Did Madoff Act Alone

Madoff did not share the credit for perpetrating the biggest Ponzi Scheme in the annals of crime. After his arrest on December 11th 2008 he insisted to the FBI and federal prosecutors that he, acting entirely alone, organized and ran the confidence game that created over $50 billion in imaginary profits and that resulted in more than 6,500 investors losing $13.2 billion in real money. According to him, here is how the lone swindler operation worked. He confined the fake part of his enterprise to a sealed-off suite of offices called "House 17." It was located one floor below his legitimate market-making business in the Lipstick Building on 3rd Avenue Manhattan. Access required a coded key-card and was limited to only about 20 clerical employees. In the back of suite was the so-called "cage" in which three clerks logged in all the checks and wires that were deposited or withdrawn in the JP Morgan Chase bank account for Madoff’s "Investment Advisory" service (which was the cover for the Ponzi Scheme swindle). They manually recorded the amounts on index cards for Madoff. This tally gave him a running total of how much actual money was available. Outside the "cage" was an open area in which three young researchers filled in the historic prices of stocks and options that Madoff requested, using tables from the Bloomberg wire service and other public sources. This data helped him verify the forged trades. Next, he gave data-entry clerks in a glass-enclosed area in the center of the room called the "fish bowl" a list of the trades he supposedly had made and they would punch it into an 1988-vintage IBM AS 400 computer (which was not connected to any external system.) The computer then calculated "commissions" as well as "profits" or "losses," and generated daily and monthly customer statements for each account, which were then printed and posted by regular mail. As the "profits" were consistently greater than the "losses", the value of the accounts increased accordingly. All these operations were done under the eagle-eyed supervision of Madoff’‘s long-time deputy, Frank DiPascali, who is pleading guilty for his part in the criminal scheme and currently cooperating with the FBI investigation. According to Madoff, neither DiPascali nor anyone else in House 17, had any inkling that the trades they were processing were fictional. As for his 18th floor employees, and his accountants– he used a two-man accounting firm that worked out of a 700 square foot office in Westchester– they saw nothing more than the wealth of computer-generated statements showing the trades for the Investment Advisory accounts.
The flaw in his lone swindler story became evident to me when I was allowed to examine Madoff’s actual confirmation slips. These were made available to me at a global business intelligence company founded by former American and British intelligence officers, which specializes in investigating, as they put it, "opaque business environments". The person there who had obtained these Madoff files from off-shore "feeder" funds that had been supplying Madoff with more than half the money funneled into the Ponzi scheme since 1998. Unlike hedge funds which invest money, feeder funds simply raise money and then turn it over to a hedge fund with which it has an arrangement. Ordinarily, the feeder fund gets a relatively small percent of the money it corrals from the hedge fund– typically 1 percent– while the hedge fund charges the investors both a hefty performance and net asset fee. Madoff had, however, offered select feeder funds a much better deal. Instead of charging them anything for managing their money, he would work for them for free, allowing them to collect the entire performance fee, which could be as much as 20 percent of the profits. This provided a bonanza for feeder funds which deducted the performance fee from their clients’ accounts each year, transferred it to their own "carry" account, and then withdrew it. To justify these fee, these funds verified that the trades reported in Madoff’s confirmation slips were in keeping with the conditions specified in the trading authority that they had agreed upon. Since conditions often varied between feeder funds, and even their sub-funds, Madoff could not make all the same fictional trades for all the funds. As a result, by 2008, he needed to invent a huge number of transaction in order to keep turning over the $64 billion that supposedly was in his accounts (especially since he "sold" all his holding and went to cash before each reporting period). The typical "trade," as far as I could concern from the file, was well under $500,000, which meant he needed to invent hundreds of thousands of trades a year that both conformed to the different conditions in the trading authorizations, was consistent with the price of that security that day, and resulted in his achieving his overall "targeted earnings." Each slip I reviewed contained every relevant details of the transaction, including even the securities "cusip number"
"It is impossible that Madoff could do all this work himself," the person at the private intelligence firm said as he pushed over to me a foot-high stack of Madoff confirmation slips.. "Every price on every slip had to be checked against the actual high and low that day. Just the paperwork for these feeder funds would require the full-time services of a group of people who knew exactly what they were doing." He estimated that "at a minimum, you would need 5 people." These operatives would presumably also have to be willing and discrete participants in a con game.
Furthermore, these feeder funds were not the only part of the criminal enterprise that required systematic forgery. A handful of Madoff’s long-time associates had about 100 accounts that had been used between 1992 and 2008. to siphon off billions through redemptions. To get fictional profits into these men’s accounts Madoff faked transactions on a very different scale from those faked for the feeder funds. Some were credited with fictional trades that produced a rate of return 40 times greater than that of the off-shore feeder funds, In one such favored account, according to the Trustee for the bankruptcy, Madoff "purported
to earn over 950% in 1999" [emphasis Trustee’s], while most of the feeder funds were earning a mere 15 percent. In another favored account, according to a SEC complaint, not a single loss was reported in thousands of trades over a ten year period. These were bespoke accounts, custom- tailored to produce enormous profits. Just two of his long time associates were thus able to withdraw $8.8 billion (which is more than half the money actually lost in the Ponzi scheme.) In addition, such customized padding of accounts was used, according to the SEC, to pay some associates off the books, and, via back-dating, to minimize tax bills. These customized transactions exponentially added to the fraudulent paperwork.
In reality, this was not a financial scandal, but a well-run confidence game. Not a penny of the $13.2 billion that disappeared was lost in the stock market. The lion’s share of this loot exited through a few accounts that had been systematically inflated with non-existing "profits" over two decades and its ultimate whereabouts still remains a mystery. To be sure, Madoff, was the impressive face of the criminal enterprise. As a former Chairman of the NASDAQ stock exchange and well-respected doyen of Wall Street, he lent what is crucial in any confidence game: credibility. As federal prosecutors themselves pointed out before he was sentenced to 150 years in prison, "his demonstrated ability to lie, mislead, and deceive is staggering." If so, his claim that he was the sole employee and sole author of this criminal enterprise can hardly be accepted at face value, especially since he may have a interest, such as fear of the consequences, in not fully sharing the credit.
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Madoff's Incredible Money Laundry

Bernard Madoff did not merely plead guilty to running a multi-billion dollar Ponzi Scheme.
He’ also pleaded guilty to multiple counts of "international money laundering." This latter
criminal enterprise has not fully come to light because while Madoff talked freely to prosecutors
about the mechanics of the swindle itself, he stonewalled the court-appointed Trustee Irving Picard’s effort to unravel his tangle of money laundering to the extent that his counsel, David Sheehan, wrote the court just before his sentencing that Madoff has "not provided meaningful
cooperation or assistance to the trustee since his arrest." So even looking at a 150 year prison sentence, his money laundering operation therefore remains a crucial missing piece in the puzzle. At stake is the $13.2 billion that his investors lost.The Ponzi scheme itself was relatively simple. Madoff had investors wire their funds into his bank account at JP Morgan Chase for him it for them through his proprietary strategies in the
stock market. But he made no investments. Instead he forged trading tickets providing them with a fictional profit in their account. These imaginary profits exceeded $50 billion by the time
the scheme was exposed in December 2008. As far as the actual money went, Madoff shuffled between two different bank accounts, siphoning off some of it to pay the clients who withdrew their money. He also wrote checks to pay for his life style and operating expenses (both licit and
illicit). These banking records as well as the checks he wrote and credit card bills are now in the hands of the Trustee’s forensic accountants. Their analysis shows that all the money that Madoff withdrew for himself and family members, including everything from his expenditures
on yachts, country clubs, real estate, plane and travel to loans to his children, gifts, and capital calls on his wife’s private equity investments, amount to less than one percent of the stolen money. The money Madoff withdrew from all his bank accounts to run his scam, including rent
for his offices in the Lipstick building in Manhattan, his payroll (which included his boat crew), commercial taxes, accounting, legal bills, and even the surreptitious kickbacks to fund managers through his London subsidiary amounts to, at most, another 4 percent. He paid these expenses by wiring money to his London subsidiary which then wired it back to his account at Bank Of New York Mellon. So the money he withdrew from all his banks account for himself and his business expenses amount to less than 5 percent of the missing $13.2 billion. What happened to the other 95 percent of the looted money? "That is the $13 billion question", a lawyer involved in the liquidation process answered, adding "Lets not forget Madoff was a truly ingenious money launderer."
Madoff’‘s notional system of book-keeping that provided an ideal way to launder money. Unlike the classic Ponzi scheme in which all investors are credited with uniform "profits," Madoff favored some accounts with what the Trustee called "implausibly high" profits and
allowed through large redemptions to convert imaginary to real profits (which of course came out of other investors’ money). This money could then be deposited some place else, such as a numbered account in a off-shore haven. There is no doubt Madoff had some purpose in stuffing
some accounts with notional profits. For example, according to a SEC civil fraud action filed in June against the brokerage firm Cohmad (which operated out of his Madoff’s own offices),
Madoff padded the account of one close associate with $100 million in fake profits by awarding him roughly triple the putative return others were getting. The SEC alleges this was done as a surreptitious pay-off for his steering over $1 billion of investments to him (Madoff also,
according to the SEC, accommodatingly back-dated the non-existent transactions for this associate so that his fake profits taxes were taxable only at the minimal capital gains rate.)
Others Madoff clients got even larger "profits" put in their accounts through this device. The Trustee’s investigation found instances in which Madoff credited accounts with returns more than 40 times greater than his others investors (even though Madoff was supposedly using the
same trading strategies for all his accounts.), For one such favored account, Madoff "purported to earn over 950% in 1999" [emphasis Trustee’s]. The Trustee alleges that such "implausibly high purported returns" resulted in 84 accounts controlled by two of Madoff’s long-time clients withdrawing the lion’s share of the money that other investors lost, and he filed law suits against both of them.
One of these favored clients is Jeffry Picower, a lawyer, accountant, deal-maker, tax shelter promoter, and philanthropist, who knew Madoff for about 30 years. According to the Trustee’s suit , Picower redeemed no less than $6.7 billion from 24 accounts under his control.
Where did this huge sum come from? According to analysis by the Trustee, "at a minimum, more than five billion dollars [came from] other people’s money." One reason that some much money accrued to some Picower accounts is that Madoff favored them with extraordinary
returns. According to the Trustee, a few of them "enjoyed 14 instances of supposed annual returns of more than 100%" (while other clients got returns of only between 10% and 15%.)
The other favored client sued by the Trustee (and the SEC) is Stanley Chais, a former resident of the Bronx who established himself in Beverly Hills an unregistered investment advisor to a wealthy clientele. Like Picower, Chais had known Madoff for three decades, and his access was
such that his name came up first on Madoff’s office speed dial. According to the Trustee’s complaint, Chais withdrew $1.15 billion from 60 accounts for himself, family members, corporations in which he held interests, funds into which he consolidated his clients, and other
entities. He was also favored with inexplicably high phantom profits, with rates of returns in some accounts, according to the complaint, "in excess of 100 %–or even 300%– a year."
The Trustee alleges that Chais and Picower together withdrew a total of $7.9 billion between 1995 and 2008– most of which came from the phantom profits Madoff allocated to them.. If so, they, or the accounts they represented, took away nearly one-hundred times as much money as
Madoff himself siphoned off by writing checks for his personal and family use.
For their part, Chais and Picower, via their respective lawyers, deny any wrong doing and both men say they are themselves victims of the massive swindle and suffered ruinous losses.. Chais even wrote the federal bankruptcy judge that he is so short on cash that he has a "serious problem" paying a lawyer to defend him, Meanwhile, Picower virtually closed down his foundation because of the losses it suffered. Perhaps these men did not ultimately get the billions that the Trustee
alleges were withdrew from accounts under their control. After all, Madoff was not above forging his internal records. As one prosecutor pointed out, "Madoff’s " demonstrated ability to lie, mislead, and deceive is staggering." But if the $7.9 billion moved to other hands, where did it end up? This issue may be cleared up when Picower, Chais, and others have their day in court this summer (if the proceedings are not delayed ). But given Madoff’s international money laundering skills the $7.9 billion may already have been swallowed up by what the Trustee modestly describes as " a labyrinth of interrelated international funds, institutions, and entities of almost unparalleled complexity and breath."
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The Car Czar Quits

On March 29th 2009, Steven Rattner, the co-chairman of President Obama’s auto task force, met with Rick Wagoner, the chairman of General Motors, in Rattner’s new office in the Treasury Department, and in one of the most dramatic confrontations of the Obama administration in its first 100 days told him he would have to resign because he had lost the confidence of the Obama Administration. Wagoner, a 30-year veteran of GM, fell on his sword. Now, Less than 4 month after disposing of Wagoner, Rattner has announced he himself is resigning.
He now has to deal with the investigation by New York Attorney General Andrew Cuomo into the role that bribes played in inducing public officials to invest pension funds in private equity deals. What brought Rattner, a former golden boy of investment banking, into Cuomo’s investigative cross-hairs was deals he made when he headed Quadrangle Group, which specialized in raising money for leveraged buy-outs in the communications industry. The largest source of money for such buy-out funds was pension funds, which collectively manage about $2.3 trillion, and so he actively recruited money from state and municipal pension funds. To get business. he had employed Henry "Hank" Morris, a top advisor for then-New York State Comptroller Alan Hevesi to act as a placement agent for Quadrangle. In March 2009, Morris was arrested and charged in a 123-count criminal indictment for, among other things, "enterprise corruption" and "money laundering" in regard to selling access to the New York State Common Retirement Fund. Quadrangle had received $100 million from this pension fund just after paying Morris’s firm a placement fee. It also paid Morris for his help in getting money from the Los Angeles pension fund , the New York City pension fund and the New Mexico pension fund.
It is perfectly legal in these states for a private equity fund to pay fees to placement agents for this service so long as it discloses the, Such disclosures are necessary to identify possible conflicts of interest. Rattner presumably was familiar with these requirements since he had himself worked as a placement agent while at Lazard. However, in garnering investments from the Los Angeles and New York City pension funds, Rattner’s firm reportedly failed to disclose the placement fees that went to Hank Morris. In the case of the Los Angeles pension fund, Quadrangle identified two other placement agents it used, but not Morris’ firm. One of the key issues New York’s attorney general is now investigating is whether the New York City Pension Fund was"intentionally misled or deceived "in 2005 by Quadrangle’s failure to disclose paying finder's fees to Hank Morris’s firm.
Further increasing Rattner’s exposure to the bribery scandal, the New York attorney general’s office is also investigating whether Quadrangle might have evaded crucial reporting requirements with New York State Common Retirement Fund in 2005 by having one its private equity holdings buy DVD rights to a movie that was produced by the brother of David Loglisci, New York’s deputy comptroller. Loglisci, a close associate of Morris, was also indicted with Morris on corruption charges. The low budget movie entitled "Chooch," an Italian expression for a bumbling idiot, had failed at the box-office, taking in less than $40,000, before Quadrangle’s private equity holding bought the DVD rights for $88,000. According to a studio executive who deal with DVD distribution, the DVD rights to a movie like "Chooch" would be worth "zilch" since it would "cost more to manufacture the DVDs than a distributer could realistically hope to make from their sales." So was there another benefit to investing in Chooch? About three weeks after buying these DVD rights, Quadrangle got its $100 million from the New York State Common Retirement Fund for which Loglisci was the top investment officer. Adding to the intrigue, an executive at the CarlyleRiverstone fund, a joint venture of the Carlyle Group, which also used Morris’ firm to get money from the New York State pension fund, made a similar investment in Loglisci’s "Chooch." Among the charges against Loglisci (as well as Morris) is "money laundering."
To be sure, Rattner himself may be innocent of any wrong doing in making payments to Morris’ placement agent company and having a subsidiary invest in Loglisci’s "Chooch" venture. But with both the SEC and New York Attorney General Andrew Cuomo investigating these charges, and Morris and Loglisci due to go on trial in New York, Rattner may have unfinished business to settle with Cuomo, and reportedly hired his own lawyer. So ends the brief tenure of Obama’s auto czar.
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The Feeder Frenzy

The Third Missing Piece of The Madoff Puzzle is in my article in the Daily Beast today

http://www.thedailybeast.com/blogs-and-stories/2009-07-05/the-madoff-victims-who-came-out-ahead/?cid=hp:beastoriginalsR2

Like the mythic vampire, a Ponzi scheme needs to find new blood to sustain itself. So while Bernard L. Madoff had no problem creating the illusion of constantly expanding profits through the simple device of wholly inventing the transactions in accounts he managed, the only way he could meet requests for redemptions was to find new money. The amounts he needed became staggering in the 1990s, as a handful of his longtime associates cashed in billions of dollars of imaginary profits in their accounts.
To replace these billions, Madoff needed a new source. The mother lode he turned to was the ganglia of so-called feeder funds.
A feeder fund, unlike a hedge or private-equity fund, does not manage investments. It is simply a marketing operation. Its principals raise money from investors—often through their social, country club, and professional connections—that they then consolidate into a single account, which they funnel to a money manager with whom they have an arrangement.
Typically, in return for finding investors for the money manager, the feeder gets a relatively small placement fee of about 1 percent. The money manager then charges for his investing skills, typically deducts a performance fee of 20 percent from the profits as well as an annual "net asset" fee of 2 percent on the investor’s nest egg.
But Madoff offered feeder funds a much more alluring deal for finding him money. Instead of merely giving them the standard placement fee, he allowed them to take the entire cut of profits usually reserved for the money manager by waiving all his fees. This generous accommodation became extremely lucrative for them because Madoff reported profit annually of about 15 percent. So the principal of the feeder could deduct 20 percent of that putative profit from all their clients’ accounts, transfer it to their own "carry" account, and redeem it, with the result that they got cash while their clients’ fictitious profits grew each year.
But why would a highly successful money manager like Madoff make such an accommodation and essentially work for free for feeders? The explanation Madoff gave was that he was not greedy and content making a mere .04 cents a share from trading stocks in the accounts (which he could have made anyhow if he charged them a fee). As incredible as this rationale might sound, feeders had little incentive to look a gift horse in the mouth. This amazing inducement, together with the track record Madoff had totally invented, brought in enough from feeder funds to more than cover the $8 billion in withdrawals made by his longtime associates.
For their part, his feeder funds fared well, earning hundreds of millions of dollars in fees from their 20 percent cut of Madoff’s imaginary profits and their equally imaginary "performance."
Consider, for example, the success of Fairfield Sentry, a unit of the Fairfield Greenwich Group, whose principals included the socially prominent financier Walter Noel Jr., his four well-connected sons-in-law, and Jeffrey Tucker, a former Securities & Exchange Commission official. According to the complaint filed by Irving Picard, the court-appointed trustee for the liquidation of Madoff’s business, between December 1, 1995, and 2008, "it invested approximately $4.5 billion with Bernard L. Madoff Investment Securities through 242 separate transfers via check and wire."
From its cut of Madoff’s notional profits, the Fairfield Greenwich Group "reaped massive fees, in excess of hundreds of millions of dollars, purportedly for investment performance which has proven to be nothing but fiction."
The Wall Street Journal, which reviewed Fairfield Greenwich’s own records, reported that the firm earned $160 million in the fees it garnered from the money it outsourced to Madoff in 2007 alone. Before the Ponzi scheme collapsed in 2008, the trustee alleges that Fairfield Greenwich, and the entities under its control, withdrew more than $3.5 billion from Madoff. Presumably part of those redemptions included its own fees. Fairfield Greenwich denies it engaged in any wrongdoing and insists that it informed its investors of its relation to Madoff.
But some feeder funds failed to disclose their cozy relationship with Madoff, according to complaints filed by authorities in New York, Massachusetts, and Connecticut.
Consider, for example, the charges files against the entities of investment guru Ezra Merkin, who sits on the board of and invests for a number of universities and charities. Merkin’s three funds had (at least on paper) some $2.4 billion invested with Madoff, according to the 54-page civil complaint filed by New York State Attorney General Andrew Coumo.
Cuomo alleges that Merkin collected hundreds of millions of dollars of performance and net asset fees based on the fictional transactions of Madoff while he "actively obscured" that Madoff, not he, was managing money. Merkin’s three funds, called Ascot, Ariel, and Gabriel, all had money with Madoff. Ascot was purely a feeder fund for Madoff, whereas Gabriel and Ariel, which were supposed to perform complex arbitrages on distressed debt, divided their money between Madoff and two other money managers.
"The incentive fee Merkin collected included 20 percent of the profits reported by Madoff, which, of course, were fictitious," the complaint notes. "Even after subtracting expenses and fees paid to other outside managers, Merkin’s fees for Ariel and Gabriel totaled more than $280 million."
Meanwhile, Ascot produced an additional $169 million in net asset fees. And, according to the complaint, these fees were paid directly to Merkin, who did not reinvest them with Madoff via the feeder fund. While collecting these fees, Cuomo alleges, "Merkin’s deceit, recklessness, and breaches of fiduciary duty have resulted in the loss of approximately $2.4 billion" to his investors.
Merkin denies any wrongdoing. In the court papers filed on July 1, 2009, he asserts that his dealings with Madoff were known to his investors and there was no deceit or breach of his duty. Perhaps so, but if Cuomo’s assessment of Merkin’s financial records is accurate, Merkin raked in nearly $450 million in fees by giving Madoff the lion’s share of his investors’ money.
Madoff may have provided even more extraordinary emoluments to some other of his feeders. Consider, for example, what the trustee describes as "The Curious Case of Sonja Kohn." Kohn met Madoff in the mid-1980s, when she had her own brokerage company in New York. She then founded the Bank Medici AG in Vienna and used it as a feeder fund for Madoff.
Raising money from the newly rich oligarchs of Russia and Eastern Europe, she eventually placed (on paper, at least) an estimated $3.5 billion with Madoff. After the collapse, the trustee sorted through the records of one of Madoff’s front companies and found that sizable transfers had been made to Kohn, even though she did not work for that company.
Next, as The Wall Street Journal reported, prosecutors in the U.S., Britain, and Austria launched their own investigations of alleged payments she received from Madoff. According to the affidavit filed by U.S. prosecutors in Vienna, some $32 million was paid by Madoff over a course of 10 years to a New York company that was "owned by Sonja Kohn personally," while, according to a similar British affidavit, $11.5 million was paid by Madoff’s London subsidiary to another company she allegedly controlled.
If such payments were indeed made by Madoff, they provide an additional inducement for money-raisers to feed Madoff’s insatiable Ponzi scheme. Kohn states through her spokeswoman that neither she nor the Bank Medici received any kickbacks from Madoff and describes herself as "the greatest Madoff victim."
Even excluding such alleged side payments, Madoff’s feeders extracted more than $1 billion in performance and net asset fees from his phantom profits. While there is no evidence in any of the litigation that indicates that any of these feeders were privy to Madoff’s grand Ponzi scheme, they had intriguing clues that might have cast their golden goose in a different light, such as Madoff’s inexplicable generosity in relinquishing his entire performance fee just to get his hands on their money, his curious practice of exiting the market entirely at the very end of each quarter so that his quarterly statements to the feeder funds would list nothing but Treasury bills and cash, and, even curiouser, his employment of an unknown two-man accounting firm in New York's Rockland County—operating out of a 13-by-18 office, no less—to audit all his multibillion-dollar operations.
Missing such flashing signs that something was amiss while they harvested their rich bounty of fees may be understandable on Wall Street but, in my book, it hardly qualifies them for victimhood

Madoff's Winners

The party is over for Bernard L.Madoff. He was sentenced to 150 years in prison and all his property confiscated. His crime was forging all the financial statements of his clients so as to create the illusion that they were making steady profits. In reality their money was being siphoned out of their accounts and given to others. As is now clear from recent court filings by the bankruptcy trustee, Irving Picard, and the SEC, this amazing Ponzi scheme had both winners and losers. While some 4,900 hapless investors, including retirees, family trusts, and charities lost their nest egg, a handful of financiers, all well versed in the arcana of investing other people’s money, made huge fortunes from Madoff’s notional book-keeping. The reason they could profit so handsomely from this shell game, as the Trustee explains in documents filed in U.S. bankruptcy court, was that "The money received from investors was not set aside to buy securities as purported, but instead was primarily used to make the distributions to – or payments on behalf of – other investors." So people who redeemed the imaginary profits in their account got the actual funds put in by the new investors. According to a lawyer involved in the bankruptcy case, the redemptions in excess of investments, as calculated by the Trustee, amount to over $10 billion. If so, the major redeemers took home many billions of dollars. As it turns out, almost all of fortunate redeemers turn out to be close business associates of Madoff who had been involved in his money game for two decades. Consider, for example, Jeffry Picower, who, as a lawyer, accountant, deal-maker, and tax-shelter promoter, who was well-experienced in financial arrangements, and who had dealt with Madoff for more than 30 years. According to the complaint of the Trustee for the bankruptcy of Bernard Madoff’s firm, Picower had 24 Madoff accounts under his control from which he withdrew a staggering $6.7 billion from which he got, for himself and his entities, "at a minimum, more than five billion dollars of other people’s money." Madoff kept meticulous records of correspondence with his early investors which show that Picower, according to the court filings of the Trustee, "was one of a handful of clients with special access" to what Madoff called his "targets" for profits each year. These "targets" could be then achieved by since Madoff since virtually all his trades were fictitious for each accounts. So, If any of his clients with special access requested a higher or lower number than his target for tax or other purposes, Madoff simply adjusted the "profits", and, if necessary, backdated them Picower, the Trustee alleges, frequently specified the profits he wanted for different accounts and, in one case cited by the Trustee, even supplied backdated documentation that Madoff then used in his fabricated book-keeping. Madoff also allegedly shifted billions of dollars of taxable income for Picower’s entities into future years by phony trades. In December 1999, for example, he trustee alleges that Madoff forged nearly $11 billion in short sales in Picower’s accounts in December 1999 "to increase the net cash deficit across these accounts by $2.5 billion" in tax-year 1999. And then reversed these fake trades in January 2000. Such artful legerdemain could defer taxable income and, by doing so, further enhance the value of the $5 billion that Picower, and the entities he controlled, walked away with.
Another intriguing winner, according to a civil fraud complaint filed by the SEC this week (June 22nd), is Stanley Chais. Chais, an unregistered investment advisor with a long roster of wealthy clients in Beverly Hills, Hollywood and elsewhere, also knew Madoff for some 30 years. He was indeed in such close contact with Madoff that his name came up first on Madoff’s office speed dial. Chais had, or controlled, 60 separate Madoff accounts. Some were for himself, his family members, and his foundations; other were for outside investors he had consolidated into 3 feeder funds The SEC states in the complaint , that "unlike the thousands of investors who lost money in the Madoff scheme, Madoff’s enterprise ultimately proved to be extremely profitable for Chais." The SEC says that Chais, along with his family and foundations, "withdrew approximately a half billion dollars more than they had invested with Madoff." As for the outside investors, Chais levied a heavy performance fee of 25% on their putative profits each year based on Madoff’s performance. which, according the SEC complaint, amounted to $269.7 million. Chais also had impressive access to Madoff, according to the separate complaint filed by the Trustee in bankruptcy court, that alleges that Chais was able to specify the size of the "profits" and "losses" in his different accounts "presumably for tax purposes." In all the entities under his control– which includes his fees on :profits", the Trustee calculates Chais withdrew $1.2 billion.
A third winner, according to another SEC complaint filed this week (June 22nd), is Robert Jaffe. A well-know investor in Palm Beach and Boston, Jaffe is a son-in-law of Carl Shapiro, a 95 year old multi-millionaire philanthropist, who was one of Madoff’s earliest financial backers in 1960. He has known Madoff for over 30 years and his brokerage firm Cohmad, which was partially owned by Madoff, operated out of Madoff’s offices in the Lipstick building. The SEC alleges in the complaint it filed against Jaffe and other members of Cohmad, that Jaffe received hidden side payments directly Madoff of over $100 million for recruiting more than $1 billion of investments from his social circles in Florida and elsewhere for Cohmad (which put 99.7% of its investments in Madoff’s scheme). According to the SEC, Madoff channeled this money to Jaffe by crediting his account with at least three times the "profits" that he was crediting to Cohmad investors, and then allowing Jaffe to redeem between 1996 and 2008 over $150 million. Jaffe also made, according to the SEC, "specific requests" to Madoff for "a specific dollar amount of gains for a given period," including ones for "long term gains." A Madoff employee "would then insert a backdated trade going back days, weeks or even months that afforded Jaffe's account that particular gain." By transforming short term gains into capital gains, these "trades" may have helped reduce Jaffe’s tax bill on the $150 million he withdrew.
Picower, Chais, and Jaffe all deny via their lawyers that they had any knowledge of the Ponzi scheme. If so, they presumably believed that Madoff had been gifted with a Midas touch– indeed one so deft it could produce the precise results for which they wished . Was this willful blindness? Financiers’ capacity for self-deception should never be underestimated, especially when it serves to rationalize hundreds of millions of dollars in profits. But to depict such major redeemers as victims of Madoff’s Ponzi scheme stands on its head Balzac’s dictum that "Behind every great fortune is a crime."
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Madoff's Secret Service

A missing piece in the Madoff puzzle is the motive of his early wave of investors in Madoff’s operation before he had established an impressive track record. Why did a dozen or so multi-millionaire businessmen put both a large share of their personal wealth and that of their tax-exempt foundation in multiple accounts with Madoff? If these financially savvy investors only wanted to compound their wealth, other highly-regarded money managers, such as George Soros, Julian Robertson and Paul Tudor Jones, offered better track records over longer periods as well as much safer financial controls, including outside custodian and auditing services. Presumably Madoff was able to offer these wealthy investors some other service they could not obtain elsewhere. But what?

The secretive way in which he personally ran his operation from a small office in the Lipstick Building in New York may well have been part of the inducement. Since he alone handled each account and determined its profits and losses from each putative transaction, he was in a unique position to custom-tailor how they were allocated between a client’s taxable personal accounts and his tax-exempt charitable accounts. In fact, presumably unknown to these investors, Madoff was running a Ponzi scheme in which he forged the paperwork to create imaginary profits. Even without such notional book-keeping, it would have been child’s play for Madoff to provide his clients with the results that helped them minimize their annual tax bills. This service became particularly valuable to wealthy individuals after Congress in 1982, at the behest of Senator Daniel P. Moynihan, amended the Economic Recovery Tax Act to prohibit a common practice in which wealthy investors used commodity trades to shift their taxable profits into future years. Madoff’s correspondence with his clients, according to one lawyer involved in the ongoing civil suit, shows that this was precisely the secret service Madoff was supplying his early clients. "If a client needed to offset taxable income in a given year," the lawyer explained, "Madoff would give him a paper loss, and put the off-setting profit in his tax-exempt account and then presumably return it in the next year, or when he needed it." As far as how he did this legerdemain, he apparently had a "Don’t ask, Don’t Tell" policy.

Irving Picard, the court-appointed trustee in the bankruptcy liquidation of Madoff's firm, found correspondence in Madoff’s files showing that investors specified the loss that would be helpful. Indeed, he charges in court papers that one of these early investors, who had $178 million in different Madoff accounts requested, as reported by The Wall Street Journal, "fictitious losses from Mr. Madoff's firm, apparently to offset gains he made through other investments in order to avoid taxes." He cites another early investor, who had nearly a billion dollars in 12 different accounts for his family and foundation who, according to Picard, had an assistant at his foundation request a $12.3 gain for his foundation. According to him, there were wide variations in different accounts. Even though allocations between accounts might raise tax evasion issues, all the investors cited in the Trustee’s suit deny any wrongdoing, and no charges have been brought against anyone to date except Madoff himself, who pleaded guilty to fraud in March 2009, and his firm’s auditor, David Friehling, who is out on bail awaiting trial.
The bespoke tailoring of taxable income was not the only special service. Madoff also provided these early clients with a steady increase in the reported value of their total investments in both good and bad times (such as in the crash of 1987). We now know that he achieved these results by inventing them. And they provided him with the sort of enviable track record he needed to attract a second wave of investors in his Ponzi scheme. As word spread among the rich of Madoff’s amazingly steady returns in both good and bad years, he was approached by numerous"feeder funds." These are essentially money-raising operations that turn virtually all the money they raise over to another money manager. As compensation, they usually get a relatively small placement fee from the money manager, who then charge the investors his own performance fee– typically 20 percent of the profits– and an annual charge– typically one percent of the value of their total investment.

Madoff offered these money-raising funds a far more lucrative deal in which he would waive his fee entirely, allowing the feeder funds to charge the investors a performance fee as well as an asset fee on the profits that Madoff would generate each year. Madoff explained that he could afford to provide this zero-fee service to funds because he earned commissions buying and selling options on the shares. Rather then looking a gift horse in the mouth, feeder funds eagerly outsourced their investors’ money into Madoff. The profits they earned from these fees were staggering. For example, in 2007 alone, Fairfield Sentry, a unit of the Fairfield Greenwich Group, raked in $160 million in fees on the money it had outsourced to Madoff. Such fees, of course, were based on the fake numbers Madoff supplied. After the Ponzi scheme was exposed in 2008 by Madoff himself, many of these funds claim to be victims of his fraud. Perhaps so, but certainly the investors in these feeder funds qualified as the prime victims. As lawsuits brought by bankruptcy trustee Picard and the ongoing federal investigation proceed, and we learn more about the special services Madoff provided "victims," including the bespoken allocations that allowed them to reduce their taxable income and the zero-fee management that allowed feeder funds to harvest a huge bounty from his phantom profits, it may be useful to ponder W.C. Fields famous dictum "You can’t cheat an honest man."
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The Russian Take Over The Diamond Cartel

De Beers Consolidated Mines, Ltd., whose mines up until recently produced over 40 percent the world’s diamonds, reduced its output of rough diamonds by about 90 percent in 2009. Moreover, in accordance with the new anti-trust laws of the European Union, it stopped buying diamonds from other producers for its stockpile. By doing so, it effectively relinquished control over the diamond prices to the Russia’s state-controlled monopoly, Alrosa, which is now the largest the world’s largest diamond producer.
For more than a century, De Beers had been the undisputed overlord of a global diamond cartel. Indeed it masterfully created and perpetuated the diamond invention, the idea that diamonds are rare and forever valuable. To be sure, until the late nineteenth century, diamonds were truly rare, found mainly in a few riverbeds in India and South America, and the entire world production of gem diamonds amounted to a few pounds a year. Then in 1870, huge diamond mines called “pipes”
because of their circular shape were discovered in South Africa, where
diamonds were soon being scooped out by the ton by steam shovels. As
these diamonds poured onto the market, the price dropped to loss than
$10 a carat, endangering the investments in these mines. Realizing that
the flood of diamonds from these pipes, if not abated, would destroy the
public’s perception that diamonds were scarce, and that without the
perception of scarcity diamonds would become at best only
semiprecious gems, the mine owners moved to limit the surfeit of
diamonds by merging their properties in 1888 into a single entity, De
Beers. This diamond cartel, which then came under the control of the
Oppenheimer family, maintained the “price security” crucial to the
illusion by releasing onto the market only the number of carats to satisfy
demand at the established price and stockpiling the excess diamonds in
its vaults in London and Johannesburg. When diamonds were found in
more and more countries, it worked through an intricate system of
bankers, shell corporations, and buying agents to keep them in a single
channel of distribution called the “Central Selling Organization.” By
acting as the buyer of last resort, De Beers proved be the most successful
cartel arrangement in the annals of modern commerce. Then, in the
1960s, it was confronted by a new challenge: a huge pipe mine
discovered outside in purview in Siberia. Even though the Russians had discovered it in 1955, the incredibly harsh conditions in Siberia delayed its development until 1962.
Concerned that these small, mainly quarter to half carat diamonds would
disturb the precariously balanced market, Sir Philip Oppenheimer, the
head of the Central Selling Organization, rushed to Moscow to negotiate
a 5 year deal to buy virtually all the Siberian diamonds. De Beers
considered it a good investment, even if had to stockpile all these
diamonds, because, based on the data, it had it could reasonably expect
the production from that Siberian mine to gradually diminish as similar
mine had done in South Africa. Instead, production accelerated at an
incredible pace, and by 1968, it was delivering nearly two million carats
a year to De Beers, most of which were added to its bulging stockpile.
In return, the diamond haul provided the Soviet Union with so much
hard currency that the head of the Mirny Diamond Administration said,
"We call ourselves the country's foreign exchange department."
When Russia delivered some 2.5 million carats in 1976– -almost onequarter of the world's supply– Sir Philip insisted on personally inspecting the mysterious Siberian mine before he would renew thecontract. He was accompanied by Barry Hawthorne, who was then De Beers' chief geologist in Kimberley. By the time they had completed the arduous journey to Mirny– fog delayed the flight for nearly a day–
they had very little time to inspect the mine. "We had about a twentyminute tour of the mine," Hawthorne later told me, and what he saw at the open pit site only deepened the mystery of how the Russians produced vast quantities of gem diamonds from the depth of the excavation he could calculate that less ore had actually been taken from
this mine since 1960 than would be able to produce anywhere near the
quantity of gem diamonds the Russians were shipping to De Beers– at
least by comparison to their South African state-of-the art mines.
Hawthorne theorized that Russia must have “secret mines” elsewhere.
The Siberian diamonds also intrigued the CIA since the hard currency
they provided could fund KGB operations. The CIA’s
counterintelligence staff even looked into the possibility that the
Siberian diamonds were man-made, or “grown”, in hydraulic presses– a
process which had been demonstrated experimentally by General
Electric but proved economically unfeasible (at least in the US)– though
it could not find any evidence to substantiate this theory. In any case,
for de Beers, the enigma became a moot issue: wherever these diamonds
came from– whether the Mirny mine or some other secret sources– they
could not be allowed to inundate the market and destroy the illusion of
scarcity. Whatever their origin, De Beers had to keep them in its
“single channel” of distribution. So though, the price was a matter of
tough negotiations, it continued to bear the burden of sustaining the
illusion of scarcity.
After the Soviet Union collapsed in 1990, De Beers still bought about
half of Russia’s diamonds (with the balance consigned to local
consumption or the Russian stockpile that had been created by the
Communists in 1917 to hold gems taken from the Czar.)
Since acting as buyer of last resort put enormous financial strains on
the company, and mew antitrust laws in Europe made it more difficult to
stockpile diamonds, De Beers sought a new strategy by moving to
establish its brand in the retail end of the diamond business. Then,
facilitating this change, the European Union in 2008 prohibited De
Beers from stockpiling Russian diamonds. Even though the Supreme
Court of the European Union later suspended that prohibition, De Beers
agreed to end its long-standing deal with the Russians by 2009. As a
result, the baton has been passed to the Russian diamond monopoly
Alrosa.
The Russians are aware of the requisites of running the cartel. “If you
don’t support the price,” Andrei V. Polyakov, a spokesman for Alrosa
told the New York Times, “a diamond becomes a mere piece of carbon.”
The immediate problem confronting the Russians is the $5 to $7 billion
worth of diamonds in the so-called pipeline, which are the diamonds
bought by cutters, dealers, and manufacturers, mainly with bank
financing, that because of the collapse in retail sales, remain in their
inventories. On top of that, new pipe mines in Angola and Australia
threaten to further destabilize the market. So the new overlords of the
diamond cartel have their work cut out for them.
But while the Russians may share the motivation and even logic of
De Beers, the diamond invention is far more than a monopoly for fixing
diamond prices; it is a mechanism for converting tiny crystals of carbon
into universally recognized tokens of wealth, power, and romance. De
Beers managed this feat through the intangible but crucial element of
good will. For three generations, the Oppenheimer family built a
network of relationships with diamond cutters in Antwerp, brokers in
Tel Aviv, intermediaries in Africa, and bankers in London which was
based on a long-standing mutual trust. This network furnished, among
other things, much of the pricing intelligence, discipline and public
relations that allowed De Beers to control the diamond trade. If the
Russian monopoly lacks the necessary human capital to run this delicate
mechanism, the illusion at the heart of the diamond invention , along
with the diamond prices it has for so long sustained, may be forever
shattered.
Part II- What Happens If The Russians Fail
Edward Jay Epstein is the author of The Rise and Fall Of Diamonds

Cuomo's Matrix Of Corruption

The corruption of pension funds by private interest is hardly a new phenomenon. Las Vegas after all was largely built with money from the Teamster’s Central States Pension Fund, with the intermediary Sidney Korshak, a mob- connected lawyer, channeling a large part of it to casino owners. Korshak himself was never conducted of any wrongdoing, but Jimmy Hoffa, the President of the International Teamster Union, was imprisoned on corruption charges in 1971, Then, after getting a pardon from President Nixon in 1974, he literally disappeared without a trace (his body, according to the latest FBI theory, had been cremated by his associates in organized crime). Today, Pension fund financing is a far more respectable and civilized industry. It is also vastly richer, with pension fund s holding over $2.7 trillion in assets, and providing private equity firms with the most of the capital they use for their leveraged buy-outs, real estate acquisitions and other ventures. In return for allowing pension funds to participate in their deals, the private equity firms exact lucrative fees, taking both a percent of their total investment– typically two percent per year– and part of the profits– usually 20 percent of each successful deal. In 2008, the ten largest pension funds had allocated $105 billion to such private equity deals, creating a veritable El Dorado. To mine this mother lode, private equity firm had to first access to the functionaries at the pension fund who controlled these allocations, and while there is no single powerful intermediary in the class of Sydney Korshak, there are legions of less visible intermediaries called, "placement agents," who use their political contacts, financial experience, powers of persuasion, and other means to extract pension fund money for private equity firms. Indeed, it is now a multi-billion dollar industry. In return for inducing pension fund officials to invest in such deals, they get a cut from the private equity firm of usually between 1 and 3 percent of the total commitment. Since placement agents gets nothing if they fails, they have a powerful incentive to do what is necessary to close the deal. The question currently concerning New York State Attorney-General Andrew Cuomo, the SEC, and some 36 other state attorneys general law is: how do they accomplish their amazing feat of inducement?
According to Cuomo, who is spearheading the investigation, there is " a matrix of corruption, which grows more expansive and interconnected by the day." So far six people have been charged criminally and two people have pleaded guilty. Among those charged with "enterprise corruption" are Henry "Hank" Morris, and his friend David J. Loglisci. Morris, a former top aide to former New York Comptroller Alan Hevesi, who was in charge of New York’s $122 billion pension, raked in at least $15 million dollars in "placement" fees from private equity firms. Former deputy comptroller Loglisci, the top investment officer of the state’s pension fund, allegedly got paid from Morris and also had private equity firms steer money into a curious movie venture called "Chooch he and his brother produced, and whose plot, aptly enough, concerns a bag of mystery money. Both Morris and Loglisci deny any wrong doing and are currently awaiting trial.
Cuomo’s game plan, according to one lawyer knowledgeable about the investigation, is "to work his way up the food chain." This strategy, as the lawyer explained, involves making deals with less-culpable parties in return for their cooperation and testimony against other private equity firms whose real exposure comes not from their making payments to placement agents, which is perfectly legal in most states, but from their failure to disclose them or, even worse. "disguising them" as sham transactions.
Consider the recent guilty plea of placement agent Julio Ramirez Jr. to a misdemeanor securities fraud violation. According to Cuomo’s office, Ramirez, , who worked for the placement agent Wetherly Capital Group in Los Angeles, entered into a "corrupt arrangement" with Hank Morris to get private equity firms $50 million in investments from New York's $122 billion Common Retirement Fund. Ramirez then split his fees with Morris, but did not disclose Morris’ involvement. Since that omission made him vulnerable to prosecution, he elected to cooperating with the Cuomo’s investigation, further tightening the prosecutorial vice on Hank Morris.
Cuomo also made settlements with the Carlyle Group, one of the nation’s largest private equity firms and Riverstone Holding a private equity company headed by David M. Leuschen. Their joint venture had paid $10 million to Hank Morris’ firm for its help in getting it $730 million in investments from the New York Pension fund. Leuschen, had also invested $100,000 of his own money in the movie Chooch, a movie venture that involved David Loglisci, the chief investment officer of that pension fund. Since the joint venture had fully disclosed its payments to Morris’s firm and could claim that it was not involved in Leuschen’s personal investment in the Chooch investment, Cuomo made a deal with both Carlyle and Riverstone in which each paid a fine– Carlyle $20 million and Riverstone $30 million and agreed not to use placements agents in any future deals and to fully cooperate in the ongoing investigation. In addition, Carlyle, issued statement saying that it "was victimized by Hank Morris's alleged web of deceit." It also moved to sue both him and his company for more than $15 million in damages, further racheting up the pressure on Morris to make a deal. The settlement did not include Leuschen, who is still, according to Cuomo, "under investigation." It also does not bode well the 20 other investment firms ensnared in Cuomo’s Matrix. The Quadrangle Group, for example, paid Morris placement multi-million dollar fees for assisting it get pension fund money in New York, New Mexico, and California and also invested money in the mysterious Chooch venture. But, unlike Carlyle and Riverstone, Quadrangle failed to disclose it’s the fees it paid Morris’ company to New York City Pension Fund and the Los Angeles Fire and Police Pensions Fund. Nor can it separate itself from its Chooch investment by, as Carlyle and Riverstone did, shifting responsibility to a personal investment, since it had one of its own private equity holdings buy the video rights to movie. One possible problem for Cuomo– as well as the SEC investigation is the prominence of Quadrangle’s then chairman Steven Rattner, who in 2009 became a key member of President Obama’s task force that is presently desperately working to save General Motors and the American car industry.
But Cuomo has pledged that "The investigation will continue until we have unearthed all aspects of this scheme." As he is both a tenacious– and ambitious investigator, he will undoubtedly topple more dominoes as he proceeds up the food chain . But will he break the matrix of corruption? Stay tuned.

(Updated June 12)

The Amazing Chrysler Trick

The latest casualty of the economic crises is the Rule of Law.
Consider the sad case of Chrysler. Its troubles became manifest in 2007,
when it was owned by the German auto giant, Daimler, and it was unable to come to terms with the United Auto Workers labor union (UAW). Rather than suffer more losses from an unfavorable union contract, Daimler decided to rid itself of Chrysler by handing over 80 percent of its ownership to Cerberus Capital Management, a private equity fund named after the mythical creature guarding the doors of hell. After Cerberus agreed to keep the car company going, Chrysler celebrated with a huge fireworks display and acrobats swinging on ropes from its roof at its headquarters in Auburn Hills, Michigan. Chrysler then borrowed $10 billion from a banking syndicate, led by J.P. Morgan Chase, Citigroup, and Goldman Sachs, to fund its operations. The loan was secured by mortgages on Chrysler's real estate,manufacturing plants, patents, and highly profitable brand licensing rights (Jeep alone earned $250 million a year licensing its name to toys, clothes,and other products.)
The lenders assumed (incorrectly, as it turned out) that their secured loan which was senior to any other Chrysler debt, would be protected even if Chrysler went bankrupt, since the iron rule of bankruptcy held that secured loans get fully paid before unsecured loans. Without this rule, financiers would be reluctant to lend money to corporations on their assets. What these lenders had not reckoned on was the political power of the UAW, especially after the 2008 Democratic landslide.

With automobile manufacturing shifting from the unionized factories of the Big Three– Chrysler, General Motors, and Ford– to the non-unionized factories owned by foreign manufacturers, including those of Toyota, the UAW was rightly concerned that it would lose its grip on the automotive industry. Already, in 2008, these non-union factories‹located mainly in traditionally Red, or Republican, states whose "right-to-work" laws prevented employees from being forced to join a union‹were selling almost as many passenger cars in America as the Big Three. So if Chrysler was allowed to collapse, the UAW stood to lose heavily. As
did the Blue states in the Midwest where its factories are located. So the
UAW had little difficulty in rallying massive support for a rescue among the Democratic leadership of both the House and Senate. By February. President Obama had appointed investment banker Steven Rattner to head his auto task force and come up with a plan.
The solution that Rattner (aka the car czar) endorsed involved dividing Chrysler into two companies‹an old Chrysler, which would be saddled with the debts, and disappear, and a new Chrysler, to which all the valuable assets would be assigned, including those that had been mortgaged to the senior secured creditors.

The new Chrysler would be owned by the UAW, which would get 55 percent of the shares; Fiat, the Italian manufacturer, which would be get 20 percent, with the option of increasing its ownership to 35 percent if it conformed to the targets imposed by the U.S. government; and the U.S. government, which would get most of the remaining shares. Fiat would essentially run the company, supplying its small-car technology and its management (even though, on previous occasions, its managerial efforts in America proved unsuccessful.) The new deal is a win-win for Fiat, since it is not investing any money in the new Chrysler, and can walk away without a penalty.
But what of the people who lent the old Chrysler money secured by its
assets? According to the rules of bankruptcy, they were entitled to be paid
the full $6.9 billion they'd lent the old Chrysler before those assets could be shifted to the new Chrysler‹and before the unsecured creditors, including the UAW's pension fund and auto-part suppliers could be paid a cent. That was not in the car czar's game plan, however, Instead, the creditors were confronted with a take-it-or-else offer of 29 cents on the dollar,
substantially less than the unsecured creditors would receive. (The UAW's
fund, for example, would receive an implied 55 cents on the dollar.) The "else" turned out to be what President Obama described as a "surgical bankruptcy" for Chrysler in a pre-selected U.S. bankruptcy court. Here the administration was able to play its ace in the hole. The four bank that held 70 percent of these loans, namely Citigroup, Goldman Sachs, Morgan Stanley, and JP Morgan Chase, all had received government bailout money, making them vulnerable to government reprisals. So while denouncing hold-outs as "speculators" and "obstructionists" or, as one Congressman from Michigan termed them, "vultures", it was not difficult for officials to strong-arm these banks into accepting the deal.
Using these tactics, Chrysler was able to secure the support of more than two-thirds of its creditors. Once that threshold had been crossed, U.S. bankruptcy judge Arthur Gonzales was within his rights to force the remaining creditors to approve the plan.
Whether or not this extraordinary intervention saves Chrysler, which lost a
staggering $16.8 billion in 2008, remains an open question. After all, even
Fiast's organizational skills may not be enough to persuade
American consumers to buy cars from a company emerging from bankruptcy, especially since its much-heralded small-car technology, meanwhile, will not appear until 2012.
But the consequences of upending the rule of law, even if it was done with
the best of intentions, may prove far more serious than whatever befalls
Chrysler in the Rustbelt. For one thing, it will undoubtedly become far more difficult for an American corporation to borrow money on its assets, since even a senior secured lender can no longer be sure his claim will take priority over those of labor unions and other unsecured creditors.
As one savvy investment banker told me, "Now that we live in a banana
republic, secured lending is anything but secure."

Ruling The Secret World Of Money

The Bank of International Settlements, better known as the BIS, is now calling for a global currency to replace the dollar as a reserve currency. Such a change would upend a financial system that has been in place since the Great Depression. As I reported well before the current crises, the power of the BIS, though cloaked in secrecy, should not be underestimated. It is, after all, the private club of the world's central bankers.

Is The car Czar Due For a Recall?

On March 29th 2009, Steven Rattner, President Obama’s newly-appointed car czar, met with Rick Wagoner, the chairman of General Motors, in Rattner’s new office in the Treasury Department, and in one of the most dramatic confrontations of the Obama administration in its first 100 days told him he would have to resign because he had lost the confidence of the Obama Administration. Wagoner, a 30-year veteran of GM, fell on his sword. Now, Less than a month after disposing of Wagoner, Rattner may confront a similar decision about his own tenure.
Up until leaving Wall Street for Washington in, Rattner, a 56-year-old former New York Times reporter, had a golden career in investment banking, working first at Morgan Stanley, then becoming a senior partner at Lazard Freres, and finally, in 2000, co-founding his own firm, Quadrangle Group, which specializes in raising money for leveraged buy-outs in the communications industry. The largest source of money for such buy-out funds was pension funds, which collectively manage about $2.3 trillion, and so he actively recruited money from state and municipal pension funds.
What brought Rattner into the investigative cross-hairs was that he had employed Henry "Hank" Morris, a top advisor for then-New York State Comptroller Alan Hevesi, to act as its placement agen. In March 2009, Morris was arrested and charged in a 123-count criminal indictment for, among other things, "enterprise corruption" and "money laundering" in regard to selling access to the New York State Common Retirement Fund. Quadrangle had received $100 million from this pension fund just after paying Morris’s firm a placement fee. It also paid Morris for his help in getting money from the Los Angeles pension fund, the New York City pension fund and the New Mexico pension fund.
It is perfectly legal in these states for a private equity fund to pay fees to placement agents for this service so long as it discloses them. Such disclosures are necessary to identify possible conflicts of interest. Rattner presumably was familiar with these requirements since he had himself worked as a placement agent while at Lazard Frere. However, in garnering investments from the Los Angeles and New York City pension funds, Rattner’s firm reportedly failed to disclose the placement fees that went to Hank Morris. In the case of the Los Angeles pension fund, Quadrangle identified two other placement agents it used, but not Morris’ firm. One of the key issues New York’s attorney general is now investigating is whether the New York City Pension Fund was "intentionally misled or deceived" in 2005 by Quadrangle’s failure to disclose paying finder's fees to Hank Morris’s firm.
Further increasing Rattner’s exposure to the so-called pay For play scandal, the New York attorney general’s office is also investigating whether Quadrangle might have evaded crucial reporting requirements with New York State Common Retirement Fund in 2005 by having its subsidiary buy DVD rights to movie that was co-produced by David Loglisci, New York’s deputy comptroller. Loglisci, a close associate of Morris, was also indicted with Morris on corruption charges. The low budget movie entitled "Chooch," an Italian expression for a bumbling idiot, had failed at the box-office, taking in less than $40,000, before Quadrangle bought the DVD rights for $88,000. According to a studio executive who deals with DVD distribution, the DVD rights to a movie like "Chooch" would be worth "zilch" since it would "cost more to manufacture the DVDs than a distributer could realistically hope to make from their sales." So was there another benefit to investing in Chooch? About three weeks after buying these DVD rights, Quadrangle got its $100 million from the New York State Common Retirement Fund for which Loglisci was the top investment officer. Adding to the intrigue, a top executive of the CarlyleRiverstone Fund, a joint venture of the Carlyle Group, which also used Morris’ firm to get money from the New York State pension fund, made a similar investment in Loglisci’s "Chooch." Among the charges against Loglisci (as well as Morris) is "money laundering."
To be sure, Rattner himself may be innocent of any wrong doing in making payments to Morris’ placement agent company and having a subsidiary invest in Loglisci’s "Chooch" venture. But with SEC ans New York Attorney General Andrew Cuomo investigating these charges, with law officers in California, New Jersey, and New Mexico preparing their own investigations, and Morris and Loglisci due to go on trial in New York, Rattner needs to weigh whether, like Caesar’s wife, the car czar needs to be above suspicion. If so, just as he had the courage to ask Wagoner to retire for the good of General Motors, he might be prompted to consider the same course of action for himself.

The Placement Agent Scandal

Is it Placementagent Gate? The placement agent scandal continues to unfold today with Steven Rattner, Obama’s car czar, more and more in the cross-hairs. This afternoon New York Attorney General office announced that it is investigating whether Rattner’s firm Quadrangle Group "intentionally misled or deceived" New York City Pension Funds in 2005 by failing to disclose money paid to a politically-connected placement agent (since indicted.) Meanwhile New York State announced a permanent ban on the use of placement agents. The real scandal here is how these agents of influence are used to corrupt pension funds, as well as college endowment funds, which put over 130 billion tax-free dollars in leveraged buy outs in 2008. For the implications, see my Clog in yesterday’s Daily Beast.

The AIG Bail-Out: A Necessary Conspiracy?

AIG was a death star on September 15th 2008. One does not need a conspiracy theory to understand why the Fed intervened to prevent financial Armageddon. See my article in the Daily Beast.

Diamonds Are No Longer Forever

Responding to the global recession in late February, De Beers’ once mighty diamond cartel closed down about half its global production, including Orapa Number 1 in Botswana, the world’s biggest diamond mine. The immediate problem was a nearly 25 percent drop in prices in December. But De Beers’ fear is not just that retail prices will continue to decline - it has managed that problem before - but that the public will begin to sell its hoard of diamonds, or what is called at De Beers "the overhang."
At the heart of this concern is the reality that, except for those few stones that have been permanently lost, every diamond that has been found and cut into a gem since the beginning of time still exists today. This enormous inventory, which overhangs the market, is literally in - or on - the public's hands. Some hundred million women wear diamonds, while millions of other people keep them in safe deposit boxes as family heirlooms.
De Beers executives estimate that the public holds more than 500 million carats of gem diamonds, which is more than 50 times the number of gem diamonds produced by the diamond cartel in any given year. The moment a significant portion of the public begins selling diamonds from this prodigious inventory, the cartel would be unable to sustain the price of diamonds, or maintain the illusion that they are such a rare stone that their value is, as the ad slogan claims, "forever."As Harry Oppenheimer, who headed the cartel for more than a quarter of a century, pointed out, "wide fluctuations in price, which have, rightly or wrongly, been accepted as normal in the case of most raw materials, would be destructive of public confidence in the case of a pure luxury such as gem diamonds, of which large stocks are held in the form of jewelry by the general public."The genius of the cartel was creating this "confidence" in the myth that the value of diamonds was eternal. In developing a strategy for De Beers in 1952, the advertising agency N.W. Ayer noted in a report to De Beers: "Diamonds do not wear out and are not consumed. New diamonds add to the existing supply in trade channels and in the possession of the public. In our opinion old diamonds are in 'safe hands' only when widely dispersed and held by individuals as cherished possessions valued far above their market price."In other words, for the diamond illusion to survive, the public must be psychologically inhibited from ever parting with their diamonds. The advertising agency's basic assignment was to make women value diamonds as permanent possessions, not for their actual worth on the market. It set out to accomplish this task by attempting through subtly designed advertisements to foster a sentimental attachment to diamonds that would make it difficult for a woman to give them up. Women were induced to think of diamonds as their "best friends."This conditioning could not be attained solely by magazine advertisements. The diamond-holding public, which included individuals who inherited diamonds, had to remain convinced that the gems retained their monetary value. If they attempted to take advantage of changing prices, the retail market would be chaotic.
Even during the Great Depression of the 1930s, there was only a limited overhang, since the mass-marketing of diamonds had begun only a single generation before the crash. So even though demand for diamonds almost completely abated, De Beers, by shuttering all its mines and borrowing money to buy up the production of the small number of independent mines that still existed, was able to weather the crisis.Today, however, with many generations of the diamonds it mass-marketed overhanging the market, and most of global diamond production in independent hands, it no longer is in a position to bring supply and demand into balance. Adding to this precarious situation, diamond cutters, manufacturers and dealers, have, as of Feb. 15, an estimated $40 to $50 billion worth of diamonds in mines in the pipeline that will intensify the downward spiral when the gems reach the market later this year.If the current recession so deepens that the desperate need for money trumps the tenacious grip of sentiment, and the public begins selling even part of its hoard, it could finally shatter the brilliantly nurtured illusion that the value of the glittering stones kept on fingers, in jewel boxes, and in vaults is eternal. As the overhang came pouring into the maket, De Beer's nightmare could become a reality.

Sympathy For The Devil: Why AIG Had No Choice But To Pay

If you want to understand why AIG awarded derivative traders in its Financial Products Group $165 million in bonuses, don’t be distracted by the on-going morality play staged by politicians about the misuse of Federal funds, the blame-shifting game played by AIG executives, or even the disingenuous hand-wringing about the sanctity of contracts. The real decider here is money, specifically, $1.6 trillion worth of volatile derivative contracts. This portfolio, managed by some 400 people in a London-based subsidiary , mainly consists of credit default swaps, interest rate swaps, and other exotic hedging swaps that have the potential of inflicting hundreds of billions of dollars of losses on AIG– and, its de facto partner, the US tax payer.
How did the world’s largest insurer become a hostage to its subsidiary? In 1998, this tiny group got into the newly-created credit default swap business when JP Morgan Chase came to it with a proposition to transform debt on its books into security packages that could be sold off its books. To make these bank debt packages salable to other institution, they needed credible insurance against default to get Triple-A rating. So the AIG financial product group, seeing no risk of default, sold it in the form of credit default swaps. Soon afterwards, with the support of Treasury Secretary Lawrence Summers (now President’s Obama’s economic advisor), the Commodity Futures Modernization Act was passed, which excluded credit default swaps from being considered a "security" under the jurisdiction of the SEC or any other government agency. This act allowed these swaps to be deployed on a massive scale to convert all kinds of debt, including even subprime mortgages and car loans, into triple A securities and turned AIG’s arm, now headed by Joseph J. Cassano, an aggressive Brooklyn-born alumni of Drexel’s back office operations, into a multi-billion dollar profit center for the insurance behemoth. Even though the unit’s 400-odd man group constituted less than one-third of one percent of AIG’s total employees, it produced close to twenty percent of its total operating profits. While Cassano kept the list of his counterparties in the credit default swaps a closely held secret, he bragged at a conference in 2007 that they included a global swath of "investment banks, pension funds, endowments, foundations, insurance companies, hedge funds, money managers, high-net-worth individuals, municipalities and sovereigns and supranationals." One of his more complicated operations involved using a subsidiary called Banque AIG to provide the largest banks in France with custom-tailored swaps that effectively allowed them to evade regulatory capital requirements on hundreds of billions of debt on their books. By 2006, his group was raking in nearly $4 billion in profits, and, as is the tradition in the derivative game, he and his traders got a rich cut of the loot, which on average amounted to roughly $440 million (or about $1.1 million per employee)..
With the collapse in 2008 of the debt AIG was insuring, came such massive losses that Cassano resigned, and AIG, unable to post collateral, faced bankruptcy. At this point in September 2008, the US government rescued AIG, pouring in $173 billion of tax payers’ money. Even so, there remained a $1.6 trillion in potential liabilities that could be triggered by thousands of the credit default and other derivative contracts. To prevent hundreds of billions of losses, these custom-designed contracts, , many of which would not expire until 2012, had to be continually watched, and, if necessary hedged, by traders who understood each one’s particular vulnerability.
. To perform this critical task, key people in the group wanted the same sort of guaranteed compensation in the form of retention bonuses as had in their previous two year contracts. The situation for AIG, and the US government that now owned 77 percent of it, was not unlike the one in Mario Puzo’s Godfather in which an offer is made that cannot be refused. In this case, even without a bloody horse head under the blankets, AIG and its federal overseers could not risk falling into a $1.6 trillion black hole by turning down the demands of those in the financial product group. It was not that they had such unique skills in derivative contracts that they could not be replaced by other people since the managing of these contracts is not overly complex. It is that they knew a proprietary secret, to wit, AIG’s secret book, which included the identities of all the counterparties to the credit default swaps and the unhedged parts of the positions vulnerable to price fluctuations. In addition, replacing some of these operatives in the complex of arcane subsidiaries it had set up technically constituted a change of control and could trigger defaults. For example, as it explained in a secret memo to the staff at the U.S. Treasury in February 2009, just the resignation of two of its Banque AIG executives, Mauro Gabriele and James Shephard, could set in motion renegotiations, and possible defaults in $234 billion in its European derivative contracts with banks. So even key people who had resigned, such as Cassano, were kept on as consultants at fees of up to $1 million a month. The implicit threat was that, if they were simply let go, not only would it cause havoc with the status of the derivative contracts but that traders would be in a position to use the secrets to which they were privy to trade for others against AIG as it attempted to protect the positions in its $1.6 trillion dollar portfolio. Under these circumstances, rather than risking immense losses from having its secret book compromised, AIG paid to keep the key members of the group from defecting. Their compensation, when approved by the Fed and Treasury, would amount to about $500,000 per person a year ( less than half what they had been getting in 2008.) The staff at the NY Fed, while Timothy Geithner was still its head, in fact helped negotiate the terms for these retention bonuses. When Geithner moved on to become Treasury Secretary in January 2009, he presumably understood how financially dangerous it could be to do otherwise, since he intervened with the Senate Banking Committee Chairman in February to get a provision dropped from a bill that would have prevented AIG (and other recipients of federal money) from paying such huge bonuses. In fairness to Geithner, the alternative to making these pay-offs might have proven a thousand times more costly to AIG, and its defacto owner, the US Government. Washington, after all, is ruled by pragmatism, and what difference is there between AIG paying $165 million to the derivative traders who caused the havoc, and the Fed rewarding the rating services that made possible the proliferation of trillions of dollar of toxic debt with $1.2 billion in fees to rate the new debt under its TALP plan to restore the credit markets damaged by its old Triple A rated toxic debt?
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Buffet Versus The Hedge Funds

Warren Buffet’s holding company, Berkshire-Hathaway, finally released its numbers on Saturday (February 28, 2009) which showed that it had the largest decline in its book value in its history. But even before this bad news was announced, hedge funds were massively shorting not Berkshire Hathaway itself but the publicly-traded companies in its $50 billion portfolio. Their bet was that Buffet would be forced to dump the stock of these companies was based largely on his vulnerability to massive losses on derivative contracts, including credit default swaps. It turns out that even while Buffet was denouncing derivative contracts as "financial weapons of mass destruction" and " time bombs", he was amassing one of the world’s largest position in them. For example, he sold derivative contracts on four stock market indexes– the S&P 500 in America, the FTSE 100 in the U.K., the Dow Jones Euro Stats 50 index in Europe and the Nikkei 225 Stock Average in Japan– for $4.9 billion that expose his company to over $35 billion in losses. In 2008 alone these contracts had lost on paper nearly $10 billion and with the market in free fall in 2009, they lost another $3 billion. Indeed, each percent these indexes decrease adds another $350 million to the loss Berkshire Hathaway is liable for. He also sold more than $2/4 billion worth of the infamous credit default swaps, not unlike the ones that brought AIG down once it lost its triple A rating. Such contracts insure that companies will not default on their debt. In addition, Berkshire Hathaway subsidiaries sold derivative contracts on energy for "operational purposes."
Although even the multi-billion dollar paper losses on these derivatives don’t require Berkshire Hathaway to put up money to guarantee payment to its counterparts, they weaken its balance sheet. And since Buffet prides himself on maintaining a "Gibraltar-like financial position," the hedge funds are gambling Buffet will protect Berkshire Hathaway balance sheet– and its triple A rating– by selling part of Berkshire Hathaway’s portfolio. If that happens, they expect to profit in their short sales from the plummeting prices. Whether or not their play succeeds against Buffet, remains to be seen.