(For previous posts in this series, see here.)

While Bernie Madoff has pleaded guilty to various charges of fraud, what he actually did has not yet been unraveled and who else was involved not revealed, though all the signs are that it was a pyramid, or ‘Ponzi’, scheme in the classic tradition, pretending to have a business that made money while merely taking money from newer investors to pay off the obligations to the older ones.

As with Charles Ponzi and Allen Stanford, there had been clues long before that Madoff was running some kind of fraudulent scheme, but those who suspected it were not sure exactly what. As long ago as November 2005, Harry Markopolos, an investment hedge fund manager and derivatives expert, sent a confidential report to the Securities and Exchange Commission, the supposed watchdog agency, saying that based on his analysis Madoff could not be providing his returns legitimately. In his report, Markopolos listed 29 red flags about Madoff’s operation.

As Eamonn Fingleton, a former editor for Forbes magazine and the Financial Times, explains in the CounterPunch newsletter of Feb 1-15, 2009:

Markopolos’ interest had been first piqued as far back as the 1990s, when colleagues told him of this amazing fund manager who was ostensibly using a conservative options-based hedging strategy to generate consistently superlative returns. As an options expert, Markopolos quickly determined that what Madoff was claiming was impossible (in this conclusion, he was joined by many Wall Street authorities, not least analysts at Goldman Sachs). Either Madoff was faking or he was pursuing a quite different investment strategy, in all probability a shady one, known as “front-running” (more about this in a second). At a minimum, Madoff was a liar.

What is front running?

Front-running refers to the practice by brokers of exploiting privileged knowledge about future buying and selling by large financial institutions to make private profits. A typical instance might start when a broker receives a big order from an institutional investor to buy shares in, say, IBM. This is more or less guaranteed to send the price shooting up, and if the broker can nip in seconds ahead with an order for his personal account, he or she is guaranteed an almost certain, risk-free, and instantaneous profit. Front-running is pandemic on Wall Street and, as Madoff’s more sophisticated investors realized, almost no one was better placed to profit from it than Madoff.

So this is the scheme that Madoff led his investors to suspect that he was carrying out. While it is technically illegal (since it involves using insider knowledge), it is not uncommon because it is hard to prove and prosecute. What aroused Markopolos’s suspicions is that, as in the case of the Ponzi and the Afinsa/Escala business models, while it was superficially plausible, the returns being provided implied a scale of operations that simply was not possible. But only people who understand the business model being used and do the calculations realize this. As Fingleton writes:

[A]fter years of piecing together information from a wide variety of mainly private sources, however, Markopolos became convinced that front-running was not the explanation. That left only one possibility: Madoff was running the biggest Ponzi scheme in history.

But others had also had their suspicions aroused, though they did not make them public.

For years, [Madoff] had been pegged as an outright Ponzi artist by Goldman Sachs and Credit Suisse, for instance, and he was blacklisted also at Deutsche Bank, Merrill Lynch, and UBS. Indeed, as far back as 1991, CounterPunch contributor Pam Martens, in her capacity as a Wall Street broker had told him she was on to his game and had so advised a client.

The business media and the regulatory agencies also dropped the ball. Markopolos’ now famous dossier was also given to the investigative reporter John R. Wilke of the Wall Street Journal. As Fingleton says:

It is hardly an exaggeration to say that, on the strength of an afternoon’s research, a good reporter could have worked up any one of Markopolos’ points into a cracker of a front-page story. Taken as a whole, the dossier represented the biggest “career development opportunity” any journalist has been handed since Deep Throat delivered the goods on Richard Nixon to Woodward and Bernstein a generation ago.

And yet, nothing happened. Neither the SEC nor the Wall Street Journal picked up on Markopolos’s investigation. Even the New York Times, which had to have been aware of all the worried whisperings about Madoff that were circulating in the elite social circles that their own editors inhabited, did not investigate or reveal these misgivings until after the scandal broke. Why?

Infected by the “greed is good” virus that has ravaged political discourse for nearly three decades, American financial regulation has now become so corrupt and incompetent that it would embarrass a Third World kleptocracy. What is news – at least to those who lack independent sources of information – is that top American editors and reporters now seem no more willing to tackle wealthy and well-connected crooks than their avowedly venal and cowed peers in, say, Jakarta or Harare.

This is what Jon Stewart excoriated Jim Cramer for in the now famous interview. But Cramer was merely a pathetic minor representative, a circus clown, of the financial reporting industry. The sickness runs deep. Consider the recent decision by Andrew Rosenthal, editorial page editor of the New York Times, to publish an an op-ed piece by one Daphne Merkin saying that there were no “victims” in the Madoff case since “no one was holding a gun to anyone’s head, saying sign up with Mr. Madoff or else.”. It is certainly true that some of the investors who gave Madoff money were driven by greed. But who is Daphne Merkin? In her piece she coyly says parenthetically that “I did not know Mr. Madoff nor did I invest with his firm, but have a sibling who did business with him.”

But as that excellent blog Talking Points Memo pointed out, there is far more to this connection.

That sibling is Ezra Merkin, the financier and former chairman of GMAC, who was the second-largest institutional investor in Madoff’s funds, losing billions of other people’s money. In a civil suit filed this week by New York Attorney General Andrew Cuomo, Ezra Merkin, who collected over $40 million from Madoff’s funds, was charged with “betraying hundreds of investors” by lying to them about how much of their money he had invested with Madoff, and by failing to disclose conflicts of interest.

So there were many people who were swindled by Madoff because other money managers like Merkin gave him their money, sometimes despite explicit instructions not to. When TPM contacted Rosenthal to question why the full extent of Daphne Merkin’s connections with Madoff was not made explicit and why she was given this platform to mitigate Madoff’s crime, he refused to answer, which suggests how complicit the media has become in the face of massive government and financial corruption.

Next: The problem of ‘entitled mediocrity’

POST SCRIPT: Biblical torture

The story of Job is one of the weirdest in the Bible, which is quite an achievement when you consider that it is a book full of truly weird stories. God essentially allows the devil to torture an innocent man for no reason other than to prove a point. This animation gives you a quick and accurate synopsis of the story.