>>>There is something to that. My dad always used to say that you can’t cheat an honest man.<<<
I don’t buy that, honest men get cheated all the time. A con artist might need to run different types of scams on honest men, but they can be cheated. For example, they might use charity scams rather than get rich quick schemes.
From what I understand about Maddoff’s scam, honest men would be more vulnerable to his Ponzi scheme than to most other such schemes. Typcially, Ponzi schemes promise extremely high rates of returns (”We’ll double your money in 6 months”), with dubious or mysterious sources of these profits. A sesnible, honest person should realize that such profits (without tremendous risk) are either next to impossible or illicit.
I believe Maddoff typically offered returns in tne neighborhood of 10% per year, which while high for “safe” inevestments in today’s climate of low interest rates and a shaky stock market, is not so high as to seem “to good to be true”.
Some of the more sophisticated, institutional Maddoff investors probably should have known better, but the average Maddoff investor couldn’t be expected to know. I have a lot more sympathy for them than for people taken in by Nigerian bank scams and other such overtly shady deals.
a) I was taught the same thing by my parents; ie, “You cannot cheat an honest man.”
b) Part of that lesson was “There ain’t no such thing as a free lunch. Anyone offering you a free lunch is trying to get something out of you. Always. There are NO exceptions.” An honest man knows what is an “honest return” or an “honest wage.”
c) Madoff’s returns were “modest” compared to dot-com equity returns, yes, but put in the perspective of long-term, sustainable returns of “safe” investments, they were very high - like DOUBLE what the real market returns for such claimed risks.
Moreover, for the strategy he claimed to employ, the returns were impossible, because his mythical returns showed almost no perceptible correlation to rather large market volatility. To achieve this is nearly impossible, requiring market timing of an omniscient being.
d) Madoff was promising these higher-than-long-term-average returns with a consistency that was unheard of. You can achieve Madoff-like consistency with much lower returns using Treasury notes and bonds, but not with equities. Using Treasury notes and bonds won’t get you to even half of Madoff’s supposed returns.
e) As Harry Markopolos noted, a “line that goes up and to the right without any deviation is a something out of geometry class, not financial markets.” Investment “professionals” know this. The “sophisticated” investors in Madoff’s fund should have known this was a scam within five to 10 minutes of looking at his claimed returns and his claimed methods of achieving them. Markopolos went further, looking for the footprints of a $50 billion fund in the options markets.... and found NOTHING. There simply isn’t enough liquidity in OEX options to allow a $50B fund to trade without sticking out like a submarine periscope in a bathtub. No complicated access to internal market information was ever necessary to spot this - merely some looking around at option exchange data on OEX stocks showed that the volume necessary for Madoff to actually be doing even 50% of what he claimed was simply not there.
f) Now to your point that “Typically, Ponzi schemes promise extremely high rates of returns...”
Yes, for the amateurs. That gets them busted.
The two recent biggest ponzi schemes have used very modest (by comparison to the small fry) rates of return, coupled with the idea of “safe” returns to suck in investors far and wide into schemes in the billions of dollars that ran over 10 years.
Here’s the OIG investigation for Allen Stanford:
http://www.sec.gov/news/studies/2010/oig-526.pdf
What was he promising?
“The FlexCD Account required a minimum balance of $10,000, had maturities and annual interest rates ranging from one month at 7.25% to 36 months at 10% and withdrawals of up to 25% of the principal amount were allowed without penalties with a five day advance notice. “
That sounds within the realm of the possible, right? 7.25% APR for a one month CD and 10% for 36 months?
Not on stuff with the supposed safety of these investments. The 7.25% APR for a one month CD is astronomically high for that maturity, meaning there’s either significant undisclosed liquidity risk or outright fraud. Turns out, it was the latter.
BTW, in the OIG’s report, you see that the field staff thought that Stanford was a Ponzi scheme as far back as 1997. The enforcement arm of the SEC never pursued a case against Stanford.