The entire purpose of the hedge fund industry is to loot and pillage. Only the people who push the limits too far are the ones who publicly get caught and shamed.
Bernard Madoff ran his hedge fund too explicitly as a Ponzi scheme. He was literally using new money raised to pay off previous investors, and explicitly running a Ponzi scam.
Notice the fallacy used in this case. Suppose a person has a gun and shoots people. The mainstream media calls for stricter gun control laws. The system that allows freedom is blamed, and not the individual. In this case, Bernard Madoff is blamed, and not the corrupt system that allowed this to occur. Similarly, when Illinois' governor auctions off a Senate seat for bribes, the governor is blamed and not the corrupt system. If Illinois' governor was less explicit in his bribery solicitation, he probably would have gotten away with it.
Bernard Madoff could not have pulled off such a scam alone. Some of his assistants and accountants were probably consciously helping him. They can claim plausible deniability, or plea bargain to testify against Bernard Madoff in his trial. As employees, they are protected by sovereign immunity like all corporate employees.
In a true free market, when there's a massive fraud, there is no limited liability incorporation. All of the employees and accountants who worked for Bernard Madoff would be personally liable for their part in the scam. Such a massive fraud would be impossible without limited liability incorporation, because an employee who suspects fraud would become concerned about his own personal liability, exposing the scam. Limited liability incorporation encourages management to cover up problems, because they can always declare bankruptcy and cheat their creditors. As long as you aren't the person directing the scam, you usually have a plausible "I was just following orders." defense.
Further, in a true free market, you probably would not have a situation where one person is managing $50 billion of other people's money. There would most likely be a large number of small banks or investment pools. State regulation of the investment market encourages consolidation. This means there are a few huge funds, rather than many small funds.
As a hedge fund manager, you're investing other people's money. You need excellent personal connections to raise billions of dollars. A lot of times the investor is a pension fund or a fund of hedge funds, which means the person investing in the hedge fund isn't managing their own money either. Even if I would make an excellent hedge fund manager, I don't have the connections of people willing to let me manage money for them. When investing other people's money, the incentive is to cover up problems so people don't withdraw their investments. This leads to a natural temptation to organize direct and indirect Ponzi scams.
Suppose you have a bad quarter and lose 10%. Perhaps you lie and say you had a profit of 5%. There are all sorts of accounting tricks you can use to cover up losses, especially when you invest in illiquid assets that you don't have to "mark to market". Suppose that next quarter you have an actual profit of 25%. You now declare a profit of 5% and you're back to even. Having gotten away with it once, the temptation is to try again, until you're running a Ponzi scam.
Hedge funds may borrow at a slight premium to the Fed Funds Rate. In addition to managing other people's money due to their connections, hedge fund managers receive a State subsidy in the form of negative real interest rates. A hedge fund manager borrows at a 1.5%-2% and then invests in bonds yielding 4%-6% or other tangible assets. The hedge fund manager must avoid margin calls during a recession/depression, which would wipe him out. Therefore, the incentive is for the hedge fund manager to carry assets at a value greater than their fair market value. Over time, leverage plus inflation equals profit. It's the secret magic ingredient of the profit equation:
- Borrow money and buy underpants.
- Wait for inflation.
- Sell underpants and profit!
The entire purpose of the hedge fund industry and financial industry is to loot and pillage. Hedge fund managers and workers make great salaries, but do no actual work. Their profits are paid by the rest of society as inflation. When a hedge fund manager makes $1B without doing any real work, that means that the rest of society did $1B of work without getting paid.
Hedge fund managers are secretive about what they do. People would be outraged if they knew that hedge fund managers made their huge profit without having any special skills, besides their connections and ability to manipulate a corrupt system for their personal benefit.
I liked this WSJ article, via Hacker News. Bernard Madoff made investors seem like it was an honor to be invited to participate in his fund. If an investor asked too many questions, they were kicked out of the fund! The secretive nature of hedge funds makes the manager seem like a genius, even if secrecy is used as a cover for fraud. His fund had regular 1% monthly returns; the low volatility and high return should have raised red flags.
Not mentioned in that WSJ article, most hedge funds have a 3rd party managing their investments and auditing. Bernard Madoff didn't have a 3rd party auditing or holding his positions. This led to the natural conflict of interest and opened the way for fraud. Due to his "stellar" reputation, he was able to dodge the rules everyone else was required to follow. Anybody who asked too many hard questions was not allowed into the fund. Not invested in the fund, why would they care? Therefore, any potential investor who could expose the fraud was weeded out in the initial due diligence process.
Bernard Madoff did exactly what every other hedge fund manager does. He pushed the limits too far and got caught. He followed the example set by a corrupt economic system. The corrupt system should be blamed, and not the people who exploit it.
The fnord is "Bernard Madoff and Illinois' governor were corrupt and got caught. Therefore, everyone who is corrupt gets caught. The system has no defects that need to be corrected." The reality is that the economic and political system are completely corrupt and need to be discarded.