January 4, 2009

They Told Me That Madoff Never Lost Money

On Friday, December 26, 2008, the infamous Ben Stein wrote an op-ed column for the New York Times. It started with comments about the Madoff scandal, but even better is the ending. I wanted to share it with you because it hits on something all of us should think about...

They Told Me That Madoff Never Lost Money
By Ben Stein
Published: December 26, 2008

ABOUT two years ago, a little delegation from a major investment bank arrived at my home in Beverly Hills. These nice young people were from the bank’s “wealth management division.” I told them straight away that I didn’t have anywhere near enough wealth to make their trip worth their time, but they smilingly insisted that we could help each other.

They told me that if I invested a certain sum with them, they would make sure that a large chunk of it was managed by a money manager of stupendous acumen. This genius, so they said, never lost money. He did better in up markets than in down markets, but even in down markets he did well. They said he used a strategy of buying stocks and hedging with options.

I protested that a perfect hedge would not allow making any money, because money made on the one side would be lost on the other. They assured me that this genius had found a way to spot market inefficiencies and, indeed, to make money off a perfect hedge.

I thanked them for their time and promptly looked up Bernard Madoff online. Nothing I saw was even a bit convincing that he had made a breakthrough in financial theory. Besides, this large financial firm was going to charge me roughly 2 percent to put my money with Mr. Madoff’s firm. I could invest my few shekels with Warren Buffett for no management fee at all.

I checked with my investment gurus, Phil DeMuth, Raymond J. Lucia and Kevin Hanley. None of us could see how Mr. Madoff could do what his friends said he could do. I politely passed and went on my way, finding my own inventive ways to lose money on a colossal scale during these last 15 months.

My point is not that I was so smart. I am not and I was not. Mistakes are a big part of my life. My point is that, as humans, we seem unable to learn from our mistakes very well.

I have never heard of an entity that could make money in all kinds of markets consistently, year in and year out. Yet we continue to believe that there will be one. It is, like much else in finance, a myth that will not die. I have never heard of a financial manager who promised to be able to defeat the markets anytime he chose and who, in fact, was able to do so. Even Mr. Buffett says repeatedly that he will have losing years and losing stretches of years. (Wow, is he right this year.)

By the same token, I belong to a number of country and town clubs. In all of my years at them, I have never gotten an investing tip that made money. In fact, as far as I can recall, I have never gotten a tip from any source that made me money, except for my former agent’s wife mentioning Berkshire Hathaway, Mr. Buffett’s company, 30 years ago.

The same goes on a much larger scale for the debacle of subprime mortgages. In essence, it is a much larger version of the Drexel Burnham Lambert junk-bond debacle of the 1980s. Back then, investors were charmed by the idea that the lower-ranked the bond, the more money it would make. It seemed like a great idea: there’s this little corner of the market that the big boys turn up their noses at. But in this little corner, huge money is made. It’s almost like the myth that you get great bargains in poor parts of town.

In fact, the Drexel episode should have taught us to be wary, indeed, of poorly rated debt. But it didn’t. The new version of the myth was so alluring that it drew in not just billions of dollars from lenders and mortgage bond buyers, but much more in derivatives linked to the myth.

Then there was the myth of the hedge funds. One great advantage of being 64 is that I can remember the early hedge funds of the 1960s. They, too, were supposed to turn water into wine, but they fell hard in the stock market meltdown that also laid low the Nifty Fifty — another 1960’s idea that 50 carefully selected stocks could long beat the indexes.

I can still recall visiting an early hedge fund pioneer. He had a small stereo playing rock music in his office as he tried to make millions. That’s how cool he was. I don’t know where he is now and I don’t want to know.

AND there are many other myths I could talk about, myths that we believed in and that tricked us and hurt us. But I will tell you about the main myth that’s hurting investors right now. It is well expressed by my hero, Bob Dylan, who warns against being “ nothing more than something they invest in” in the immortal song, “It’s Alright Ma (I’m Only Bleeding).”

(The important information is below...)

We are more than our investments. We are more than the year-to-year or day-by-day changes in our net worth. We are what we do for charity. We are how we treat our family and friends. We are how we treat our dogs and cats. We are what we do for our community and our nation. If you had $100 million or $100,000 a year ago and now you have a lot less, you are still the same person. You are not a balance sheet, at least not one denominated in money, as was explained to me recently.

Losing and making money are not moral issues so long as you are being honest. You may have a lot less money as this year ends than you did two years ago. But you are just as good or bad a person as you were then. It is a myth that money determines who you are, and if you have gotten over that myth by now, then 2008 will have been a very good year.

Ben Stein is a lawyer, writer, actor and economist.

Source: New York Times

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