Quick quiz: Would you be better off today if you had invested a half-million dollars a year ago in: a) Bernard Madoff’s infamous Ponzi scheme or b) AAA blue chips such as General Electric, AIG, Citibank or Bank of America?
The answer is, believe it or not, a). It was supplied last week by Irving Picard, the trustee liquidating Madoff's investment firm who, after examining Madoff’s records over the past 13 years, revealed that Madoff was a total fraud who. instead of buying any securities for his victims. swindled them out of their money. This is great news for his investors since it makes them eligible to collect 100 percent of their losses from the Securities Investor Protection Corp, an exchange-backed fund, which indemnifies investors against fraud up to $500,000 per investment account. So if our hypothetical investor was lucky enough to have invested $500,000 with Madoff, he would have zero loss. If on the other hand, he had been unlucky enough to invest this nest egg in the blue chip AAA blue chip selections, he would have lost at least 80 percent of his money (or up to 95% with AIG). So he would be out at least b$400,000. Making matters worse for our blue chip investor would be his tax situation. According to the U.S. tax code, a maximum of only $3,000 a year from an "investment capital loss" can be deducted against ordinary income. So if the unfortunate investor had no investment capital gains to offset the loss, it would take him over 133 years to fully deduct it from his taxes.
On the other hand, even if an investor put more that $500,000 an account with Madoff, the loss (beyond the $500,000 the investor gets back) is, thanks to an odd feature of the US tax code, a theft loss, and can be deducted dollar for dollar from his other non-investment income at present or for the past three years. So, under almost any scenario, an investor with taxable income he would be better off swindled by Madoff than having invested in General Electric, Citibank, AIG or Bank of America. Alas. as the Bonpartist Antoine Boulay de la Meurthe famously said of the assassination of the Duc d’Enghein. "It is worse than a crime, it is a mistake."