M-RCBG Fellow Mark Fagan Compares Bernie Madoff and Charles Ponzi

Bernie Madoff and Charles Ponzi were both entrepreneurial con-artists, but each man had distinct differences in their investment schemes, according to Mark Fagan, senior fellow at the Mossavar-Rahmani Center for Business and Government.

Fagan led the “Ponzi Schemes: Why Madoff will not be the last,” seminar Friday (March 20) in which he discussed the nature of Ponzi schemes, when someone uses capital from one investor to pay off another, and drew contrasts between the two men and their actions.

Fagan said Ponzi was actually an entrepreneur with good business ideas, but the ideas never came to fruition. Ponzi had a legitimate strategy to make a return on investment for his famed scheme, which was to take advantage of a price discrepancy between postal coupons (essentially stamps) in the United States and Italy. If the idea was successful, Ponzi would have tripled his profits, but he encountered problems with exchanging the coupons in America, and eventually resorted to his hoax.

Madoff was highly respected in his field, and ascended through the ranks of NASDAQ, eventually becoming the chairman. Unlike Ponzi, however, he never had the intention of investing the money people gave him.

“He never made the investment at all,” said Fagan. “I figured [Madoff] made a bunch of bad investments – no – the guy just never bothered, and kept faking transactions, and so what makes it possible is he literally fakes confirmations.”

Another key difference between the schemes was the strategy to incite interest among investors. Ponzi garnered a lot of publicity for his scheme, especially through newspaper articles, which generated interest among the masses; Madoff, though, was very secretive about his scheme, making his investors feel like they were part of an exclusive club, which, in turn, made others want to join the party.

“There is an important difference between who the customers were,” said Fagan. “In Ponzi’s case, he goes, and he starts with the Italian community … and then it’s largely the cop on the street, the coffee server. It’s very small-dollars, locally based, and everyone’s in. Madoff is very different. His is ‘Oh, I don’t want your money. You’re not good enough for me.’ It was by pushing away, the ultimate soft sell, [Madoff] was able to draw in very, very large amounts.”

There were also different strategies for legitimizing each scam to critics. Ponzi wanted to comfort his investors through familiar words, and came up with the Securities Exchange Company (before the modern SEC existed) to help assure investors could go to any bank to receive their payment. Madoff referred to the “split-strike conversion strategy” when pushed to describe his investments, which was full of complicated and obscure financial terms but carried no substance.

So, how can we prevent repeats of Charles Ponzi and Bernard Madoff? Mark Fagan said that it’s difficult for regulators to identify Ponzi schemes, but they can certainly look for indications of fraudulence.

“There are some things I think you can do,” said Fagan. “Certainly, see the red flags. If someone’s proposing something to you with very high returns and very low risks, chances are there’s a reason, and it probably isn’t legitimate business, it’s hard to do that on a sustained basis. If there’s too much mystery about the returns, if you can’t understand it, don’t invest in it.”