Magic Victims

I was watching something about the Madoff scandal last night (yeah, I don't really know why either). It reminded me about how angry I used to get when the scandal first broke and all those news pieces came out with such pitiful stories of all the people who lost so many millions of dollars.
First, am not a completely arbitrary cynic. I appreciate that any loss of money by any person is unfortunate, even if we are talking about a billionaire losing one million dollars. It's an extreme example, but for him, it's a tiny amount, though it's still a loss. That said, the key for this man is not to focus on the million lost but the $999,000,000 that he still has. The million is not important. The 0.1% loss is.(1) This is the first extremely important to remember when hearing about all the huge monetary losses in this scandal. A large chunk of the "losers" were very very wealthy to begin with.
Second, and most frustrating to me, is the issue of dividend payments and annual returns.
Madoff began his scheme most likely in the late 1980s. At that time, the Dow Jones was at about 2,000. A year ago, when he was jailed, it was over 8,000, but just about a year before that it was at 14,000. The point here is that over these 20 years, the stock market as a whole increased between 400-700%. For a fund that was "successful" enough to lure as many big fish as Madoff's you would have to assume he was claiming better-than-average returns and thus beating the simple Dow numbers.
So, now, who wants to play with Excel?(2) Actually, first we need to make a few assumptions. The first I will make is that our initial investment into Madoff's fund is $1,000,000, mostly because it's a round number. Secondly, for illustrative purposes, I'll assume this investment is made in 1989. That is in the fund's youth and also allows us to have a full clean 20 years of investing. Next I assigned a 10% annual rate of return and a 5% annual dividend payment. I'm no CPA so all I did was google and find that these are roughly standard amounts. In fact, after thinking about it for a second, I added another column for 15% annual returns, due to the market success over the period.(3)
In cell D4 I inputted 1,000,000. In cell D5 (representing year 1990 here) I inputted "=(D4*1.15)-(D4*0.05)." This covers the 15% increase less the 5% dividend payout. Our $1,000,000 becomes $1,100,000, a nice increase, plus the $50,000 we pocket in the dividend. You play this out for twenty years and the total account balance goes over $6 million. But remember that because this is a ponzi scheme that number is meaningless because there were no actual trades to increase the fund value, so the effective total of the balance in 2008 is not $6 million but actually $0.
In a lot of the reports about huge losses but the Madoff victims, the numbers cited were either this $6 million or if they were trying to be more simply truthful, the initial $1 million, plus any inflation adjustments, if they were being especially diligent.(4)
In addition to this D column of my spreadsheet, I also have another column which sums the dividend payments only. After 20 years, this amount totals $2,863,749.97.(5) Yes, really. This is how rich people get richer. A mere $1 million almost tripled, and that's just the dividend payments. Most importantly, pertaining to the Madoff "victims," this $2.8 million is real money that was given to them. This is some of the money that those rich people--sorry, "victims"--lived on. If you can follow the basics of a ponzi scheme, you also realize that this money was stolen. Old Bernie and his wife weren't the only ones getting fat off the poor souls who invested in his fund, many many of the actual investors were profiting as well. If you want to be fair about it all, you'd have to go and find the earliest investors and repossess their precious luxury items too.
Even for those folks who weren't early investors, any returns or payments they were receiving were fraudulent. They were living a lie. Sure, they were lied to, but they went right along with it because anyone likes a free buck. The only true victims were those people who only joined the scheme shortly before he was shut down (though I imagine for them the paper trail would be easier to follow and they might have a much better chance in court to recoup their losses).
It's a simple statement, but one that bears repeating for people dealing in the market: you can't make assumptions. You can't lose money you never actually had.
If you walk down the sidewalk every day and find a twenty dollar bill in the same spot and pick it up and use it every day, then whatever you buy with that money is a tangible benefit to having found it. But then what if you find out that some foolish person had purposefully left that twenty there every day for someone else to pick up. Obviously this person should not leave his money out on the sidewalk like that, but still if you pick it up it isn't yours. Perhaps you haven't officially "stolen" the money, but ethically you have deceived and manipulated someone and benefited at his expense. I'm not sure how you could be innocent in this case, let alone have the audacity to call yourself a victim when the fool stops leaving his twenty on the sidewalk.(6)



1. For comparison's sake, if you are a middle-class schmo who invests $10,000 in the stock market and you lose 0.1% of it, then you would have lost $10. Sure, it's a loss, but come on, now. We're not calling this a tragedy.
2. For work, I've been dabbling more and more with excel sheets, and curiously I've got to say I enjoy it a little. Figuring out how to best write a simple function to capture what I'm looking for tickles my efficiency bone. And using copy-paste over and over and watching the numbers fill themselves in is oddly satisfying. Of course--disclaimer--I am a complete novice, and only really know how to use the SUM and AVERAGE functions.
3. A 10% return increases our intial million by 250% over the 20 years, while a 15% return increases it by 600%. The latter here would be the more likely for an exclusive and successful fund such as was this one.
4. Even this is not so simple as I'm making it, because you could technically argue that in addition to the real million dollars lost, there is also an opportunity loss, since if they weren't investing with a crook like Madoff they could have been doing so legitimately and actually made money. In this case, the loss amount would be somewhere between $1 million and $6 million. I personally think that's a bit unfair because anyone can claim "losses" this way. Just because you aren't winning doesn't have to mean you are losing. There a tons of investors who don't make large returns or even any returns; these people can't complain about "unfair losses" any more than a traditional gambler can.
5. I have another two columns that track what happens if the person, instead of pocketing the whole dividend, keeps only 25% of it and reinvests the rest. This is perhaps closer to the truth for the financially savvy investors, but I'd hardly say it was the norm. You've seen the interviews with lots of these people. They don't often strike me as responsible about their wealth. For your curiosity, the dividend re-investors make only $1,139,392.96 in dividends over twenty years (still higher than their initial investment), but their total fund balance is an enormous $12.2 million. While I'm at it, lowering the annual return estimate to 10% would change the total balance to $2.56 million without dividend reinvestment and $5.0 million with reinvestment. The total dividend profits would be $1.65 without reinvestment and $0.62 with reinvestment at this 10% return level.
6. Again, this is a simple analogy. To be more fitting, the person picking up the twenty would have to also be leaving something like $18 on another sidewalk and have another person "steal" that from him. The point is, whether or not you know at the time that you are stealing from someone else, that doesn't change the fact that someone is being stolen from. And that outrage is hardly an appropriate response when the too-good-to-be-true stealing ends. Shame is closer to it.