"for those who invest with prudence and an eye toward long-term values, the market need not be a Ponzi scheme. "

From the NY Times, a Value Investing View:

"By ROGER LOWENSTEIN

Published: January 6, 2009

In October, Columbia University’s business school honored its most famous investing guru, Benjamin Graham, with a series of panel discussions loosely connected to the market crash, which was then accelerating. The panelists, of which I was one, had contributed to an updated version of Graham’s 1930s textbook, whose signature themes are caution, avoidance of speculation and — at all costs — the preservation of capital( HE'S THE MAN BEHIND THE MAN BEHIND THE MAN ). The day we met, the Dow Jones industrial average fell 350 points en route to one of its worst months ever.

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J. Ezra Merkin, a Wall Street sage, noted philanthropist and professional money manager, seemed to embody more than any of the other panelists the fear that was gripping traders. When it was suggested that the government should stop intervening in markets and bailing out banks, Merkin rejoined that the system had cracked and desperately needed help( I AGREE ). As the world now knows, Merkin had entrusted close to $2 billion of his investors’ money to someone even less dependable than the Dow — that is, the accused Ponzi artist Bernard Madoff. I have no reason to think that Merkin, at the time, had any knowledge of the fraud that was soon to secure his 15 minutes of fame, but that afternoon at Columbia now seems pregnant with latent connections. Perhaps Madoff’s investors lost a greater percentage of their money, and lost it more suddenly, than the rest of us. But beyond these mere matters of degree, is there really any difference?

At least for investors of attenuated time horizons, there is not. Public-securities markets are a wondrous artifice precisely because they offer permanent capital to industry and short-term liquidity to investors. Think about it: a General Electric or a Google sells stock to the public and then retains the proceeds — the capital — indefinitely. Even if the companies earn a profit, by selling more light bulbs or Internet ads, they are under no obligation to pay out the gains in dividends. How, then, do the shareholders claim their reward? Why, by selling their stock to other investors, of course. This means that, in the short term at least, each investor is dependent on the willingness of other investors to hop on board. If other investors go away, prices (even of solvent companies) plummet, to devastating effect on those who sell( I AGREE ).

In a Ponzi scheme, there is no G.E. or Google underneath the pyramid( TRUE. THE PHRASE IS NOW BEING MISUSED FOR RHETORICAL EFFECT. ): only air. Outgoing investors are paid from the money put up by new ones. And the game for Madoff ended, as Ponzi schemes always do, when he ran out of suckers.

In theory, stocks and bonds are more valuable than air. But when investors get hooked on trading securities (as distinct from owning them)( ALSO INVESTMENT VS SPECULATION ), especially ones that are overvalued, they are courting disaster. In retrospect, this was true of the legions that invested in mortgage-backed securities and in the banks that owned them, not to mention the many other companies affected indirectly. Nobody was thinking about what these companies were worth, only about the next quotation on the screen.

This was doubly true for the banks that held those wearily complex and difficult-to-value mortgage bonds. Look at the post-mortem issued by UBS, one of the world’s largest banks, which has suffered mortgage-related losses of some $50 billion (enough to bail out the auto industry several times over). Discussing one particular write down, the bank admitted, “The super senior notes were always treated as trading book (i.e., the book for assets intended for resale in the short term), notwithstanding the fact that there does not appear to have been a liquid secondary market( NEGLIGENCE AND FIDUCIARY MISMANAGEMENT ).” Legally, UBS was a bank; conceptually, it was investing with Bernie Madoff( TRUE ).

There is, of course, an alternative to this madness. Which is to invest for the long term, independent of the market action on any given day or year. This is what most small investors pretended, and maybe believed, they were actually doing.

Robert Barbera, the chief economist at ITG, an investment firm, says there are really three schools of investing. There are people who think they can identify superior stocks and bonds over the long term and selectively invest in those that they deem to be undervalued. Second, there are people who recognize that they don’t have this ability and resolve to salt away a fixed portion of their savings, month after month, in a generic and diversified portfolio. Though the first approach requires considerably more talent and is not recommended for novices, both should work.

What does not work is believing you are following either strategy No. 1 or 2 when you are actually engaging in the third approach — which is, essentially, following the crowd, day by day and hour by hour. At the top of the market, investors told themselves they were disciplined and in for the long haul. Now they are selling or refraining from investing. Some misjudged their liquidity needs and have come under pressure to raise cash; others have simply lost heart. Either way, they are dependent on new money to come in for them to get out.

Benjamin Graham’s premise (which he did not abandon, even in the depths of the Great Depression) was that, sooner or later, markets will reflect underlying corporate values( TRUE. ). Thus, he wrote, long-term investors had a “basic advantage” over others, because they could ride out bubbles and crashes rather than be gulled during such highs and lows into, respectively, buying or selling. In other words, for those who invest with prudence and an eye toward long-term values, the market need not be a Ponzi scheme( TRUE ). While stocks periodically go for roller-coaster rides, the earning power of the U.S. economy, albeit with serious fluctuations, endures( TRUE ). The people who chased unrealistic returns at the top, like those who are selling now, have simply cashiered their “advantage” to play a game that more nearly resembles Bernie Madoff’s.( I AGREE, ALTHOUGH SOME SPECULATION IS FINE, IF DONE CORRECTLY. IN OTHER WORDS, WITH FUNDS THAT YOU CAN AFFORD TO LOSE.)

Roger Lowenstein, an outside director of the Sequoia Fund, is a contributing writer for the magazine. His most recent book is “While America Aged.”

“The purpose of these laws is to balance the losses among the various investors, but how that balance is supposed to be struck is not clear,”

Bloomberg on an odd aspect of the Madoff situation:

"By Carlyn Kolker, Tiffany Kary and Saijel Kishan

Dec. 23 (Bloomberg) -- Like some of Bernard Madoff’s clients, a Florida restaurant owner was lucky enough to withdraw part of his investment before the money manager allegedly confessed to a $50 billion Ponzi scheme. Now he’s worried he might be asked to give it back.( YEP )

The 53-year-old investor, who asked not to be identified to protect his stake, took out about $600,000 this year from his $1.5 million account, using some of it to pay down a mortgage. He and other Madoff clients who withdrew funds as long as six years ago may be sued on behalf of other victims to return profits and even principal, securities and bankruptcy lawyers say( WOW ).

“Right now there are Madoff winners and Madoff losers,” said Lynn LoPucki, who teaches bankruptcy law at Harvard University. “Before this is over there will be nothing but Madoff losers( TOO MUCH ).”

Clients of Madoff had about $36 billion with his firm, according to a Bloomberg tally that may include some double counting. Before his arrest on Dec. 11, Madoff, 70, confessed to employees that his “giant Ponzi scheme” may have cost as much as $50 billion, according to an FBI complaint. His misconduct may have stretched back to at least the 1970s, two people familiar with the government’s inquiry of Madoff said last week.

The Florida investor, who first gave his money to Madoff five years ago, said he had no hint of fraud and would go to jail rather than give up the amount he took out( I UNDERSTAND HOW HE FEELS ).

Irving Picard, the trustee appointed to liquidate Madoff’s brokerage, Bernard L. Madoff Investment Securities LLC, holds the fate of the restaurant owner and other investors in his hands.

Enough Funds Left?

Picard, who didn’t return a call seeking comment on plans to sue victims to recover funds, said in a court filing yesterday that “there has not been any showing or determination that there are sufficient funds” to satisfy victim claims.

A so-called clawback of paid-out funds in the Madoff liquidation could result in lawsuits against investors such as charities, hedge funds and individuals who redeemed profits and took out principal. Nonprofit institutions such as the Carl and Ruth Shapiro Family Foundation, a foundation controlled by Democratic U.S. Senator Frank Lautenberg of New Jersey, and Yeshiva University relied on funding from Madoff investments.

Lawyers and representatives of the Shapiro and Lautenberg foundations didn’t return calls seeking comment. In a statement, Rick Matthews, a Yeshiva University spokesman, said, “Our lawyers and accountants are in the process of an investigation.”

‘Further Risk’

“Charities are looking at their legal options as regarding their right to recoup money,” said Mark Charendoff, president of the New York-based Jewish Funders Network, whose 1,000 members fund Jewish causes and are assessing losses from Madoff investments. “I don’t know that they’ve been focused on or are aware that they may in fact be at further risk of loss.”( COME ON )

Bankruptcy laws authorize a trustee like Picard to recover money that was distributed as part of a fraud and share it among the victims, LoPucki said.

“The purpose of these laws is to balance the losses among the various investors, but how that balance is supposed to be struck is not clear,” LoPucki said.( THIS LAW IS BIZARRE )

Under New York state law, which can be invoked for Madoff recoveries, a trustee can seek redemptions going back six years( TOO LONG ), said Tracy Klestadt, a New York bankruptcy lawyer.

In a similar case, U.S. Bankruptcy Judge Adlai Hardin in White Plains, New York, ordered investors of defunct hedge-fund manager Bayou Group LLC in October to disgorge( FIND ANOTHER TERM PLEASE ) profits they’d taken out. Investors were required to pay back any gains they’d redeemed involving “fictitious profits.” Before the fraud was discovered, Bayou paid out more than $135 million, according to court papers.

‘Good Faith’ Rule

Hardin also ruled some investors would have to hand back their principal. Only investors who acted in “good faith” -- a legal standard that makes investors prove they didn’t have knowledge or suspicion of fraud -- could protect their initial stake, Hardin ruled. He said investors could show they had good faith if they didn’t see any “red flags” when they withdrew the funds( SUPPOSE THEY TAKE THE MONEY OUT AND WARN EVERYBODY ELSE ? ).

That decision could be a guide for Picard, Klestadt said.

The Bayou decision set a high bar for investors who hope to protect their principal, said Carole Neville, a lawyer representing Bayou investors.

“What the Bayou case holds at the moment, is, if you had any reason to feel uncomfortable about your investment and took your money out, you don’t have good faith,” Neville said.( I DON'T LIKE THIS LAW OR DECISION )

“On the surface it seems a standard that’s almost impossible for people to meet( THAT'S ONE REASON THE LAW IS WRONG ),” said Robert Crane, president of New York’s JEHT Foundation, a group dedicated to criminal justice matters that relied on donors who invested with Madoff and said it’s closing in January.

Seeking money from investors who say they were defrauded can result in protracted litigation. In the Bayou case, which is being appealed, $20 million of the $33 million recovered from redeeming investors went to pay legal fees( WHAT A WASTE ), Neville said."

I'll be honest. I don't like this law. I could accept two years and a standard that said you took out your money and had actual evidence of fraud which you didn't pass on to the authorities. Otherwise, it's a needless mess.

"Bernie Madoff has caused disproportionate pain in the Jewish community, prompting unedifying sneers on the blogosphere."

I can't say that I didn't see this coming. From Andrew Clark in the Guardian:

"It has been a fertile financial week for bigots. The astonishing scale of corruption allegedly unmasked at the offices of Wall Street fund manager Bernie Madoff has caused disproportionate pain in the Jewish community, prompting unedifying sneers on the blogosphere. ( I'M NOT SURPRISED. JEW HATERS LOVE USING BLOGS )

Madoff, who is thought to have lost $50bn of assets, recruited many of his private clients through informal social networks in New York, Florida and Los Angeles.

The sense of disappointment and betrayal is palpable – particularly among Jewish philanthropic organisations. Several charities have had to shut their doors overnight, including the Lappin foundation, which funded trips to Israel for children, and the Chais Family Foundation, which supports educational and health-related projects. ( I'VE POSTED ABOUT THIS )

The Los Angeles-based Jewish Journal noted that the saga gave "ammo to antisemites everywhere" and highlighted mocking comments posted on a popular financial website, Dealbreaker. Another Jewish blogger, Tvzee's Talmudic Blog, complained that he had had to "moderate out many racist comments" after writing about Madoff. ( SAD )

The wrecking impact of Madoff's fraud on Jewish philanthropy has a broad impact which extends far beyond any single religious community. Gary Tobin, president of the Institute for Jewish and Community Research in San Francisco, reckons Jewish philanthropy in the US is worth about $5bn annually.

The money is spent on everything from poverty relief to educational initiatives, bridge-building between religions and community centres – which are open to people from any faith.

"I know the antisemitic websites are picking this up – they love Jewish cabals and conspiracies," says Tobin. "But for most of the world, the antisemitic reaction will be minimal. This is a philanthropic and charitable tragedy – it's more sad than anything else." ( AN OPTIMIST )

The Wall Street Journal noted that older Jewish investors put so much faith in Madoff that they jokily nicknamed him "the Jewish bond". Lawyers for Madoff's victims say that in a close-knit community, people put a disproportionate amount of trust in a small number of individuals. Ross Intelisano, a class-action lawyer based in New York, says: "We've been talking to a lot of direct investors. This is a rare case in which a lot of investors we've spoken to had all their money with one firm." ( TERRIBLY SAD )

Many have lost everything overnight. Arnold Sinkin, a retired carpet-fitter in Florida, lost the nest egg of nearly $1m he built up with his wife, Joan. ( AWFUL )

"We started out by giving $5,000 to him [Madoff] in the 1970s," said Joan Sinkin. "At the time, $5,000 for us was really a huge amount. I think we probably had about $1.75 left in the bank once we'd given it to him."

The septuagenarian couple's retirement planning crashed to earth when Madoff's alleged fraud materialised last week. They will be selling their apartment in New York City and relying on their children for financial help. ( GOOD LUCK FRIENDS. AND YOUR CHILDREN DESERVE KUDOS )

On an institutional level, the impact goes far beyond any single community. Banks as far afield as Japan, Switzerland and Spain are suffering Madoff-related losses, not to mention Britain's HSBC and Royal Bank of Scotland. Even Hampshire County Council somehow managed to stick part of its pension fund in Madoff's business (although everybody says he was choosy about whose money he accepted).

In New York, one secular charity destroyed by Madoff's apparent corruption is the JEHT Foundation, which stands for "justice, equality, human dignity and tolerance". Since 2000, the charity has promoted reform of the criminal justice system to try to reduce the rate of incarceration in the US, handing out $25m to $30m annually. ( I'VE POSTED ABOUT THIS A FEW TIMES BECAUSE I WANT THE DEPTH OF PAIN THIS KIND OF CRIME CAUSES TO BE UNDERSTOOD )

The funds of JEHT's donors, Jeanne and Kenneth Levy-Church, were managed by Madoff and have evaporated overnight. The foundation's director, Robert Crane, has the shattering task of shutting down the charity. ( WOW )

"We're going to cease existence at the end of January," Crane told me. "All of our 24 people will lose their jobs."

It's a pretty dismal situation – and Madoff ought to be ashamed. ( HE OUGHT TO BE IN JAIL )

"It's devastating not only for us but for the people we support," says Crane. "In the areas we operate, there aren't a huge number of other funds, which makes the impact even worse." ( PATHETIC )