Madoff's Innocent Victims

The saddest aspect of the Madoff scandal is the number of people who gave Bernie Madoff money they couldn't afford to lose. Many charities fall under this general heading: they were formed for the purpose of giving money to the needy, and ended up giving it to the greedy.

I hope that the Madoff affair will mark the point at which charities start thinking much more seriously about how they invest their money. As I wrote last year about the Gates Foundation, why do good with only 5% of your assets, while having no mandate to do good with the other 95%?

There is a big problem here, that charities generally have a strong institutional bias towards self-preservation, and therefore seek to invest the overwhelming majority of their funds in a manner which will allow them to operate in perpetuity. As a result, they end up taking quite a lot of market risk. (Not to mention Ponzi scheme risk.) Almost never do they ask themselves whether they could do more good by front-loading their disbursements now and deliberately putting themselves on a road to disappearance.

Alternatively, charities could at least invest their money somewhere socially responsible and do good with it, at the cost of lower returns. One example which is close to me personally: they could invest in preferred stock in community development credit unions, or just make non-member deposits at them, which are federally guaranteed. Such an investment carries much less risk than a Wall Street split-strike strategy, and fits much more cleanly into the charity's mission.

Then there are the individuals who invested their life savings with Madoff, normally with the express intention of passing it on to the next generation. As Justin Fox says,

When I think of all the Jewish grandmothers and grandfathers (a.k.a. Bubbies and Zadies) who lost everything with Madoff I get very sad. They weren't being greedy, and they weren't stupid. They just wanted a steady investment managed by somebody they knew and trusted.

He's quite right. But on the other hand, some of them -- not all, by any means, but some -- were being greedy, like one anonymous guest at a birthday party in Palm Beach:

Several Madoff clients were among the 70-plus guests. One had mortgaged two homes to maximize his investment.

Talk about a perfect storm: Not only are you underwater on your Palm Beach mortgage, but you invested all the proceeds with Bernie Madoff. Ouch. If only you just lived happily in your bought-and-paid-for multi-million-dollar home and didn't try to be clever or greedy, you'd be infinitely better off.

Most of us save up money to buy a house; some people, it seems, do it the other way around. Which makes much less sense to me.