miracle

  1. Pingback: The Third Rail | The Rio Norte Line

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