The Wizard of Lies: Bernie Madoff and the Death of Trust (32 page)

“And unfortunately,” he continued, “the upside is capped by capacity at Madoff so the risk/reward is disproportionate—a less obvious risk with Madoff than the risk that he ‘blows up’ but a real one nevertheless.”

Other hedge funds, private bankers, and wealthy individuals scattered around the world have invested billions of dollars in the Fairfield Sentry fund. If one of the risks these investors are taking is that Madoff will blow up, it clearly is not obvious to them.

W
EDNESDAY,
M
AY 14, 2008

Bernie Madoff looks quizzically at the two men who have been waiting in his nineteenth-floor conference room since 11:00
AM
, and gestures them into his adjacent office.

“I don’t know why I agreed to see you,” he says. He doesn’t sound rude, just a little confused.

Madoff moves to his seat behind the desk as the visitors, a retired New Jersey businessman and his accountant, settle into the chairs across from him.

The businessman mentions the name of the wealthy Madoff investor who had made the introduction. Madoff looks blank, as if he does not recognize the name. He has thousands of investors—but his visitors do not know that. They still think Bernie Madoff is an exclusive, highly selective investment adviser. After all, the businessman made at least a half-dozen calls before finally getting this spot on Madoff’s calendar.

“All right, as long as you’re here…,” Madoff says, as he seems to relax slightly, his cherubic face taking on a kindly smile. He does not have a lot of time to spare, he adds—he will be leaving the next day for the south of France. They trade some pleasantries about his vacation plans. He seems in no hurry to make a sales pitch; he shows no sign of wanting the businessman’s money.

Suddenly the businessman asks, “You didn’t grow up wealthy, did you?”

Madoff smiles. He begins to recount his humble beginnings, the classic biography of the self-made man, something he has in common with his visitor.

Finally they get down to the details.

What is his fee? There is no fee.

What is the minimum investment? Five million dollars.

“I’m not really prepared to put in that much at first,” the businessman says. Typically he starts small with a new money manager, waiting for good results before committing as much as Madoff requires.

Madoff shrugs. “Well, you can put in two million now, but by the end of the year you have to put in the rest.”

At that, the businessman’s accountant knows this discussion is going nowhere and he turns his attention to his surroundings. There is not a single item on Madoff’s desk—not even a pencil. He notices the array of costly Roy Lichtenstein prints on the wall, all variations on the figure of a bull, Madoff’s icon. He takes in Madoff’s expensively cut dress shirt and handsome tie, his silver hair curling stylishly over his collar. Madoff truly seems indifferent to the outcome of the meeting.

The businessman continues to quiz him—that’s his style, as his accountant can attest. He pokes and prods until he gets answers.

Abruptly, Madoff becomes firmer. “Listen,” he says, “you ask a lot of questions. I just want to make one thing clear: With all due respect, once you invest, you can’t call me. You’ll deal with someone else.”

The businessman smiles—his accountant knows the comment has shut the door on any possibility of a deal. Perhaps that’s what Madoff intended. As much as he needs this man’s cash, he cannot afford this relentless curiosity. After a few more pleasantries, they rise, exchange handshakes, and walk toward the double glass doors leading to the elevators.

F
RIDAY,
J
UNE 6, 2008

Today the Madoff firm sends a check for just over $6 million to lawyers handling Mark and Stephanie Madoff’s purchase of a new gray-shingled house on the beach in Nantucket.

It is a beautiful property, larger and better situated than their former vacation home there, which they’ve just sold for $2.3 million. Located on the exclusive island’s south shore, it has five bedrooms and baths, a gracious guest cottage, a pool and hot tub, and a 180-degree view of salt grass, sand, and ocean from its deep wraparound porch.

There is room for their two-year-old daughter to play and for Mark’s two older children, from his previous marriage, to come for summer visits full of bike rides, fishing trips, and games.

Perhaps it isn’t wise for Madoff to let Mark borrow so much cash right now. The trends are getting more worrisome. Some of Madoff’s important feeder funds are withdrawing more than they’re bringing in. Even the vast Fairfield Sentry hedge fund, that $7 billion behemoth, is losing cash.

But to refuse Mark would be almost impossible. How would he explain it, after all these years of being the family’s bank? His two sons live the way the heirs of any successful hedge fund manager would expect to live. Operating at the level Madoff pretends he has reached—with many billions in assets supposedly invested with him, with a net worth in the hundreds of millions, with three vacation homes of his own—how could he explain that it simply wasn’t a good time for him to part with a mere $6 million?

The younger Madoffs will close on the home on Monday, just in time for the sweet summer months on Nantucket.

F
RIDAY,
J
UNE 13, 2008

It’s not really his job, but the financial consultant in Boulder, Colorado, feels he must warn the Fairfield Greenwich Group about the options trading Madoff did for the Fairfield Sentry fund last month. For one thing, it violated the rules that Madoff is supposed to be following when he does trades for the fund. Stock options are to be used only to hedge existing stock positions, not to generate profits independently. But this is exactly what Madoff reported doing last month: he bought twice as many options contracts as his stock positions required. In fact, his excessive options trading accounted for $95 million of the fund’s monthly earnings.

Something just doesn’t add up. This isn’t the first time the consultant has noticed that Madoff was “over-hedging,” but it is the most extreme example.

In an e-mail this morning to the fund’s chief risk officer, the consultant concedes that he may be a bit out of bounds, since he was hired merely to summarize the trading activity “without providing editorial commentary.” However, he continues, “I must mention to you that I find the May options trading activity to be unusual and difficult to explain, and would encourage you to investigate it further.”

The risk officer replies a bit later that he, too, “found the activity somewhat abnormal.” But he has two weeks of travel ahead, so they agree to discuss the trades in a phone call later in the month.

During that call, the consultant will share his fundamental fear. Even as skillful a trader as Madoff cannot wind up on the winning side of every single options trade, so there is the risk that he is backdating his trades to fake his profits. Someone needs to find out who is trading with him. More urgently, someone needs to verify that Madoff actually is holding all the assets he supposedly has purchased for the Fairfield Greenwich funds.

There probably is a simple explanation for these options trades; most likely they were the only fictional trades Madoff could concoct that would explain how he made money when the entire market was down. But it was clumsy—and too obvious. Perhaps he wonders why nobody at Fairfield Greenwich has called him on it, but no one ever has.

And, despite the consultant’s urgent warnings today, no one ever will.

T
UESDAY,
J
ULY 15, 2008

Bernie Madoff is meeting with four visitors from Florida—and he knows this meeting could cost him as much as $33 million.

Three of the visitors are associated with the MorseLife Foundation in West Palm Beach, which operates one of the premier senior care facilities on Florida’s golden East Coast. The fourth is a financial planner in Merrill Lynch’s West Palm Beach office, who has recently expressed a few mild doubts to the foundation’s board about its Madoff investment. His specific concern is that the foundation is putting too many of its eggs in Bernie’s basket. In the spring, he recommended pulling out some of the Madoff money and investing it elsewhere.

The MorseLife Foundation, whose board is dominated by the same sort of wealthy Jewish philanthropists Madoff has cultivated everywhere, opened an account with him in 1995. Since then, the foundation has invested more than $11 million and has never made a withdrawal. On this hot summer day, these visitors believe that MorseLife has about $33 million in that account, representing almost 60 percent of its total endowment.

There is nothing in the account, of course. It is just another small pipeline into Madoff’s huge criminal enterprise. But if MorseLife asks for some of that money back, Madoff will have to write a check—further reducing the pool of cash that is keeping his fraud alive.

He is caught in an increasingly dangerous market environment. This week, the stock of the once-impregnable mortgage giant Fannie Mae is in freefall. Madoff knows some of his big, nervous hedge fund clients could soon demand their billions back. But steady long-term endowments such as that of MorseLife have been his bread and butter for years. It will greatly magnify his worries if they start pulling money out, too.

No doubt he is determined to charm the man from Merrill Lynch.

Madoff is relaxed and calm, as always, and he clearly succeeds in reassuring his visitors about his hedged, conservative “split-strike conversion” strategy. Shortly after this meeting, the Merrill executive will reverse his position and accept the foundation’s continuing investment with Madoff.

Still, it is an ominous victory. Not long ago, the question of whether the foundation should stay would never have come up at all, much less have made its way into Bernie Madoff’s appointment book.

W
EDNESDAY,
A
UGUST 20, 2008

There is a strong whiff of worry in the e-mail traffic today at Fairfield Greenwich Group. Nervous investors and prospective clients are pressing for answers about Madoff—indeed, one client is pulling $74.5 million out of the Sentry fund specifically because of its concerns about Madoff. And staffers at HSBC are asking questions as part of an operational due-diligence analysis of the Sentry fund.

Even after years of due diligence, Fairfield Greenwich’s chief risk officer, Amit Vijayvergiya, conceded in an e-mail yesterday that “there are certain aspects of BLM’s operations that remain unclear” to him and his colleagues. They are trying to respond to the questions from HSBC, which is still focused laser-like on Madoff.

The root of all these worries is counterparty risk. Even institutions confident about their own health know they can be brought down by the failure of an institution on the other side of a trade or on the receiving end of a loan. There are frightened whispers all over the Street about Lehman Brothers and Morgan Stanley. Those worries could become self-fulfilling prophecies—if counterparties are afraid that Lehman or Morgan won’t survive, they may refuse to trade with them or lend to them, thereby ensuring the very failure they fear.

Trust—it all comes down to trust.

In one of his shorthand messages today, Vijayvergiya reminds the firm’s Risk Assessment Committee that “the biggest single counterparty exposure risk we have at FGG” is Bernard L. Madoff. “I think the larger question is if the Risk Group is comfortable with BLM counterparty risk.”

It used to be. Is it still?

S
UNDAY,
S
EPTEMBER 7, 2008

The weather is hot and humid, but a soft west wind is making the Long Island shore a little more comfortable. Bernie Madoff’s calendar shows that his son Andrew and Andrew’s children are to spend this weekend with him and Ruth at the beachfront home in Montauk.

Anyone who leaves the beach and switches on the television today will find the news almost unthinkable: the federal government is seizing control of Fannie Mae and Freddie Mac, the two largest mortgage finance companies in the country. The bailout is the brainchild of Secretary of the Treasury Henry Paulson, and its price tag is rumored to be in excess of $25 billion.

The alternative could be far more costly. Fannie Mae and Freddie Mac have issued billions of dollars in publicly traded debt backed by home mortgages. Fears about the quality of those loans is driving investors out of the credit markets; money to finance new mortgages is drying up.

Andrew Madoff surely knows this news will roil the markets tomorrow, and he and the other traders at his father’s firm will probably have a grueling day.

Privately, Bernie Madoff knows this news will further alarm his institutional investors, especially the overseas hedge funds he is fleecing through his Ponzi scheme.

But no one without a crystal ball could know that this epic bailout—detailed under outsize headlines in all the next day’s newspapers and debated on television talk shows as an unwarranted and dangerous intrusion of the federal government into the private sector—will soon look like a mere footnote to the calamity bearing down on Wall Street.

M
ONDAY,
S
EPTEMBER 15, 2008

September is the perfect time to visit the south of France. The air is sweet and fresh, the vineyards are glowing, the sea is vivid and clear. Bernie and Ruth Madoff and some friends had come over on the company jet before the weekend. They plan to fly on to Italy after a few days here at the Madoffs’ small stucco town house, tucked into the rear corner of a modest complex called Château des Pins.

But the news from New York is so alarming that the Madoffs and their guests probably just hover inside around the television, ignoring the sunshine on the hills above Cap d’Antibes.

Lehman Brothers, one of the most fabled names on Wall Street, filed for bankruptcy this morning, after a frantic weekend of failed negotiations with bank regulators and government officials. Treasury officials refused to throw the firm a lifeline; the Fed did not offer financial backing to attract a willing buyer. This time—after Bear Stearns, Fannie Mae, and Freddie Mac—there was no bailout. It is the largest bankruptcy in American history.