What's long baffled me about Madoff's scheme is that Madoff was already rich. He began as a successful money market manager building faster, more technologically advanced, platforms. Why begin a Ponzi scheme? Ron Chernow has an article this week that might provide an answer. He delves into the story of Ivar Kruegar, a Swedish matchmaker who began with a deviously brilliant scheme to trade countries low-interest loans in return for monopoly access to their match markets. But then the funding dried up. So he he began funding the loans with a Ponzi scheme in order to build up the monopolies so he could go back to legitimate business. But the match business never overwhelmed the fraud. Years of wild success and international stardom eventually gave way to wide suspicion. Kruegar shot himself in the heart. Chernow concludes:
Few financiers become embroiled in Ponzi schemes voluntarily, for the simple reason that such schemes are mathematically certain to fail. At some point, the incoming money cannot keep pace with the outgoing claims, and the fraud must unravel. And so the saga of Ivar Krueger presents a credible explanation of how giant Ponzi enterprises come about: not as sudden inspirations of criminal masterminds but as the gradual culmination of small moral compromises made by financiers who aren't quite as ingenious as they think. As Charles Baudelaire once said, we descend into hell by tiny steps. Indeed, in pleading guilty last Thursday, Madoff explained that he had initially thought his fraud would be short-lived. He may well have fancied himself a brilliant money manager. Perhaps, early on, he even had a few good, legitimate years When his lucky streak suddenly ended, he might have thought that he would temporarily make whole the losses of old investors by giving them money from new ones. And then he was off and running.
In a way, the Ponzi scheme is actually more analogous to the bubble earnings than some want to admit. The Ponzi schemers didn't mean for it to go this way either. They didn't begin by trying to defraud anyone. The fundamentals of the business were unorthodox but they had reason to believe the numbers would come into alignment. In the meantime, they were just trying to keep solvent, and that required more earnings, and that meant stepping outside the acceptable risk profile. The real difference is that Madoff and Co. lost their plausible deniability earlier in the process than Citibank did.
