Hedge Funds Are Victims, Raising Further Questions

[Adsos Letter]

Source: The New York Times

The case against Bernard L. Madoff, the respected longtime trader accused of running one of the biggest frauds in Wall Street history, has been Topic A in the investor community. But close behind is a heated discussion of how the sordid drama will affect the already-battered community of hedge funds and other investment firms — many of which invested with Mr. Madoff.

The collapse of Mr. Madoff’s firm took the vast majority of investors by surprise. Mr. Madoff, once the largest market maker on the Nasdaq stock market, was known for his modest demeanor and, perhaps more important, his steady and overwhelmingly positive returns. That in turn appears to have attracted scores of investors, from Palm Beach country clubs to Manhattan social circles.

It is difficult to map out the swath of damage that the Madoff firm’s collapse is likely to cut through the hedge fund industry, not to mention a wide range of other investors. But among its biggest investors were funds of funds, firms that invest in several hedge funds and are nominally among the most sophisticated judges of character in the industry. Because Mr. Madoff reported consistently positive returns for more than a decade — some say impossibly so — he drew vast amounts of business from them.

Now, the collateral damage is likely to add to the chaos that has already been ravaging hedge funds. Spooked by losses and forced to raise cash quickly as the financial crisis ballooned, investors have sought to pull out their money from hedge funds, causing serious pain, and even some forced closures. A growing list of large, well-known firms have sought to block redemption requests in an effort to stem a mass exodus of investors who now desperately want to get into cash.



Read more: http://www.nytimes.com/2008/12/13/business/13damage.html

---

What do you suppose the likely impact of this will be on any attempt to rescue the economy? Seems like the Madoff affair has thrown a satchel-charge into an already disastrous situation.

[brentspeak]

1. The Madoff affair will cause a lot more people to make runs on banks and investments

[shraby]

2. There'll be people jumping out of windows now

on Wall Street.

[madrchsod]

3. he sucked investment money out of the economy.

i do not feel sorry for anyone who lost one penny to this guy. there`s no way to restore the confidence in our monetary system until guys like this are exposed and the system is regulated.

[Tansy_Gold]

4. The point that's being missed is that

they are ALL ponzi schemes. None of these funds -- hedge funds, funders of hedge funds, etc.etc.etc. -- actually "make" any money. They take it from source and give it to someone else. If they "invest" it, they're only investing in someone else's ability to take the money from someone else and give it back to the "investor."

Madoff may have been more blatant, but the principle is still the same in all of them.

Maybe now they will all crash. Maybe.



Tansy Gold

[pjt7]

5. Hedge funds are pretty sophisticated investors

it's hard to believe they had no clue that this guy was cheating.

[jetphixer]

6. CLUE ???

Simple 1 word answer "GREED"

[sarcasmo]

9. I fully agree, that they are all Ponzi schemes and this one could tumble the whole hose of cards.

[WriteDown]

12. Ridiculous....

My cousin works for a Mom and Pop and to refer to every hedge fund as a scheme shows a lack of knowledge and understanding. Investment is an important part of any economy as well as things like consumptions and taxes.

[Odin2005]

16. I disagree.

IMO much of the financial sector is just speculators manipulating money without doing any real, useful work or creating real wealth. The Investment Class are a bunch of parasites.

[PassingFair]

22. !

:applause:

It has certainly gotten away from
the original idea of supplying
capital for business that would
then be used to upgrade or expand.

It's all about balloons now.

[Odin2005]

25. IMO private capital investment has become obsolete.

The Investor Class is a relic from back when governments were not as powerful and wealthy as they are now and thus wealthy private individuals were needed as a source of capital for new economic enterprises, especially for inherently risky economic enterprises. But now governments are wealthy enough to fund publically owned investment banks, and thus get rid of an class of rich investors that now corrupt our politics.

I'm not so much an "anti-capitalist" as much as I am a "capitalism-as-we-know-it-is-obsolete-ist". That is, capitalism is not inherently good or bad, but it has served it's purpose and has become obsolete. It should of been replaced decades ago, but the forces of inertia causes by entrenched interests has prevented this from happening, resulting in the sick and diseased economy we have now.

Also, the concept of "Capitalism" must no be confused with the concepts of "Free Enterprise" and "Market Economy". Capitalism needs those 2 things, but those 2 things do not require Capitalism. Conflating these 3 concepts results in much bad thinking on the subject, to the benefit of the entrenched economic interests, and in many cases this confusion has been promoted by those entrenched interests. This confusion is also the result of conflating "Socialism" with Marxist-Leninist Economic Planning, with the result of the entrenched economic interests using the failure of Marxism and Economic Planning to wrongly declare Socialism to be a failure, which is total BS.

Unfortunately the conflation of "Capitalism" with "Free Enterprise" and "Socialism" with "Planning" has become the basis of Neo-Liberal Globalist attacks on Socialism starting with Fredrich Hayek's famous work The Road to Serfdom, Where Hayek rightly attacks, and warns of the dangers, of Economic Planning, but then he wrongly conflates planning with Socialism, mainly because when people talk about "Socialism" most people are actually talking about the Marxist form of it, something that annoys non-Marxist Socialists like myself.

My socialism doesn't come from Marx, but instead is in fact partly based on the thinking of Marx's most famous critic, Karl Popper and his concept of the "Open Society". IMO Capitalism has become the enemy of Popper's "Open Society" because it has come to oppose all democratic efforts to reduce human suffering and increase the freedom needed to find our own happiness. Capitalism instead has hitched itself to Market Fundamentalist cultism that puts a supposedly sacred "free market" ahead of the moral need to reduce suffering and enhancing people's freedom to find happiness.

[Blue_Tires]

27. good points n/t

[gravity]

38. The government would be even more corrupt at this

Bribes will be a huge issue and politicians don't have to put their own ass on the line when taking risks.

[sarcasmo]

26. A hedge fund is in no way important to the economy, it produces nothing.

[WriteDown]

29. Kind of like.....

doctors, lawyers, teachers, charities, politicians, etc. :eyes:

[Nihil]

40. 2 out of 5 ... not bad for you I suppose ...

You are correct that neither lawyers nor politicians provide any
more benefit to the world than hedge funds but your other guesses
give away your "inner self".
:eyes:

[sarcasmo]

33. The Stock market is a Ponzi scheme, it has tumbled fifty percent in a short time

and Millions lost half of their 401k's and still think they will rebound. Do you fail to forget the Republicans wanted our Social Security money to disappear into the Wall Street scheme a short while ago.

[Tandalayo_Scheisskopf]

7. I know that this is not A Good Thing.

On the other hand, being reliably poor and having been so for a long time, I must admit that the evil little bastard that lurks inside of me is wallowing in a warm, frothy bath of Schaedenfreude.

I just cannot help enjoying the spectacle of The Masters of The Universe going down in flames and Wall Street being exposed for the pile of utter and irredeemable bullshit that it is and has been for nearly forever.

If I get any former stockbrokers in my advanced webmaster class, looking to change careers, I am gonna have so much fun! :evilgrin:

[kirby]

10. Seriously?

So when you read the article about the Jewish charity in Mass that invested their $7 million dollar endowment (with 5 employees), you felt pleasure in their pain? Wow. I can sometimes be heartless, but not even that heartless.

Unlike many Ponzi schemes which promise 'double your money' or such, apparently this guy had relationships with his clients for up to 30 years. The returns were on the order of 10%, the historical average of the stock market, and everyone who needed to withdraw money had no problem over the years.

[Cronopio]

11. That's not being heartless.

That's realizing you've been screwed by a system of people who have benefited from screwing you. The fact that a few honorable investors invested their honorable money with a pit of dishonorable, greedheaded vipers for honorable purposes doesn't change the fact that the entire hedge fund business was built on fake valuations and tax breaks. The taxes they *could* have been forced to pay could have funded many worthy charities and public works projects, but ended up funding the unworthy (corporate) ones. The Jewish charity in Mass knew about these tax breaks and invested their money because of them - defunding other charities and public projects in an indirect way.

If the damage could have been limited to the ones who caused it (which are a very large number of people), I would be indulging in Schadenfreude too. But when you see a society of smallminded, short-term-thinking people get nailed by their own devices, it's hard to get too worked up about it in their case. I'm more concerned with the people who weren't involved in the Ponzi scheme and are still having to pay the cost.

[WriteDown]

13. Entire hedge fund business?

Why don't you make a few more sweeping statements? All politicians are corrupt? All cops are crooked?

[Cronopio]

14. Yes, the *entire* hedge fund business.

Without the tax and oversight exemptions it would not have been nearly as financially lucrative or would have netted trillions of dollars in deposits. *Every* investor was attracted to invest in hedge funds over many other viable investments for precisely those reasons.

Yes, it's a sweeping judgment, and it's a correct one.

[WriteDown]

15. Spoken like somone who really doesn't know what a...

hedge fund is or how long they've been around.

[brentspeak]

19. How was the other poster wrong?

[Cronopio]

31. How long hedge funds have been around is irrelevent to this issue.

What a hedge fund is is an investment vehicle that has always been known to be:

1. Very risky. (meaning you can lose your investment - a scenario that few investors seem to really understand or believe)
2. Exempt from most of the regulations and oversight that other vehicles are subject to.

What it is *not* is something to trust your charity funds to, especially if people rely on those funds to survive. This isn't exonerating Madoff, but if it's your money it's also *your* responsibility, not the SEC's.

[WriteDown]

32. Please elaborate....

On the regulations and oversight they are exempt from?

Hedge funds are generally limited to a pool of very wealthy investors or finance professionals. Of course they are risky. Madoff's actions are not really a hedge fund though. Especially considering that other hedge funds managers were suckered in as well.

[mbperrin]

17. Yes, a completely artificial construct that never produced a single

tangible object - not one nail, tire, or can of compressed air!

Created out of thin air as you say by laws and regulations designed to foster them and cripple actual investment in real, tangible production.

[Cronopio]

23. Precisely.

You hear the word "fraud" tossed around in Madoff's case, but every rule he broke was unenforced (until now, when it's too late). No regulator and no investor took those rules seriously enough to do their due diligence with the millions they were tossing into Madoff's care. So what rules there were clearly not worth that much to Madoff or his investors, or there would have been more enforcement or calls for enforcement.

Madoff traded on his reputation, like any scam artist. Honest brokers have an actual track record and transparency in their operations that anyone can check up on if they're motivated to. In the case on someone who actually manufactures something, you can readily judge their performance by the tangible product. In the case of Madoff, it was even *more* important to check up on his operations because his product is basically commas and numbers on a balance sheet.

So basically, abstractions such as reputation were and are overvalued in the investment community (and elsewhere), and fundamentals have to come back into vogue again for this economy to survive. I would never base my millions on something as ephemeral as the reputation of someone I haven't even met, or, if I did, I'd at least acknowledge the huge risk in doing so to myself at the outset.

[kirby]

20. Hedge funds do pay taxes you know...

They pay 15% capital gains rate like other investments. The only 'loophole' tax wise is that the guy who run the funds are currently able to claim their 'performance fees' under the capital gains structure instead of income tax structure. Personally I do not think capital gains should be taxed lower than wages because of the incentive it creates, but that is another issue.

I'm not willing to make such a blank statement as you about the greed of anyone who invested in this guys fund. The guy was considered 'well respected' in the investment community, having been chairman of the NASDAQ. On paper he showed a long history of returns within the average of the market rather than pie in the sky numbers. I do feel bad for those defrauded by him. His fraud will be bigger than Enron.

I completely agree there has been a lack of oversight shown on this industry. However, unlike a mutual fund, most people running hedge funds have a significant portion of their own money tied up into the fund so they tend to be more careful.

[Cronopio]

21. Yes, I know that.

My point to the other poster was that the combination of tax benefits (in the form of offshore tax havens where most of the hedge funds are based) and freedom from regulations is the reason that the hedge funds were such an extraordinarily lucrative investment vehicle. I would also apply the tax criticism to other investment vehicles, but the sheer size of the hedge fund holdings meant a much higher tax drain on the government. Which was entirely the point - more for "us" and let the government sort out the rest.

"The guy was considered 'well respected' in the investment community, ..."

So was Ivan Boesky. So was Andy Fastow. While they were making money for others, that is.

"His fraud will be bigger than Enron."

Agreed, but the reason I throw a bigger net of blame than you do is that the largely unregulated game of hedge fund investment was doomed to attract, at least at the outset, a more unscrupulous type of investor that saw the evasion of basic regulations as a valid, fundamental investment strategy. If less wealthy investors had to pay the price with more oversight and non-investors have to pick up the tax burden for them, well, I'm sure that was just icing on the cake. I also blame everyone who created the environment, from the so-called regulators to the so-called legislators, all of whom refused to do their job because there was just too much money to be made for too many people.

I know there were people who were just taking the advice of their investment gurus and weren't intending to make money for strictly selfish reasons. But their money legitimized the need for the unregulated enivironment just the same as everyone else's, and they were looking to make outsized returns from it in the same way as the more selfish investors were.

"However, unlike a mutual fund, most people running hedge funds have a significant portion of their own money tied up into the fund so they tend to be more careful."

I have not seen that in practice. Most hedge funds make it a point to market themselves as some of the more riskier investments. I'm sure each hedge fund draws the line at a different place.

[brentspeak]

18. These were not real "returns"

Any money "gained" in an investor's account was simply money pooled unknowingly from the other investors. The books were cooked to make it appear as if they were getting returns based on stocks, bonds, etc.; but all that really happens in a Ponzi scheme is that the same money contributed by the victim-investors gets switched around from account-to-account like a perpetual shell-game. By the time investors tried to completely close their accounts, it was discovered that the fraudster had long ago squandered/spent all their money.

[girl gone mad]

28. If we had fewer hedge funds..

we probably wouldn't need as many charities.

Madoff's clients were told they shouldn't ask questions. Apparently, most of them thought he was using insider trading to get those spectacular returns. In other words, they didn't care that people were getting screwed on the transactions as long as they were making a profit.

[kirby]

30. You should contact the SEC...

Obviously you have very detailed insider knowledge of what happened and investor motives.

[girl gone mad]

34. Those statements came from published reports..

in the New York Times and on the AP.

It appears that the SEC also knew something wasn't right, but they chose to put off auditing the books. I guess we'll see if anyone is taken to task for this oversight. There are many very smart, very honest people working in our regulatory agencies. Unfortunately, they are being lead by the likes of the corrupt and incompetent Chris Cox.

Dec. 15 (Bloomberg) -- U.S. regulators never inspected Bernard Madoff’s investment advisory business, alleged to be a Ponzi scheme that cost investors $50 billion, after he subjected it to oversight two years ago, people familiar with the case said.

The Securities and Exchange Commission hadn’t examined Madoff’s books since he registered the unit with the agency in September 2006, two people said, declining to be identified because the reviews aren’t public. The SEC tries to inspect advisers at least every five years and to scrutinize newly registered firms in their first year, former agency officials and securities lawyers said.

“Given what the SEC claims is the magnitude of the fraud, this is something you would hope an inspection would have uncovered,” said Mercer Bullard, a University of Mississippi law professor and former mutual-fund attorney at the SEC. “It’s hard to imagine a fraud of this alleged size not being accompanied by significant and pervasive compliance problems.”

[kirby]

35. Actually...

Christopher Cox asked for legislation to allow more regulation of hedge funds and Sen Schumer blocked it in the Senate.

Arther Levitt, former chairman of the SEC, said SEC is way understaffed. The Democrats tried to increase fees paid to the SEC so the SEC could hire 3 to 4 times the number of auditors, but again Schumer blocked it.

[girl gone mad]

36. Cox is no angel.

He's the quintessential "deregulatory", "pro-business", pro-corruption Government-is-always-wrong-rich-people-are-always-right neocon brainstem. House Republican of course.

His entire purpose is to sit on top of jurisdiction to investigate and prosecute financial crimes, and then not do it.

from sec.gov, Cox Biogrpahy:

"Among the significant laws he authored were the Private Securities Litigation Reform Act, which protects investors from fraudulent lawsuits"

Meaning it protects insider trading executives from accountability from the private sector, given that we know the SEC has already been Deep Captured.

[BumRushDaShow]

8. A molotov cocktail thrown into a pit of oil.

This is going to cause a run on banks and other investment firms from the top tier of society looking to try to hoard what cash they can.

[excess_3]

24. welcome news

less for this vulture ...

more for everyone else

[gravity]

37. Hedge funds have no excuses

Small investors and even some charity organizations might no know how to do the due diligence, but hedge fund managers are suppose to know better. They get paid millions in order to prevent something like this from happening.

If one had invested in Madoff, they deserve to fail.

[JVS]

39. The government should start applying capital punishment to cases where such great economic damage...

is done.