Beyond cocktail parties, Madoff really created the money management business to feed himself trades. But his strategy was garbage. He absolutely bombed as a money manager, but he desperately needed the assets under management to feed his trading operations, so he started to make the numbers up. As is usually the case, most don't set out to be crooks, but Madoff became one when his talents proved lacking. There is your "why."
It's not new. This was the Enron story: They lost tons in water ventures and Indian power plants, so concocted fraudulent entities to cover up their losses. Same for Sam Israel and his Bayou hedge fund. And even (without the fraud) the Citigroup/Wall Street story, too. They tried to be investors to make up the difference of their bread-and-butter business deteriorating and were awful at it, so they levered up in off-balance-sheet vehicles.
Who knows when the fraud started? As early as December of 1990, he was taking money from the Fairfield Sentry fund of funds. The bull market resumed in January of 1991 as Operation Desert Storm commenced. Madoff showed up years, as did most money managers. But 1994 was rough. So were 1996, 1997 and 1998, yet he did have double-digit years.
Since 2001 and 2002 were ugly, and Madoff showed "only" single-digit returns this decade, so my sense is that money kept flowing in and flowing in. The Tremont fund of funds and Nomura and European banks--my partner and I were out raising a hedge fund and couldn't raise a tarnished nickel from these groups. And we tried.
Public begging is humiliating. But funds of funds and banks were steering money into the Madoff machine. (Ah, schadenfreude delayed.) But it went beyond these so-called professionals or even the country club set; lots of great charities fell for his fudged numbers.
As in any classic Ponzi scheme, you pay old investors who redeem with new money. Sounds like not too many wanted out, until 2008. Now, $7 billion in redemption requests since the Credit Crisis began meant Madoff has made a complete circle, from schlub to macher to goniff (a crook, swindler or cheat).
Let that be a lesson. Learn a few jokes to tell at the club. Impressing the highball crowd with your investing prowess is a losing strategy.
Andy Kessler is a former hedge fund manager turned author. Kessler writes a daily blog. Read it all here.