Bernie's Investors: Did They Lose "Everything?"

Prompted by a question from my friend Joel, I invite attention to another Bernie Madoff issue. Put it this way: these people who have lost "everything" --let's assume this means that an individual investor will get back zero percent of his capital invested. Still, it appears likely that the investor will have been getting little checky weckies over the life of the investment. Is it possible that the investor has made out okay, even allowing for the loss of capital?

I guess the abstract number has to be "sure, depending on the assumptions." But let's put some flesh on the bones. Go back 20 years. Bernie says: I have a $25,000, 20-year, four percent bond--that is, a bond that will pay you $1,000 per year for 20 years, plus a return of $25,000 at the end of 20 years. Because you are special friend, I can let you buy the stream of payments for just $12,200. This implies a return of just a shade over 10 percent a year (which is more or less what Bernie was delivering, according to press accounts).

So far, so good. But now: what if you fail to get your $25,000 back, but still get to collect (and keep) all those $1,000 coupons. Where do you stand?

Obviously, you are worse off without the $25,000 than you would be with it. But you still got a stream of 20 $1,000 payments for only $11,200. The implied rate is no longer 10 percent, but it's not zero either --in fact, it is 5.25 percent.

Is that rate "good enough?" The answer, it seems to me, depends on two further questions. Most obviously: at the time you took Bernie's deal, what was your next best shot? Obviously, 10 percent looked better than whatever else was on offer, or you wouldn't have bought the deal in the first place. Is 5.25 better than your t best shot? The answer is: we can't tell from the information given, but it just might have been. And if 5.25 percent was better than your next best shot, you would have taken the deal anyway.

The second issue is muddier, in the sense that I don't know any glib conceptual formula with which to address it. But that is: what kinds of commitments did you enter into assuming you had a locked-in 10 percent return, that you wouldn't have made if you knew you were only getting 5.25 percent? I think this one takes us into a never-never land (or is it a hall of mirrors?) where I really don't know how to travel.

In any event, though, I think this adds nuance to the idea that Bernie's investors lost "everything." By all accounts (including his own) it appears that Bernie is a criminal, perhaps of olympic scale. But to say that the "investors lost everything" may be pushing things too far.

Afterthought: Felix Salmon offers some thoughts on possible tax relief. And some of the losses may be reimbursed under SIPC, though I suspect in the great scheme of things, the reimbursement will be pretty small potatoes.