Madoff's Ponzi Lesson

You all know about good old Bernie Madoff, whose recent conviction has brought the story to the forefront. CNBC assembled some of his "victims" (scare quotes because a Ponzi scheme, more so than a normal con like driveway sealers or a money switch, relies on greed rather than just pure salesmanship) to discuss the matter. You can read some of that in this story.

Now, granted, there are plenty of reasons to point to the failure of the police in this matter (the SEC regulators who are supposed to be giving speeding tickets), and one very good lesson for those of us in academia. [The person who repeatedly blew the whistle on Madoff complained on "60 Minutes" that the SEC was full of lawyers who could check that forms were filled out correctly but could not follow a simple statistical or mathematical argument. We should mention that every time a student in the liberal arts complains that ze does not need math because ze is going to be a lawyer.] But I was sorely disappointed when one person on the TV broadcast was asked point blank what lessons she had learned.

Sadly, she did not learn that the reason she only lost 2/3 of her money while others in the room had lost all of their their retirement funds was that she had only given 2/3 of it to Madoff.

The lesson from Madoff, and other recent events, is to Diversify.

Those events have reminded me of a bit of family lore that has guided a few decisions I have made over the years. Here is the story.

Both of my parents were raised during the Great Depression, so I know some things about their view of that time but almost nothing about what THEIR parents were thinking as they struggled to survive and raise kids. I'm not sure my parents knew much about their parent's economic thinking until a half century later when illness or death brought their parent's finances under their control. Those finances have a lot to tell us, and my parents made it a point to share those stories with us.

Story 1:

After my grandfather died rather suddenly, it fell to my Dad to figure out his financial records. My grandmother had never even written a check in her life, let alone have any clue about the family finances. She got her weekly cash and that was it. [So lesson 1 is that my wife and I are careful to be sure we each know as much as possible about the big picture, including our separate retirement accounts.] My Dad ended up having to visit or write every bank in Chicago plus those in another city to try to find all of the accounts and CDs my grandfather owned. [Lesson 1A is that my parents are also careful to be sure we know where their money is buried.] One can only assume that Grandpa lost a lot of money as a result of bank failures circa 1930 and had distributed his cash as widely as feasible. He had dozens of bank accounts, in addition to other investments. He would never have given it all to Bernie Madoff.

I don't have all of my retirement money in accounts managed by the same company. That was by plan. But I never really thought about the fact that we have accounts in several different banks and credit unions until now. However, we keep it down so we know where they all are.

One of his other investment strategies always struck me as a good one, but it isn't as feasible today as it used to be in the days before mergers and conglomerates. As one example, he owned stock in Borden because he liked Cracker Jack. He had bought stock in Cracker Jack, which was later bought by Borden. (Like a product, buy their stock. Of course, today Cracker Jack is owned by Frito Lay and Borden is part of Hexion Chemical that is owned by a private equity company. So much for THAT strategy!)

Story 2:

The finances of the other set of grandparents didn't become clear until they became seriously ill and had to go into nursing care. When cleaning up and out their house, they found a bag of money (mostly silver coin) under the mattress. A big bag. Turns out they had more cash than the other, apparently much better off, set of grandparents. In fact, they didn't know how much they had, so they didn't know that they could have moved into a very nice, upscale, retirement community with lifetime care. [Lesson two, learned by my parents: Know your net worth, and plan to move into a lifetime care facility while you are still healthy enough to walk in the door. Once you are sick, your choices become extremely limited.] Sadly, they also didn't know they had the funds to visit "the old country" with plenty to spare.

Paraphrased conversation. Mom: "Wasn't it uncomfortable with that bag under the bed?" Grandma: "We were used to it." When they moved from one house to another, they had somehow moved that heavy bag of money themselves so no one, including family who helped with the move, even knew it existed. I would assume that they also lost money when banks failed circa 1930. That zero interest investment strategy looks pretty bad until you look at 40% losses in the stock market or 100% losses with Bernie Madoff.

They had continued to save even while on Social Security, just to be "safe". They could do this because they owned their home, so their only living expenses were food, power, property taxes, and insurance. That could be how their cash resources remained significant even with inflation going on. [Lesson three: Don't re-mortgage your home with payments extending 20 years into retirement. Own it, and live in it. A home is a great investment if you can live in it rent free for 20 years. What you had been paying toward the mortgage becomes available for investment while you are still working, and what you don't have to pay in "rent" will make retirement income go a lot further.]

All of their decisions were not good ones, just as all of mine have not been good ones, but diversification has (so far) protected one big chunk of our investments from any loss of value in the current slump. Talking about finances within a family can be the most valuable investment of all.