Bernard Madoff's Ponzi scheme arrested

A Ponzi scheme, defined as a "fraudulent investment scheme that involves promising high returns to early investors out of the money paid in by later investors" was named for Charles Ponzi, the infamous 1920s swindler.

First some definitions:

A Ponzi scheme is loosely defined as a fraudulent investment scheme that involves promising high returns to early investors out of the money paid in by later investors. Basically, in a Ponzi scheme, the business only makes money by suckering more and more investors into pouring money into the fund. This is illegal because investors think they are investing in an underlying business that will generate profits and revenue and lead to long-term returns to the investors. The head of the scheme knows this will never happen.

To elaborate a bit more on the workings of a Ponzi scheme, it entails seeking a continuous flow of investors. The business makes money when you get more investors to sink their money into the Ponzi scheme, under the false pretense that they are investing in a business that will be generating profit, continuing to produce money for them in the long term.

Of course this doesn't actually occur-- and any money an investor may see from the scam is generated purely by the investments of others, which is why the growing number of investors seems critical.

A Hedge Fund is a private investment fund open to a limited range of investors that is allowed to engage in a wider range of risky activities than most investment funds (i.e. your 401k, which is heavily regulated). Hedge funds are able to use methods not available to other investments, like short selling (borrowing shares to sell immediately on the open market), derivative contracts, and leverage (borrowing money to buy securities). Using these different methods allows the fund to “hedge” the risk, like a gambler “hedges” his bets by making a variety of bets.

Complicated? Yes, it is. As a matter of fact, very few people outside of Wall Street understand what hedge funds do and how they make money. There are very few regulations governing hedge funds because they are so complex. Also, generally, the Securities and Exchange Commission only lets really rich people invest in hedge funds.

A modern day Ponzi scheme was apparently perpetrated by investor Bernard Madoff -- by his own admission -- as the head of a hedge fund off Wall Street was arrested today for allegations of the financial fraud. Bernard Madoff, 70, who has operated his own multi-billion dollar investment company since 1960, apparently remarked to his staff earlier in the week that the hedge fund ran out of his company was a "giant Ponzi scheme."

Hedge funds are a mysterious, barely regulated type of investing that apparently few not fully immersed in the world and technicalities of Wall Street truly understand, claims Reilly. Only very rich people may make such investments, and a lot of it involves borrowing assets to turn around and resell right away. With hedge funds, you spread the risk to multiple arenas, increasing the chance for gain despite the shadiness of the gamble.

Madoff's hedge fund had $50 billion of investors money, reported Reilly.

This crime could earn Madoff up to 20 years in jail and millions of dollars worth of fines. He has already made bail, however, at an easy $10 million.

While people like Reilly suggest that this incident could cause financial panic amidst our already poor economic state, making people lose faith in hedge funds, there are others more like myself who say-- "who cares"? Those who actually made hedge fund investments likely had very little understanding of where their money was truly going, and they accepted that.

To the very wealthy, this is just part of the financial world and investing. It's probably an exciting gamble with throw-away money, to many of them. Hedge fund investors do not represent every day man. The things which Madoff, his company, and his investors partake in on a daily basis are over our heads yet may somehow financially affect us-- and naturally that deserves justice. But what do I know? I'm just the little guy, looking up at the great big rich fatties, thinking of all the wonderful good that could have been done with all of those billions of wasted dollars, played with like mere Monopoly money. Me, sympathize with those shaken by the instability obvious in the world of hedge funds。

Bernard Madoff was the head of a multi-billion dollar hedge fund on Wall Street. Today, he was arrested for allegedly running a Ponzi Scheme.

For financial beginners, I’m going to break this down to the very basics because this arrest is one of the biggest financial frauds in American history, and the ramifications are potentially enormous. People need to be informed.

THE BERNARD MADOFF ALLEGATIONS

Bernard Madoff, 70, is the founder of Bernard L. Madoff Investment Securities LLC, which has grown into a multi-billion institution since its founding in 1960. Public information on Madoff’s company is available here at its website.

Madoff’s company included a brokerage house and a hedge fund. According to state prosecutors, Madoff told his staff this week that the hedge fund was “basically, a giant Ponzi scheme.” Investors have put in $50 billion into the hedge fund.

In court today, state prosecutors charged Madoff with securities fraud. The maximum sentence is 20 years in prison and a fine of up to $5 million. Madoff is currently out on $10 million bail. The Securities and Exchange Commission is filing separate charges.

Why is this such a big deal?

According to the Wall Street Journal, approximately $2 trillion are currently invested in hedge funds. The hedge fund world is the financial Wild West, with little regulation and very few people with an actual clue as to where the money is really going. Given today’s crisis in the financial markets, allegations of fraud may shake investors confidence in the hedge fund world.

Hopefully, Madoff’s case turns out to be an isolated incident and the hedge fund world will survive.