Common Sense Political Thought

18 Comments

1. 

   Perry:

   This Madoff was an unbelievable man, one who could set up this Ponzi scheme and fool so many people for so long, most of whom were prominent people and prestigious charities, foundations, and institutions.

   He deserved his punishment, as he has punished so many with his crime.

   However, there is another side. How would you respond to being offered a guaranteed 15% annual return on investment?

   Folks should know well that this promise is highly suspect, being significantly higher than the stock market has ever returned over the long term.

   Here is the warning of a skeptic in May 2001:
   http://nakedshorts.typepad.com/files/madoff.pdf

   Who cares when the money is pouring in? Is this the definition of greed?

   29 June 2009, 1:50 pm
2. 

   Gort:

   If he was tried in Luzerne County he would have been sentenced to house arrest.

   29 June 2009, 1:51 pm
3. 

   OtherDana:

   Those who put their money with him forgot the very, very basic rule of thumb: If it’s too good to be true, it is.

   29 June 2009, 2:34 pm
4. 

   Tony:

   Let’s sympathize with the criminal and blame his victims.

   If he was anything other than a white collar criminal, you’d be calling for the harshest punishment possible.

   29 June 2009, 2:57 pm
5. 

   Dana Pico:

   Tony, no one is sympathizing with Mr Madoff here.

   Of course, there is something strange when a guy gets 150 years in prison for setting up a scheme directly modeled after the Social Security system . . . .

   29 June 2009, 4:32 pm
6. 

   Perry:

   Dana, the Social Security was not set up as a Ponzi scheme.

   The reason it will be in trouble is that Repub and Dem Congresses alike have allowed the FICA taxes to go into the General Fund.

   However, even now, there are some very straight forward measures that can be taken to make SS solvent for a long, long time. Problem is, no one seems to care these days.

   29 June 2009, 6:24 pm
7. 

   JohnC.:

   Many Ponzi schemes aren’t set up as such either. They are set up as investment futures. The idea being the previous investor is paid by the current and they in turn by the future. The money is actually invested in high yeild instruments which are risky but show big profits. Problem is when they hit a glitch (recession, bubble etc. or in the case of SS fewer workers and growing retirees) it unravels. From 1998 to 2006 I frequently yieled 30-46% on stock mutual fund returns. Had I solicited investors and guaranteed them a 15% return for every 100k I would have made a cool 15-31k on their money. Course when the bubble burst I’d and they’d have been screwed.

   I would be interested in the measures you think could be taken to put solvency back into a system that for all we know is tens of trillions in the red. Especially with a near zero population growth and a tsunami of future retirees heading to retirement in the next 15 years.

   I don’t believe the money collected was ever there (just a hunch, no proof before Pho starts with the “Cite” crap). But even if it were there without investing it in some instrument it wouldn’t even grow at the rate of inflation to be paid out in the future. The other problem I have with SS is that it was meant to augment retirement savings. But as time went on it was sold as the end all for retirement. The Gov. kept implying that savings was “extra” cause we had SS. Hence, people saved less and spent more figuring they were safe.

   29 June 2009, 7:37 pm
8. 

   Yorkshire:

   150 years?? Reminds of a line from an old Kingston Trio song from the early 60’s. “99 years? It could have been life.”

   29 June 2009, 7:56 pm
9. 

   Phoenician in a time of Romans:

   I would be interested in the measures you think could be taken to put solvency back into a system that for all we know is tens of trillions in the red. Especially with a near zero population growth and a tsunami of future retirees heading to retirement in the next 15 years.

   See here:

   At his tree-shaded home in Princeton, New Jersey, Krugman took a break from working on a new economics textbook to explain why the crisis is phony — and what’s wrong with Bush’s plan “to convert Social Security into a giant 401(k).”

   What would you say to college students and young workers who are convinced they’ll never see a dime of the money they put into Social Security?
   You’ve been sold a scare story. Right now Social Security has a large and growing trust fund — a surplus that has been collected to pay for the surge in benefits we’ll experience when the baby boomers start to retire. If you’re twenty now, you’ll be hitting retirement around 2052. That’s the year the Congressional Budget Office says the trust fund will run out. In fact, many economists say it may never run out. If the economy continues to grow at an average rate, the trust fund could quite possibly last forever.

   But what happens if it doesn’t?
   Even if the trust fund does run out, Social Security will still be able to pay eighty percent of promised benefits. The actual shortfall would be a pretty small part of the federal budget, quite easily made up from other sources. Once the whole baby-boomer generation is into the retirement pool, Social Security’s share of the gross domestic product will only increase by about two percent. Well, President Bush’s tax cuts are more than two percent of GDP — and they’re happening right now, not fifty years from now. So the idea that there’s this Social Security thing that is a huge problem is just wrong.

   So, if you got rid of Bush’s tax cuts and put the money towards ensuring old people could eat, the problem would go away.

   29 June 2009, 8:43 pm
10. 

    Dana Pico:

    Except, of course, that President Bush didn’t cut the Social Security tax; he got income taxes cut. Ther problem isn’t that we are taxed too lightly; the problem is that we spend too heavily.

    I’d point out that President Obama ran on continuing the Bush tax cuts for everyone earning less than $250,000, so the majority of the Bush tax cuts would (if you believe him) stay in place. The American people have voted for tax cuts time after time after time; it’s time to listen to their wishes and cut spending to match the tax revenue the American people are willing to pay.

    29 June 2009, 9:03 pm
11. 

    Dana Pico:

    Perry wrote:

    The reason it will be in trouble is that Repub and Dem Congresses alike have allowed the FICA taxes to go into the General Fund.

    This is a common statement, but it’s one that ignores the law: Social Security funds must be invested with the government. From the Social Security Trust Fund Investment Policies and Practices, which you will note is a direct Social Security Administration site:

    With but one exception, the current policies governing investment of trust fund assets were adopted in 1960 or earlier. Many of these policies actually date back to the original Social Security Act of 1935.

    The framework and many of the details of trust fund investment policy are established in law. Policies enacted in 1935 and still in effect today provide that:

    • The Managing Trustee is responsible for the investment of all available trust fund assets. The Secretary of the Treasury is the Managing Trustee and, as such, is solely responsible for the investment of trust fund assets. The Managing Trustee must invest that portion of the assets of the trust funds that is not, in his judgment, required to meet current withdrawals.
    • Trust fund assets may be invested only in obligations issued or guaranteed by the U.S. government. The assets of the trust funds must be invested in obligations of the United States government or in obligations guaranteed as to principal and interest by the United States. These obligations may be acquired (1) on original issue at the issue price, or (2) by purchase of outstanding obligations at the market price.
    • “Special obligations” of the U.S. government are available to the trust funds for investment. The Treasury is authorized to issue “special obligations” for purchase exclusively by the trust funds on original issue. In practice, these may be either short-term “certificates of indebtedness” or longer-term special issues in the form of notes or bonds.
    • Special obligations may be redeemed prior to maturity without risk of loss to the trust funds. Unlike other Treasury obligations, special obligations may be redeemed at any time before maturity at their face value (i.e., their original purchase price) plus accrued interest, if needed to cover program expenditures. Therefore, their early redemption cannot result in gains or losses of trust fund capital. On the other hand, if marketable obligations are sold prior to maturity, the prevailing market price is paid.

    Three other statutory policies also govern trust fund investment. These varied in the early years of the Social Security program, but have been unchanged since 1960 or before. They provide that:

    • Special obligations are the preferred investment vehicle. Prior to 1960, the law had generally given preference to the purchase of marketable obligations. Actual practice, however, was to invest largely in special obligations, because purchase of marketable obligations was viewed as potentially disruptive to capital markets. Since 1960, the law has provided that special obligations are to be purchased unless the Managing Trustee determines that the purchase of marketable obligations would be in the public interest. Purchase of marketable obligations has been quite limited, and has not occurred since 1980.
    • The rate of interest on special obligations is the average market yield on long-term U.S. obligations. The law originally established a fixed interest rate for special obligations. This was superseded by several formulas for computing the interest rate based on the coupon rates of outstanding U.S. obligations. The current market-yield formula was adopted in 1960. It essentially provides that the interest rate on new special obligations will be the average market yield, as of the last business day of a month, on all of the outstanding, marketable U.S. obligations that are due or callable more than 4 years in the future. 2 The rate so calculated is then rounded to the nearest one-eighth of one percent and applies to new issues in the following month. The rate of interest determined for a special obligation security is payable throughout the term of the security and does not vary.
    • Special obligations have maturities fixed with due regard for the needs of the trust funds. This provision was enacted in 1956. Previously the law was silent as to maturities. The administrative policy followed since 1959 (with rare exceptions) has been to spread the maturity dates of each trust fund’s portfolio of special obligations as evenly as possible over the next 1 to 15 years, with the month and day of maturity always being June 30. (At the time the policy was set, June 30 was the end of the government’s fiscal year.) The policy calls for immediately investing income received by the trust funds in short-term special obligations, called certificates of indebtedness, that mature on the next June 30. On June 30, the certificates of indebtedness and any other special issues that mature on that date are reinvested (”rolled over”) as special issue notes or bonds with maturity dates designed to achieve an even 1-to-15 year spread.

    Finally, several essential elements of investment policy are addressed by the law in ways that require administrative interpretation, or are not addressed at all. Primary examples of the former have already been mentioned above. These are the statutory policies and administrative interpretations governing the purchase of special versus marketable obligations, and the selection of maturity dates for special obligations. In addition, the law is silent on the policy to be followed in redeeming obligations. Two administrative policies have been adopted to fill this void.

    • Obligations held by the trust fund may be redeemed prior to maturity only when their redemption is required to pay program costs. Obligations will not be prematurely redeemed and reinvested in order to obtain higher (or lower) interest rates, or redeemed for any purpose unrelated to the payment of program costs.
    • Redemption of special obligations prior to maturity will follow a specified, hierarchical procedure. Because all trust fund income is invested immediately upon receipt, certificates of indebtedness and/or other special issues must be redeemed when cash is needed during the month to pay benefits and other program expenses. When required to pay program costs, special obligations will normally be redeemed in maturity-date order, beginning with the earliest maturity date. Special obligations with the same maturity date will be redeemed in interest-rate order, beginning with the lowest interest rate. Special obligations with both the same maturity date and the same interest rate will be redeemed on a First-In-First-Out basis. Marketable obligations will not be redeemed prior to maturity unless there are no special obligations available for redemption. On rare occasions, the order of redemption has been temporarily modified to deal with unusual circumstances.

    While stipulating how interest rates on special-issue obligations should be determined, the law is silent on how frequently interest should be credited to the trust funds. In keeping with the above administrative policy on maturities, interest on special-issue obligations is paid at the end of June. It has been Treasury’s policy to pay interest semiannually on marketable notes and bonds, and that policy has continued with special-issue obligations. Thus, interest on these obligations is also paid at the end of December. In addition, when securities are redeemed to pay expenses, interest accrued to the redemption date is paid. (The amount of securities redeemed is generally such that this amount plus the accrued interest is just sufficient to cover the expense.)

    The certificates of indebtedness and all other Treasury special obligations issued to the funds thus have three important properties. They (1) are redeemable at par at any time, (2) carry an interest rate determined for the month of issuance in accordance with the statutory average market yield formula, and (3) pay interest semiannually on June 30 and December 31, or upon redemption.

    To break it down simply:

    1. Social Security funds in excess of what is reasonably anticipated to meet current obligations must be invested;
    2. Social Security funds may be invested only in United States Treasury Bills or similar instruments issued or guaranteed by the United States Government; and
    3. Pre-maturity trading to maximize profit is not generally allowable.

    Excess Social Security funds could be invested only in the very instruments the government issues to finance the deficit! The Trust Fund Manager had no choice but to invest in the deficit!

    29 June 2009, 9:22 pm
12. 

    Eric:

    However, there is another side. How would you respond to being offered a guaranteed 15% annual return on investment?
    Folks should know well that this promise is highly suspect, being significantly higher than the stock market has ever returned over the long term.

    Here I must (gasp!) agree with Perry. These folks who got taken in by Madoff weren’t exactly babes in the woods. They all thought they could make a fast buck investing with him, and some of them got screwed. Every prudent investment advisor tells you to diversify your investments, and the ones who put all their eggs in Madoff’s basket clearly ignored that rule.

    29 June 2009, 10:55 pm
13. 

    OtherDana:

    Their problem isn’t that we are taxed too lightly; the problem is that we spend too heavily.

    This is precisely why we in Cali are in the mess we’re in - the steadfast resistance and refusal of the controlling left to admit that it is because of their over spending (and spending what they don’t have) that has caused our descent into third world abyss. In their view, more revenue (commonly referred to by honest people as taxes) is the answer. The taxpaying public can always endure yet one more “revenue” shakedown.

    29 June 2009, 11:30 pm
14. 

    Phoenician in a time of Romans:

    This is precisely why we in Cali are in the mess we’re in - the steadfast resistance and refusal of the controlling left to admit that it is because of their over spending (and spending what they don’t have) that has caused our descent into third world abyss.

    Uh-huh. You people really need to read Galbraith’s “Culture of Contentment”.

    29 June 2009, 11:37 pm
15. 

    Art Downs:

    One question remains about Madoff. Where did the money go?

    Ponzi schemers typically take a lot of money and run. Their games cannot go on for years, even decades. Some investors are going to show a huge profit to create the image of success and such faux profits should be recovered through a ‘clawback’ and used to reimburse those who lost money.

    Billions of dollars cannot simply vanish. Madoff and family lived lavishly but did not spend billions on baubles.

    Is the money hidden away?

    Perhaps Madoff was really believed that he could make a lot of money for himself and his investors and lost a lot. Could he have believed that he would really get it right and make everyone more than whole.

    Quite a few who embezzle money for gambling do so in the belief that winning the big one will allow them to return the money and retain profits. They convince themselves that they are not stealing but borrowing and have every intention of paying back what they took from the till.

    Then again, the loot may be cleverly hidden. It may not be touched until Madoff dies but he does have a family.

    These should be good times for skilled forensic accountants.

    Perhaps some of his victims might want to see Madoff waterboarded to get the truth.

    30 June 2009, 7:30 am
16. 

    JohnC.:

    Eric, I’m just saying in a world where muni and state bonds were drawing 7-9% corp. bonds were doing 11-14% and high yield (junk) bonds were at 15-21%, a return of a steady 15% was not crazy. NOW in todays market no one in their right mind would even consider an investment like that. I’m saying taken in the context of the market at the time I don’t think 15% return was greedy, it may have been seen as a good return on a safe investment. People were lured into thinking: “Bonds, they’re safe” and at a good return. They did not invest in China Growth Funds or Latin American Funds as I did with growth of over 30% for 16 quarters. They were risky and you had to be ready to move as soon as the market “burped”. They wanted to “park” their money in a safe harbor and let an advisor handle it.

    30 June 2009, 10:40 am
17. 

    Art Downs:

    Is it possible that Madoff was motivated more by ego than greed? This is a bit of contrarian musing.

    If a smart guy was to set up a Ponzi scheme, the plan would include a stopping point where the money would be taken and the run initiated.

    There would some expenditure to create a facade of prosperity and some money would be paid out to investors to maintain the image of prosperity. Most of the money taken in would provide a lot of loot.

    There might be some trading going on to create an image of action but not much money would need to change hands.

    But most of the money handed over to Madoff seems to have vanished. Are there billions in loot hidden somewhere? Or did Madoff make a lot of bad decisions in the hope that all would be made right? His Ponzi scheme would be a way of buying time. This would mean that a lot of money was lost in bad trades rather than simply skimming off money. Such a game would been needed to maintain the image of Bernie the Money Mavin. This would bet the ego factor.

    However, if there is a lot of lavish spending by Madoff family members after Bernie croaks, it would be a sign of a true rip-off.

    30 June 2009, 6:22 pm
18. 

    Perry:

    JohnC: “… I don’t think 15% return is greedy ….”

    John, 15% return year over year is unsustainable, as your own experience with foreign investments demonstrates, as you isolate 16 quarters of performance to cite your example. Besides, the context changes with each bubble and each downturn. What is the historic return on the D-J, something like 10-11%?

    I cannot think of a time going back 50 years when I would have ever considered putting all my investments in a fund that guaranteed 15% annual return. That should bring up red flags to any prudent investor!

    1 July 2009, 9:28 am

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