Thursday, February 26, 2009

Madoff Made Off With A Lot Of Money

It came to my attention the other day that everyone knows that Bernard Madoff is a bad man that took a lot of money from a lot of people. And some people even know that he's accused of masterminding a $50 billion Ponzi Scheme, mostly because Bernard Madoff and Ponzi scheme have been uttered in the same sentence by every news broadcaster in the world. But not many people know exactly what Bernard Madoff did.... What is a Ponzi Scheme?

A Ponzi scheme, named after Charles Ponzi, starts with a promoter. The promoter will go out and entice some small investors, usually investors with little knowledge about finance, and promise them huge returns on their invested funds. These investors are usually lured by the confidence and knowledge of the promoter, but typically won't be informed of the types of investments that will provide such high returns. The promoter will take the money from the investors, and provide them with the original investment plus the promised high returns in a reasonable amount of time.

The original investors now have confidence in the promoter and his ability to choose investments that provide high returns, so they are more likely to invest additional money and the returns that they recently earned. Also, word will have spread, and new investors will want to invest with the promoter. Now, the Ponzi scheme is in play, the profits that are to be paid to the original investors are not actually profits, they are the funds that are invested by the new investors as word spreads of the promoter's ability to achieve such a high return on investment.

The promoter rarely has to pay out in cash. All the promoter has to do is send statements to investors, showing them how much the investor has earned by keeping the money in the promoter's investments, in order to continue deceiving the investors into believing that the investments are providing high returns.

Bernard Madoff did this on a huge scale, taking tens of billions of dollars from regular schmoes like you and me to charities to gigantic financial institutions. However, Madoff didn't promise huge returns, the statements he provided to his investors showed modest and steady returns to his customers until the market crashed in 2008. After the market crashed, people tried to pull a lot of money out of the Madoff investments, and that's when they realized that Madoff was pulling the wool over the investors' eyes.

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