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CHAPTER 5How Did Bernie Madoff Keep His Fund Going?

A Ponzi scheme is a form of fraud in which the fraudster promises a higher-than-average level of returns with low risk. Investors are attracted by this no-risk, get-rich-fast promise and quickly deposit funds. Then more and more people deposit funds. When early investors want to withdraw some of their money (from real deposits and/or fake profits), the fraudster uses deposits by later investors to give the earlier investors their money. As we will soon show, things can run smoothly until the withdrawal demands suddenly increase. Bernie Madoff's investment fund turned out to be a Ponzi scheme. The original Ponzi scheme was created by Charles Ponzi in 1920. Ponzi promised a 50% return in 45 days or a 100% return in 90 days. The purported profits were to be obtained by buying “postal reply coupons” in foreign countries and redeeming them for a profit in the United States. The problem was that to earn the promised profits, Ponzi needed 160 million postal reply coupons when only 27,000 existed! By the end of 1920, Ponzi's scheme had collapsed, and he pleaded guilty to mail fraud.

Bernie Madoff's investment fund also turned out to be a giant Ponzi scheme. Investors put in $18 billion, and when Madoff was arrested in December 2008, the fund on paper was worth $65 billion. Amazingly, as of this writing it appears that the original $18 billion deposited with Madoff will be recovered. In this chapter we will explore the following issues: ...