Where’s the Money?

Charles Ponzi

Joseph Cannon recently a really good post about Sir Allen Stanford over at Cannonfire:

Yes, he’s American, and yes, that really is his name. Before taking French leave (the FBI caught up with him at his girlfriend’s home), he bilked investors of some $8 billion. He did this, in part, by establishing Stanford International Bank, run by family members and cronies and located in the Caribbean.

According to the SEC, the bank

sold approximately $8bn worth of certificates of deposit to investors, promising “improbable and unsubstantiated high interest rates”

Joseph covers some things about Stanford you probably haven’t heard before, so you should go read it.  I wanted to cover something else that applies to Stanford, Bernie Madoff (who pled guilty last week) and the current financial mess: 

Where did the money go?

Whenever I read about one of these fraud schemes or financial scandals I have to wonder how they determine the amount of the loss, and why so little attention is paid to where the money went.  Anyone who has seen how cops calculate “street value” of confiscated drugs knows you can’t rely on what you read in the paper.

In the Enron meltdown people said they lost millions when the stock price flatlined, but in reality the stock was grossly overvalued in the first place. They lost whatever money they put in, not what they would have got from selling the stock when it was at peak overinflated value.  I’m not suggesting it wasn’t a big deal, innocent people lost their life savings when the crash came.  What made it more painful was they thought they had made a lot of money with Enron stock and some of them liquidated or borrowed against everything they owned to buy more. 

But the fact is the stock was never worth what people thought it was.  In fact, it wasn’t even worth what they originally paid.  I’ve heard people saying they lost huge sums of money because they were prevented from selling their stock when the price started to fall.  But if they had sold Enron at its overinflated value they would have profited from the fraud, even if they were unaware of it at the time. The person that bought the stock would have been left holding the bag and would have lost whatever money they put in.

Here’s a simplified scenario that may help explain what I’m talking about:

Your next door neighbor Al tells you he has an plan to make high tech widgets but needs cash.  He offers to sell you stock in his new company “Fraudco” and promises you will double your money in 30 days.  So you get a second mortgage, liquidate your retirements and hock everything else you own and get $100,000 which you use to buy 10,000 shares at $10 each. 

If Al promptly disappears with the money and is found a month later flat-broke in Vegas you have lost the $100,000 you invested, not the $200,000 you were promised.  If Al says he spent  money on drugs, hookers and gambling then you know where your $100,000 went.

But let’s suppose Al doesn”t disappear and a month later he gives you an earning statement that says your investment is now worth $1 million.  Are you a millionaire?  No, you just have a piece of paper that says you are.  If Al runs off to Vegas now you’re still only out $100,000, not a million.

But what if you sold your stock in Fraudco to your other neighbor (Bob) for $1 million just before Al disappeared?  Bob will have lost a million dollars, but Al will have only got $100,000 of it.  You, on the other hand, will have made out like a bandit.

Ponzi schemes, stock market swindles, real estate scams and pretty much every big disappearing money scandal have one thing in common – overvalued assets.  The overvaluation may be due to fraud or just excessive optimism on someones part, but when the you-know-what hits the fan it turns out the assets aren’t worth nearly as much as the last buyer paid for them or the loan for which the assets were used as collateral.   Sometimes the assets turn out to be worthless or even nonexistent.

In the period before the crash the assets are bought, sold, traded or used to secure loans.  Lots of people make money directly (capital gains) and indirectly (sales and brokerage commissions) from all these transactions, but the people left holding the bag when the music stops get screwed.  A Ponzi scheme can be very profitable if you get in early and cash out before it collapses.

So in all these multi-billion dollar cases, why is there so little interest is where the money went? The media act like it was a magic trick and the money really vanished.  But it didn’t disappear, the money went somewhere.

It’s virtually impossible to spend that kind of money and have nothing to show for it. Remember, we’re talking about double digits in front of the word “billion,” and neither of those digits is a “1.”  The interest on that much money accumulates faster than you can spend it, even if you have a lavish lifestyle.  If you buy luxurious mansions and expensive cars they’ll still be there when the cops come.

So where’s the money?  If it was gambled away then the casinos got it, if it was lost in the stock market then some Wall Street types have it.  If it was transferred to some bank in the Caymans then it’s sitting in a numbered account in the tropics.

 Sir Allen Stanford and Bernie Madoff operated Ponzi schemes on a scope and scale that is breathtaking but they couldn’t have stayed in business as long as they did if they never paid off any investors (and a few politicians too.)  I bet if you tracked every nickle carefully you would see that a favored few of their investors did quite nicely.  Of course to do that somebody was literally robbing Peter to pay Paul.  But if Madoff had used most of the money to pay off early investors he wouldn’t have been $65 billion in the hole.

The reports indicate that if you add everything they own neither man still possessed more than a fraction of the missing money when they were arrested.  I suspect that the money isn’t hidden anywhere nor do I think that Stanford and Madoff actually spend that much of it.

As anyone who saw Brewster’s Millions knows, it’s hard to spend that kind of money.  There’s only so much stuff you can buy.  If you spent a million dollars a day it would take you the better part of three years to spend a billion.  If Bernie Madoff had spent a million dollars a day for the last twenty years he would still have only spent less than 25% of the missing loot.  The amount he gave to politicians was chickenfeed – a few million.

I’m guessing that most of the missing money was stolen by smarter crooks than Stanford and Madoff.  Not just any crooks though – Bankers, Wall Street types, bandits with briefcases, pirates with pedigrees.  You can fool your investors by transferring money around the world and claiming you’re investing overseas but the bankers won’t be fooled.  And those guys know how to steal without getting caught.