Bernie Madoff and a lack of imagination

'Cause this is a man that done stole more money than anybody else, we're talking about anybody else, one old man done took everybody. He done beat the record on everybody. He done went to the top of the list in criminality. Everybody is in there for money. The majority of the cases is about money, do you know what I mean? And here you got a man that done did it, done took it all. He's more important than Jesse James, you know what I mean? Bonnie and Clyde.   

The quote above comes from a man who was in prison with Bernie Madoff, the man behind a $60 billion Ponzi scheme -- the largest fraud in U.S. history. 

It's from Reveal's podcast "How Bernie Made Off: Are We Safe From the Next Ponzi Scheme?"  (Short answer: no). 

It's worth revisiting the Madoff scandal because it's not hard to see how it could be repeated -- and not just in the financial sector.

A couple facts stuck out to me about Madoff and his crimes:

- He was already wealthy before he started the Ponzi scheme. Not as wealthy as he would become, but he was worth plenty. He was also a former chair of NASDAQ. So why did he start the fraud? According to Madoff:

'Cause it feeds your ego. You say to yourself, "All right, all of a sudden, these banks which wouldn't give you the time of day, some of them all of a sudden, are willing to give you a billion dollars." I had all these major banks coming down, and entertaining me. It is a head trip.

- The scheme was simple. He employed a few people with high school educations, paid them enough money to put them in mansions, and they would spend their days scanning the stock quotes in the Wall Street Journal (dead tree version) and reverse engineer plausible trades. No actual trading happened -- he just paid older investors with new investors' money. Then he employed two programmers to write software that printed statements. That's it. 

- He was almost caught by both the feds and Wall Street firms. He fooled them, though, and it's worth examining why. 

First, the feds missed problems with Madoff's firm in part because he had a brand. He projected an image of being an old-school, trustworthy investor. Therefore, the Securities and Exchange Commission went soft on him. They sent newbie staff to investigate his firm. They missed basic stuff, like not knowing to check the amount of his cash holdings in the federal clearinghouse where money sits while both sides verify a trade. If they had a made a simple call, they would've realized his balance there was far, far below what it should've been for a firm worth tens of billions of dollars. 

The Wall Street banks ignored red flags with Madoff's operation because they took a cut on the money they steered to Madoff's firm. Therefore, they didn't want to check under the hood, so to speak. One major investor, a Spanish bank,  asked an employee, Rajiv Jaitly, to conduct due diligence. He wanted to do something simple: go to Madoff's firm and watch them execute a trade from beginning to end. Yet Madoff refused to let him do that. Was that a red flag for the Jaitly's bank? Far from it. Madoff called his bosses, who called Jaitly and told him to back off. 

When I then rang up to sort of see how it was going, he says, "Oh, no. No. We haven't done that." He said, "Look, Rajiv. We all know you're a difficult guy. We had to calm you down at that particular point, so we agreed to it. There's really no need to do it. We're all over this. We understand the investment strategy. It doesn't need this."

Jaitly resigned in protest. The fraud continued for several more years and the Spanish bank lost an undisclosed sum to Madoff's con.

In the end, what exposed Madoff was not the work of investigators, but the Great Recession and its massive losses. Madoff couldn't make the fake numbers work anymore, so he confessed to his sons, who then turned him in. 

***

Bernie Madoff ran his scam for two decades in part because of a failure of imagination from those whose job it was to catch him. No one could picture someone with his stature committing fraud at this scale. Because they couldn't imagine it, they missed or intentionally overlooked obvious signs. 

What else are we lacking sufficient imagination to fully consider?