‘Deception implies that an agent acts or speaks so as to induce a false belief in a target or victim.’
The Psychology of Deception by Ray Hyman
Madoff…an agent of deception
Bernie Madoff knew all about the subtle art of deception.
He cultivated an image of sophistication, respectability, and exclusivity.
Year after year, Madoff’s fictional proprietary trading system — the ‘split-strike conversion strategy’ — delivered investors consistent above-average returns…with no volatility.
Bernie knew the lure of superior past performance would entrap the gullible and greedy into his web of deception.
Amongst Madoff’s clients (or, should we say, targets and victims) were wealthy New York families, Hollywood stars, a Nobel Laureate, banks, and hedge funds.
With hindsight, it’s easy to say, ‘What were these people thinking? Didn’t they realise this was too good to be true?’
When you’re in the midst of it and your friends, family and/or business associates are regaling you with stories of how much money they’re making, it’s hard to fight your primal instinct. The longer it goes on, the greater the temptation. FOMO eventually wins out.
One person who didn’t fall for Bernie’s ruse was Harry Markopolos.
Markopolos looked at the maths, not the man…and he didn’t like what he saw.
So, who is Harry?
As reported in The Guardian (emphasis added):
‘[Harry’s] A quantitative financial specialist with an instinct for the numbers behind complex derivatives, Markopolos smelt a rat about Madoff Investment Securities as far back as 1999 when his boss at Boston-based Rampart Investment Management asked him to create a product that could provide similarly stellar returns to the astonishingly consistent numbers produced by Madoff.’
Remember, Madoff’s fraud was not uncovered until late 2008…that’s almost a decade AFTER Harry smelt a rat.
Harry — like Roger Babson — is a maths geek.
Numbers, not carefully crafted narratives, guide their investment decisions.
The Guardian article continues (emphasis added)…
‘In a newly published book, No One Would Listen, Markopolos describes agonising over how Madoff could produce 1% to 2% returns every month, in positive territory 96% of the time, producing a 45-degree curve of profit — with no volatility. For months, he tried to reverse-engineer Madoff’s stated strategy of using a basket of S&P 500 shares hedged against risk using options on Chicago’s derivatives exchange.
‘After analysing Madoff’s vague, broad-brush statements to clients, Markopolos concluded that it was impossible — not only was it mathematically inconceivable to smooth out all the ups and downs in the S&P index’s performance, Madoff would need to use more options than existed on the entire Chicago Board Options Exchange, where nobody owned up to seeing any volume from Madoff’s firm at all.’
Armed with his detailed analysis, Harry thought he had an ‘open and shut’ case against Madoff.
Not so…as reported in The Guardian (emphasis added)…
‘He [Markopolos] approached the securities and exchange commission (SEC) as early as 2001. He contacted politicians and badgered journalists to write about Madoff, succeeding in getting a couple of business magazines to publish sceptical stories. In a coup de grace, he even presented the SEC with a detailed dossier in 2005 bluntly entitled The World’s Largest Hedge Fund is a Fraud. So why did nobody take any notice?
‘“Mainly, it was incompetence,” says Markopolos…’
Unlike Bernie, the maths didn’t lie.
But, as often happens when things are going well, the boring truth becomes a casualty to the exciting and enticing deception.
There is something in human nature that makes people prefer the lie. Acknowledging the truth can be difficult…it means the end of the fantasy and back to reality.
Elizabeth Holmes…blood money
The spectacular rise and even more spectacular fall of Theranos has been the subject of an HBO documentary.
For a bit of background, Theranos was a biotech start-up founded in 2004 by 19-year-old entrepreneur Elizabeth Holmes.
Theranos was founded on good intentions. Holmes wanted to ‘democratise healthcare’ by making it possible to diagnose a variety of illnesses from a simple, low-cost blood test.
Early detection could save lives…a noble concept.
There was one small problem…her professors at Stanford University said ‘it was not possible’.
Perhaps they were wrong? Perhaps there was a way for science and technology to evolve to the stage when a few drops of blood could replace more extensive (and expensive) testing regimes?
Holmes certainly didn’t lack self-belief.
In 2011, she convinced Former US Secretary of State George Shultz to join the company’s board, which also included Henry Kissinger.
In 2013, the pharmaceutical giant Walgreens entered into a partnership to place Theranos blood sampling centres in its stores. A major coup.
In 2015, Forbes magazine named Elizabeth Holmes as the world’s youngest self-made billionaire…at the time, Theranos was valued at US$9 billion.
Elizabeth Holmes was being hailed as the next Steve Jobs.
But it was all a fraud. A massive con job.
In 2016, serious questions were being asked about the accuracy of the results from the blood tests.
Holmes’s elaborate deception fooled some of the smartest and wealthiest people in the world.
As reported by The Sydney Morning Herald, the list of the rich and famous that fell for the Holmes fraud was quite impressive…
‘The Walton family [Walmart heirs] invested about $US150 million in 2014 through two separate entities, according to the investor list. [Rupert] Murdoch put in about $US125 million, and the extended family of DeVos [Amway heirs] invested about $US100 million.
‘Other prominent investors, according to the list, included the Cox family, the Atlanta billionaires who own the media conglomerate Cox Enterprises and who invested $US100 million; and a company affiliated with Mexican billionaire Carlos Slim that put in about $US30 million. Robert K. Kraft, the owner of the New England Patriots, invested $US1 million.’
While Holmes may have dropped out of Stanford, she obviously had a PhD in BS.
But not everyone fell for her spin.
In 2013, Bill Maris, founder of Google Ventures — an investor in health and science companies — opted not to invest in Theranos.
What did he see that others didn’t?
As reported by Business Insider…
‘“We looked at it a couple times but there was so much hand-waving — like, Look over here! — that we couldn’t figure it out,”…“So, we just had someone from our Life Science team go into Walgreens and take the test. And it wasn’t that difficult for anyone to determine that things may not be what they seem here.”’
Maris’s research began and ended with a practical test of the Theranos product. A simple, yet very effective way of proving it was a complete dud.
Even though he figured this out in 2013, it still took almost three years for Holmes’s deception to be (very publicly) exposed.
Maris’s practical approach reminded me of the on-the-ground research Michael Burry and the others did in The Big Short.
Their instincts told them something just wasn’t right. They questioned the whole ‘house prices have never fallen on a nationwide basis’ narrative. And it rewarded them handsomely.
The Fed’s deceit
The US Federal Reserve is the ultimate con artist…inducing false belief in their ability to right a market wrong.
This chart — from a recent issue of The Gowdie Advisory — illustrates how the Fed’s market rescues require an increased expansion in the Fed’s balance sheet (blue line) and continued suppression of interest rates (red line).
The elliptical shapes grow bigger with each salvage mission…but can this expansion continue indefinitely?
Source: Federal Reserve Economic Data
We know ‘trees do not grow to the sky’, yet, the Fed has convinced people they somehow possess the power to keep this 40-year exponential trend going forever.
Source: Macro Trends
Are people really that gullible?
Unfortunately, as we have seen with Madoff and Holmes…the answer is…yes they are.
People want to be deceived.
Michael Burry recently tweeted this warning about the current state of the US market and cryptos (emphasis added)…
‘People always ask me what is going on in the markets. It is simple. Greatest Speculative Bubble of All Time in All Things. By two orders of magnitude. #FlyingPigs360.
‘All hype/speculation is doing is drawing in retail [Mum and Dad investors] before the mother of all crashes. #FOMO Parabolas don’t resolve sideways…’
Don’t be fooled into thinking the market’s record high is a sign of safety…all market collapses happen from record highs.
Editor, The Rum Rebellion
PS: Vern is also the Editor of The Gowdie Letter and The Gowdie Advisory — investment services designed to help everyday Australians avoid the financial pitfalls of a volatile economy and make informed decisions to grow their wealth for generations to come.