The Dirty Little Secret of Every Ponzi Scheme, or: Bernie Madoff’s 150 Year Sentence

When Bernard Madoff was sentenced to one hundred fifty years in prison last week, what was most striking was the stridency of the chorus of outraged New Yorkers outside the Manhattan courthouse, all of them insisting that there was nothing vindictive in this ruling and that “justice had been served.”

That a seventy-year-old has been sentenced to 150 years of hard time seems, well, a little odd on its face. What fraction of this sentence will he actually serve before death sets the seal to this sad story? Is the real oddity, perhaps, the notion that we can quantify just cause this way, assigning a number value to justice? Why does 150 years seem intuitively just, whereas a thousand years would seem excessive, and five years lenient to the point of ludicrous? Given the connections made between Madoff and Hitler by many of his victims, why not propose the death penalty for his crimes?

I have suggested certain parallels between several latter-day bubble bursts and the meteoric rise and fall of that consummate Scottish financier, John Law (1671-1729). A convicted murderer and death row escapee, a profligate gambler and ladies’ man, Law was also arguably the first truly modern financier. He understood that paper money was the wave of the financial future for any modern nation state. But he also understood that money could not just be printed willy-nilly. In fact, as he pressed the case for his new style of bank and his new style of banknote, he often remarked that any banker who printed runs of paper money without the necessary capital to back them up deserved a death sentence. He came to regret that suggestion.

The endlessly fascinating aspect of both the Madoff and Law stories has something to do with the confusion created by large numbers. The point is, in the financial sector, numbers need to correspond to some reality. Law’s paper notes were supposed to correspond to the gold held in his bank’s reserves. When the gap between numbers and real things grew too great, his system collapsed. It became, almost unwittingly, a nationwide French Ponzi scheme.

Law was encouraged by the French regent to covert to Roman Catholicism so that he could serve in a more official governmental post. He readily agreed, prompting the following complaint some years later in 1720, when his banking and other ventures simultaneously unraveled. According to the English ambassador to France, John Stair, it was no longer possible to doubt the sincerity of Law’s conversion, since he established and oversaw a bureaucracy as large and untrammeled as that of the Inquisition, and he armed it in defense of his own modern version of transubstantiation, “turning gold into paper.”

On the most charitable reading, when John Law was implicated in an absolutism, then he lost control of his own system. He was pressured into violating his prime directive, printing far more paper than he could reasonably guarantee. But the pressure to offer more banknotes was enormous; the frenzied public demanded it, camping outside his home by the thousands, and orchestrating all manner of public accidents and false alarms, just to arrange to meet the man who could get them access to his paper.

Once John Law consented to the mingled demands of the state and the Parisian public (his remarkable success resulted in the coinage, yes coinage, of a new term: “millionaire”), then his system became a scheme.

Just like Bernie Madoff, John Law was now trapped in a reality where he depended upon new investiture to pay off the staggering returns to his previous investors. And when it came apart, it came apart as dramatically and as quickly as Madoff’s scheme did. With equally disastrous consequences.

The John Law saga was described in the first chapter of a wonderful book first published in London in 1841 by Charles MacKay called Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. In the preface to this remarkable book, MacKay interpreted such ventures as “moral epidemics.” Law, he concluded was the new pagan god, Plutus, and his damaging effect on the moral fiber of the French nation was acute. (Why we blame the pagans, rather the Christians and Jews who actually perpetrated these crimes, is an interesting question of interpretive justice). Here is MacKay’s rather self-satisfied conclusion:

The general laxity of public morals, conspicuous enough before, was rendered still more so by its rapid perversion of the middle classes, who had hitherto remained comparatively pure between the open vices of the class above and the hidden crimes of the class below them. The pernicious love of gambling diffused itself throughout society…

“The pernicious love of gambling”—the main symptom of a pervasive “moral epidemic.” Isn’t that the dirty secret lying at the heart of every Ponzi scheme? Why did people clamor to be part of Madoff’s investments? Why did people clamor for pieces of John Law’s miraculous paper money? Presumably for the same reasons that people gamble: the thrill of risk, the desire for enormous payoffs accomplished without work or effort, to get something for nothing, and arguably enough, the secret desire to lose and to lose large.

In short, a Ponzi scheme only works if there are enough ponzis to keep it going for a while. The people are part of the problem precisely because they are the centerpiece of the system. The ravenous desire for free money, the gluttonous appetite for unearned wealth, these are the vices that drive the system.

Admittedly, the analogy between Law’s bank and Madoff Securities breaks down right here. There are some innocent victims of the Madoff scandal, perhaps most importantly those who were victimized by their own brokerage firms, firms that claimed to have diversified their holdings while secretly putting everything into Madoff and his miracle-machine. Those people lost their life’s savings without knowing where it had been invested.

In addition, Madoff was a knowing schemer; Law, to the bitter end (he died during Carnival in Venice), believed in his system and tried to explain how what happened could have been averted. The French regency seemed to know that he was not singly at fault; while the French people clamored for Law’s head, the crown quietly permitted him free passage out of the country—then seized his assets.

That is why something feels unsettled about the morality play that unfolded in a Manhattan courthouse last week. We have put Bernie Madoff, the capitalist Hitler, away for 150 years. Counted second by second, as many idle prisoners are wont do, that term amounts to nearly five billion seconds (4,730,400,0000 to be exact). Put another way, he’s been assessed one second of time for every thirteen and a half dollars he stole. Is that justice?

We are all implicated in this story, all of us. For we all live in Law’s world of paper money, and when the sacred relation between number and reality breaks down, then all we seem capable of imagining is… printing more paper money to cover the losses. The failure of responsibility, as well as of imagination, is acute, and it is collective. Ponzi schemes require ponzis. Market and real estate and banking bubbles all require a ravenous public looking for a get-rich-quick scheme, and not asking any questions about how it works or whom it hurts. When we discover that a system was actually a scheme, then we cry “Foul!”

Bernie Madoff’s amorality is clearer now, and it is astonishing; the losses to individuals and to the confidence that our financial system requires are equally profound and much of this seems beyond current repair. Yet it is unclear to me whether justice was served in Manhattan when a septuagenarian was sentenced to a prison term of more than twice his current age.

The numbers just don’t add up. And isn’t that what started this whole thing?

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