Money Stuff: A Happy Anniversary for Madoffʼs Scam

From: Matt Levine noreply@mail.bloombergview.com

To: bloomberg@wetradeforex.id
Date: Tuesday, December 11, 23A01
BloombergOpinion

Money Stuff
Matt Levine

Congrats Madoff victims!

The most basic investing scam is:

1. I convince you to invest your money with me.

2. I steal it.

It’s a good scam (for me) in that it is efficient: All of the money that you invest, I
steal, which maximizes my chances of buying a yacht and sailing away from the
criminal authorities. The margins are good. On the other hand there are some
limits to how big this scam can get. I can send you fake account statements, etc.,
to try to persuade you that your money is well invested and you should give me
more, but eventually if I want to raise a lot of money I will have to spend some of it
on creating verisimilitude rather than steal it all for myself.

The Ponzi scheme is a key refinement, in which the verisimilitude is created by

using some of the money to give other investors actual “investing” returns. (Actual
returns, but not actually from investing.) The scam is:

1. I convince you to invest your money with me.

2. I steal some of it.

3. I convince someone else to invest their money with me.

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4. I give some of it back to you as “investing returns,” and steal the rest.

Etc. This has much lower margins than the simple scam, since I am giving so
much of the money back to investors instead of stealing it for myself, but the
advantage is that this scam can grow much bigger and operate much longer. In
the limit case, if you run a really really big Ponzi for a really really long time, you
will end up stealing almost none of the money. On a percentage basis, I mean. If
you run a really big Ponzi then stealing only a tiny bit of the money can still buy
you some very nice yachts.

So, paradoxically, a really big Ponzi is, for the victims, relatively good: Most of the
money wasn’t really stolen, and can maybe be recovered! For instance:

A decade after Bernard Madoff was arrested for running the world’s
biggest Ponzi scheme, the bitter fight to recoup investors’ lost billions has
astounded experts and victims alike.

While no one will ever collect the phantom profits Madoff pretended he
was earning, the cash deposits by his clients have been the primary
objective for Irving Picard, a New York lawyer overseeing liquidation of
Madoff’s firm in bankruptcy court. So far he’s recovered $13.3 billion—
about 70 percent of approved claims—by suing those who profited from
the scheme, knowingly or not. And Picard has billions more in his sights.

“That kind of recovery is extraordinary and atypical,” said Kathy Bazoian

Phelps, a bankruptcy lawyer at Diamond McCarthy LLP in Los Angeles
who isn’t involved in the case. Recoveries in Ponzi schemes range from
5 percent to 30 percent, and many victims don’t get anything, Phelps
said.

Yeah but that is just Ponzi economies of scale. The bigger the Ponzi, the better
the chances of recovery; you just can’t spend $13 billion on cocaine. Obviously
this is a bit rough on some of the people who innocently invested in Madoff’s
Ponzi, got back a nice but not earth-shattering return for many years, spent the
money, and are now getting it clawed back, but still it’s better than everyone
losing everything.

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Today is the 10-year anniversary of Bernie Madoff’s arrest, which is a little mind-
blowing since we were just commemorating the 10-year anniversary of the
Lehman bankruptcy a few months ago. It is somehow weird that Madoff and the
global financial crisis live on the same timeline. Lehman’s failure was a crucial
moment in a crisis that still reverberates today. Madoff’s failure, huge and
shocking as it was at the time, feels like an odd curiosity these days. They even
got most of the money back!

In any case, here is a roundup of “How Madoff's Multi-Billion Fraud Changed the
Hedge Fund Industry.” And here is a story about how Madoff’s scheme created
the modern SEC whistle-blower industry, which can seem a little bit like its own
form of grift. “Two individuals filed so many frivolous reward requests—one
person has filed 143—that they were banned from making future requests,
according to agency records.” If you start a program to give multi-million-dollar
rewards to people who know about fraud, it is going to attract some fraud.

Are Tesla Inc. and Elon Musk complying with the terms of
their settlement with the Securities and Exchange
Commission?
No, the answer is no, not at all, but to be fair they have a good reason, which is
that Elon Musk does not respect the SEC, as he made clear on “60 Minutes” this
weekend:

Lesley Stahl: Look at you.

Elon Musk: I want to be clear. I do not respect the SEC. I do not respect
them.

I am not an expert in, like, journalism, but it does seem to me that “look at you”
might be the best possible interview question to ask Elon Musk. If Musk is up for it
I will happily interview him for Bloomberg and I promise that my questions will
consist solely of saying “look at you” repeatedly; I bet it will break a lot of news.
Anyway here is the lead-up to that exchange, and I write a lot of jokey
hypothetical dialogue in this newsletter, some of it involving Elon Musk, so I want

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to emphasize that this is real dialogue taken directly from CBS News’s transcript:

Lesley Stahl: Have you had any of your tweets censored since the
settlement?

Elon Musk: No.

Lesley Stahl: None? Does someone have to read them before they go
out?

Elon Musk: No.

Lesley Stahl: So your tweets are not supervised?

Elon Musk: The only tweets that would have to be say reviewed would
be if a tweet had a probability of causing a movement in the stock.

Lesley Stahl: And that's it?

Elon Musk: Yeah, I mean otherwise it's, "Hello, First Amendment." Like
Freedom of Speech is fundamental.

Lesley Stahl: But how do they know if it's going to move the market if
they're not reading all of them before you send them?

Elon Musk: Well, I guess we might make some mistakes. Who knows?

Lesley Stahl: Are you serious?

Elon Musk: Nobody's perfect.

Okay really all of the questions here are pretty great. “Are you serious,” for
instance, is almost as good a question as “look at you.” But also: If you’ve agreed
with the SEC—as Tesla definitely, definitely, definitely, 100 percent, in a
settlement approved by a federal judge, has[1]—to have a securities lawyer
review Musk’s tweets and pre-approve them if they might move the stock price,
then, right, “how do they know if it’s going to move the market if they’re not
reading all of them before you send them?” One could imagine a different CEO

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giving a different answer: “I do personal tweets myself but run anything about the
business by the lawyers, and err on the side of caution,” say, or “I like to think that
after years of service as a public-company CEO I know what is and isn’t material
to the stock price.” Musk did not give those answers!

It’s super weird. Tesla agreed to get its Musk-tweet-reviewing house in order
within 90 days after the settlement; they still have a month or so, so this
isn’t technically a violation. Perhaps after that deadline Musk will give different
answers ha ha ha ha no come on there’s no chance whatsoever that that will
happen. Who would make it happen? The securities lawyers in charge of
implementing Tesla’s SEC settlement will come to Musk—if they haven’t already
—and say “you need to run your tweets by us before you send them,” and he will
say “says who,” and they will say “says this settlement with the SEC that we
signed and that a judge approved,” and he will say “Hello, First Amendment,” and
they will say “well that is not really how this works,”[2] and he will turn his back on
them and go back to tweeting about pedos and Mars and short sellers and how
much he hates the SEC, and they will wander away looking sad and nervous.

We really live in a golden age for legal realism. It used to be that “because it is
against the law,” or “because we have agreed not to,” was widely accepted as a
sufficient reason not to do something. Obviously there were murders and financial
crimes and so forth, but, like, when corporate CEOs went on television they were
careful to say things like “we follow the law and abide by our commitments and
respect our regulators.” Now—and I am not thinking solely about Musk—a much
stronger sense of “well who will make me” has crept into legal analysis. Oh sure
Musk will ignore his SEC settlement, but what is the SEC going to do about it?
Sue him again?

I mean, maybe, right? The thing is that he hasn’t really done anything bad; he has
tweeted mean stuff about the SEC, and sort of joked that he was stepping down
as Tesla’s CEO, but there’s not much here to really alarm or deceive
shareholders. If the SEC didn’t have a settlement with Tesla requiring him to
knock off the impulsive tweeting, it wouldn’t have any real complaints about
Musk’s recent tweets, and just having the settlement is not necessarily a good
reason for it to intervene. Having the settlement and watching Musk go on

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television to say that he doesn’t respect the SEC—while the SEC and Justice
Department are also looking into Tesla’s disclosures about its production targets
—might be another story.

Hedge fund transitions

A trend in recent years has been for famous founders of big important hedge
funds to kick out their outside investors and remake their funds as family
offices. There are various possible reasons for this—popular ones include
performance being too good, performance being too bad, legal troubles, and just
getting older and tired of dealing with investors—but they all tend to end up with
the famous manager running a multi-billion-dollar investment pool consisting
mainly of his own (and his employees’) money.

Och-Ziff Capital Management Group LLC went the other way last week:

Billionaire Dan Och is pulling the majority of his capital from his
namesake company as he prepares the company for his retirement early
next year.

The hedge fund manager said in a statement Thursday that he is

redeeming all of his liquid fund investments at Och-Ziff Capital
Management Group LLC, which announced a series of other changes at
the publicly-traded hedge fund firm.

The other changes are designed both to shore up the firm’s finances—including a
reverse stock split to avoid delisting—and to transfer power and ownership to
Och’s successors, including CEO Robert Shafir. “I look forward to moving on
based on my confidence that Oz will be in good hands with Rob and his
leadership team,” says Och in the press release, but that confidence does not
seem to extend to keeping his money in the funds?

His money was only about 3 percent of assets under management anyway.
Arguably this is a better model of hedge-fund transition. The standard model
seems to tie the life cycle of a hedge fund to the life cycle of its manager: As a
brash young up-and-comer, he starts a small fund that makes bold moves and

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achieves stellar performance; on the back of that success he raises lots of money
and institutionalizes his firm and settles down in middle age to collect a lot of fees
with modest returns; as he gets old and rich he decides he doesn’t need the
hassle of clients and retires to a family office; and then, presumably—there is less
precedent for this so far—he dies and his fortune goes to heirs and charity and
perhaps a boringly managed foundation.

This is a very nice life cycle, if you are that hedge fund manager, but it is perhaps
less satisfactory for the other people involved. (Except the heirs.) There’s a lot of
value in a perpetual corporate entity! Clients and employees might feel more
secure if their long-term relationship is with an institutional entity rather than a rich
guy who might close the fund on a whim. And certainly if you go public and raise
outside money—as most hedge fund firms don’t, but as Och-Ziff did—then you
are sort of committing to perpetuity. A perpetual hedge-fund firm ought to survive,
not only its founder’s retirement, but even the withdrawal of his money. There is
something healthy—and I don’t want to exaggerate this; after all Och-Ziff is also
fighting not to get delisted—but in the abstract there is something healthy about a
hedge-fund firm whose founder decides to withdraw most of his money and that
mentions that in the third page of the press release. Meh, he’s just one investor.

In other hedge fund news, “AQR Capital Management’s flagship risk parity mutual
fund, which has suffered big outflows, will no longer be billed as a risk parity
fund.”

People are worried about bond market liquidity

The staff of the Bank of Canada are worried enough about liquidity in the market
for Canadian government bonds that they published this neat discussion paper
proposing “four blue-sky ideas for lowering the cost of funding the Government of
Canada’s debt without increasing its risk profile” by increasing liquidity. Two of
these ideas involve open-market operations (“to reopen the issuance of scarce
bonds,” or “to conduct more switch operations (exchanges of less liquid GoC
securities for new, more liquid bonds).” The other two are about reducing the
number of bonds Canada sells in order to improve liquidity in each bond:

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 Specifically, the third idea is to eliminate coupon payments from
government debt and issue debt on a simpler and fixed maturity
schedule. Issuing zero-coupon debt would eliminate a key difference
between GoC securities and increase their fungibility. Combined with a
fixed maturity schedule, it would simplify the issuance of GoC securities
throughout their life cycles and increase their liquidity.

Our fourth and most radical idea is to push defragmentation to its logical
end. We describe a government debt program centred around three
perpetuities—one to replace bonds, one to replace bills and one to
replace Real Return Bonds. The perpetuities would be standardized,
streamlined and issued in greater size than the most liquid bonds
available anywhere today. These features would make them extremely
liquid on the secondary market, which would in turn decrease their cost
at issuance.

You sometimes see similar proposals in the world of corporate bonds: Each
company just has too many bonds, and they are not interchangeable with each
other, and so each is less liquid than they’d be if they were all somehow
combined. There is only so far corporates can go with that, but with hypothetical
staff discussion papers for large rich own-currency sovereign issuers the sky is
the limit. The fourth idea here is for Canada to issue three perpetual bonds: one
with a fixed rate (and a price that varies with prevailing interest rates), one with a
floating rate “set at the central bank’s monetary policy target rate and paid
frequently, such as monthly (or even daily)” (and, one assumes, a fairly stable
price), and one with an inflation-linked rate. If the government has a surplus it can
buy back bonds on the open market; if it has a deficit it can issue new perpetuities
(totally fungible with the existing ones) at the market price; if it wants to change its
interest-rate profile it can buy back some fixed-rate (long-duration) bonds and sell
some floating-rate (short-duration) ones, or vice versa.

I am fond of this idea purely as an aesthetic matter. For one thing, there is
something pleasingly counterintuitive about saying that a government can get any
mix of debt maturities that it likes with just two types of bonds,[3] both of them
perpetual. A perpetual floating-rate bond is effectively a very short-term bond, a
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perpetual fixed-rate bond is effectively a very long-term bond, and you can get
any average duration you like by combining the two.

For another thing, perpetuities are neat because they undercut a lot of boring
political arguments. “We can’t keep borrowing like this forever,” say politicians; “if
we take on debt, it will need to be repaid.” In fact, rich countries like the United
States have more or less been borrowing like this forever, and just paying off that
debt and living debt-free seems both impossible and undesirable. (For one thing,
the money could be used for better things; for another, people like owning
government bonds.) But as long as governments are issuing term debt, two- or
five- or 30-year bonds, the maturities of the bonds do create the impression that
they need to be repaid. (And they do, though normally just by issuing new bonds.)
Issuing only perpetuities removes that illusion and reveals the debt for what it is, a
structural feature of the economy rather than a short-term IOU that the
government needs a plan to pay back.

Also if you only issue perpetuities, there will be people who want something other
than perpetuities, and how will they get it? Yes that’s right it’s financial
engineering!

Intermediaries would have a new role serving investors who desire

payments with some maturity, duration or timing. Intermediaries can
replicate any cash-flow structure desired by holding an appropriate
portfolio of perpetuities or perpetuity derivatives and rebalancing it
occasionally. As some clients are unable to do this or would find it too
costly, intermediaries could repackage the fixed payments of perpetuities
to meet the demand of clienteles. We see a competitive system of
intermediaries who are paid to serve clients as a better way to address
clienteles.

Asset-backed securities of Canadian government debt! It’s financial engineering

without the (well, without much) risk, letting financial engineers exercise their
talents and have some fun without much chance of crashing the financial system.

Things happen

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Nissan, Carlos Ghosn Charged With Underreporting His Compensation. Wall
Street's Fearless Girl Statue Gets New Place of Honor. Rising Rates Revitalize
Convertible-Bond Sales. Layoffs Become the Latest Thing in Cryptocurrency.
Cryptoassets should be 'outlawed': Allianz GI CEO. Nuns Accused Of Embezzling
Half A Million Dollars From Catholic School To Gamble In Vegas. ‘Make better
choices’: Endangered Hawaiian monk seals keep getting eels stuck up their
noses and scientists want them to stop.

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[1] Here’s the settlement agreement. The relevant language is that, within 90
days, Tesla has to “employ or designate an experienced securities lawyer
… [who] will review communications made through Twitter and other social media
by the Company’s senior officers in a manner that is consistent with the
Company’s disclosure policy and procedures … [and] implement mandatory
procedures and controls to oversee all of Elon Musk’s communications regarding
the Company made in any format, including, but not limited to, posts on social
media (e.g., Twitter), the Company’s website (e.g., the Company’s blog), press
releases, and investor calls, and to pre-approve any such written communications
that contain, or reasonably could contain, information material to the Company or
its shareholders.”

[2] Incidentally the argument that some of the securities laws conflict with the First
Amendment is not all that trivial, though I would not extend it all the way to “the
First Amendment allows me to lie about stocks.” I guess there’s some nonzero
chance that we’ll see Tesla’s lawyers making that argument someday.

[3] Fine, three, but the inflation-linked one moves me less than the other two.

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