BackLong stocks, short memories
Long stocks, short memories
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As I write this, the US stock market stands within 5% of its all-time high. American consumers are starting to spend again, layoffs have stopped and, wondrous to say, real estate prices in glutted cities such as Miami and Phoenix are showing glimmers of recovery. Americans are finally making money again.
The last thing we want now is a reminder of how gullible we were during the bubble. Yet reminders keep popping up. Perhaps the most visible at the moment involves one of the most popular institutions in New York: the Mets, one of the city’s two professional baseball teams. The teams owner, Sterling Equities, is the subject of a lawsuit made public last week by the bankruptcy trustee seeking to recover money for victims of the Bernie Madoff swindle. The press commentary focused on trustee Irving Picard’s novel legal assertion that the Mets’ owners should have known that Madoff was a crook and therefore should be compelled to return whatever money they made as a result of their long friendship with him. But when I read the facts alleged in the suit, I was struck by how little the mentality that made the massive fraud possible has changed.
Madoff, to refresh your memory, was perhaps the most successful con artist in American history. The money manager stole an estimated $18 billion from trusting investors in a fraud that lasted at least two decades. (Victims’ losses rise to $65 billion if you also count the phoney profits that his victims thought they had earned.) Madoff—a former chairman of the Nasdaq stock market—was well known on Wall Street, and among his victims were movie stars, literary figures, pension funds and well-endowed charities. His racket was the Ponzi scheme: Madoff used money from new victims to pay “profits" to prior investors; as long as fresh money kept pouring in, the scheme worked flawlessly. Testimonials from successful early participants lent Madoff credibility and helped rope in fresh victims, but no such operation—and certainly not one that lasted decades—could survive without wilful blindness by the participants.
If the facts alleged in the lawsuit are true, there was no shortage of myopia at Sterling Equities. Sterling partners Fred Wilpon and Saul Katz, the suit says, worked with Madoff for 25 years, using his investment firm almost as a private bank. Sterling steered hundreds of other investors to Madoff and held hundreds of different accounts with his firm, which collectively earned them $300 million in fictitious profits. The suit claims that both men were sophisticated enough to have known that Madoff’s steady 10% returns, year in and year out, were impossible in the real world. Indeed, Sterling’s own financial advisers repeatedly warned them about Madoff, but the partners didn’t act.
Picard is seeking as much as $1 billion from Sterling—the $300 million in phoney profits and another $700 million in principal that Picard claims is owed because of the partners’ failure to act. Wilpon and Katz reply that “not one of the Sterling partners ever knew or suspected that Madoff ran a Ponzi scheme". They are among the crime’s victims, they say, rather than accessories, having lost all of the $500 million they held with Madoff when his scheme collapsed. The pair have announced that they will sell 25% of the Mets to raise cash to fight the lawsuit and pay for a possible settlement. They might have to sell the whole team.
In retrospect, of course, the warning signs of a scam always seem obvious. But isn’t hard to imagine that at the time, the Sterling partners simply couldn’t conceive that their long-time business partner was stealing from them. Many who met Madoff, including Harry Markopolos, the financial analyst who first blew the whistle on Madoff, acknowledge that he was an exceedingly charming operator.
It’s also not hard to imagine that the “profits" Wilpon and Katz were making predisposed them to hear only what they wanted to hear about Madoff. Behavioural economists call this all-too-human tendency “confirmation bias". Yale professor Robert Shiller calls it “irrational exuberance". The sight of others making money tends to outweigh even the most well-reasoned evidence.
In these circumstances, the social pressure not to be left out of a winning scheme can be overwhelming. Stephen Greenspan, a psychiatrist and Madoff victim (and, ironically, a published author on human gullibility) explained why he failed to heed warnings himself: I genuinely liked and trusted the man [who sold me a Madoff-run fund, and was persuaded by his claim that he had put all of his own (very substantial) assets in the fund... I later met many friends of my sister who were participating in the fund. The very successful experience they had over a period of several years convinced me that I would be foolish not to take advantage of this opportunity. My belief in the wisdom of this course of action was so strong that when a sceptical (and financially savvy) friend back in Colorado warned me against the investment, I chalked the warning up to his sometime tendency towards knee-jerk cynicism.
Ironically the same week that the details of the Madoff case became public, a financial planner told me that he can’t get his clients to re-balance their portfolios—that is, to sell some of their stock market winners and shift into less risky investments. Investors in a broad US market index have now seen a return of 110% since the market’s low in March 2009, and yet American Association of Individual Investors surveys shows that more than half their members expect stocks to go higher still. This is the 22nd week in a row that the survey has shown investors more bullish than average, the second longest such streak in the survey’s history. Excessive optimism in this survey is often a sign that stocks are on thin ice.
Obviously, the stock market is no Ponzi scheme. But a return of 110% in less than two years is no more sustainable than Bernie Madoff’s steady 10% gains year in and year out. Circumstances change but human nature is constant. When there’s money to be made, memories grow short and gullibility…well, it just grows.
Eric Schurenberg is editor-in-chief, CBS Interactive Business Network, and former editor of Money.
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