Madoff: The man who sold the world

The list of Bernard Madoff's fraud victims grows ever longer. Now investigators want to know if he acted alone. Rupert Cornwell reports from Washington

Could there be a more appropriately awful end to the most awful year for American capitalism since the Great Depression? The scam operated by Bernard Madoff, once a man above all suspicion on Wall Street, is not only one of the largest frauds – maybe the largest – in US history. It is also a perfect metaphor for the ills and excesses that have brought the country's financial system and economy to their present wretched pass.

Since Mr Madoff's arrest on 11 December the list of those duped by the unfailingly lavish returns offered to investors in the Madoff Investment Fund has grown steadily longer. As befits this globalised age, the victims come from every continent. They include not just some of the world's largest banks and hedge funds, but also private individuals and smaller organisations, among them charities run by celebrities such as Steven Spielberg – even it appears, the pension fund of our own Hampshire County Council, on the hook for £7m.

Mr Madoff's Jewish community has been especially hard hit, none more so than Carl Shapiro, his long-time friend, who introduced him to many of his future investors in the exclusive resort of Palm Beach, Florida, where they and many rich northeasterners spend the winter. Mr Shapiro and his charitable foundation may have lost more than $500m (£340m), in a fraud estimated at anything up to $50bn in all.

The final 10 days of the annus horribilis of 2008 may bring, if not comfort, at least some elucidation. The 70-year-old Mr Madoff, a former chairman of the Nasdaq stock exchange and a figure once credited with securing a better deal for ordinary investors, is free on $10m bail, but under effective house arrest at his apartment in the Upper East Side of Manhattan. In the meantime, he has been ordered to produce by year's end a detailed list of his assets and liabilities – a first clue to discovering how much money has been lost and what, if anything, is left.

The financier enjoyed a more than opulent lifestyle, owning half a dozen homes in Florida, New York and elsewhere, and two private jets; but to burn through $50bn, even over the two decades the fraud may have lasted, takes some doing. By the same token, it's hard to imagine he acted alone. So elaborate and protracted a scheme required several sets of accounts and reams of documentation for clients, including confirmation of trades and regular monthly statements. So who were his accomplices? That too is a mystery that investigators have barely begun to unravel.

But there is no mystery about what Bernard Madoff was up to. He ran a so-called Ponzi scheme, using a more sophisticated version of the system made famous by the Boston swindler Charles Ponzi just after the First World War. The mechanism is straightfoward: attract funds by promising fabulous returns, and pay off the first investors with the money sent in by later investors. But sooner or later any such scheme will collapse, when existing investors' demands to cash out exceed the money coming in from new ones.

Ponzi's wheeze, however, lasted barely a year. This one may have gone on for the entire length of the bull market – from the late 1980s until 2008 and the greatest financial implosion since the 1930s, when everyone wanted their money back and the markets crashed.

So long did Mr Madoff's operation run that many early clients surely made handsome profits, enjoying returns that invariably outperformed even the soaring market indices of those years. Cleverly though, he appears to have been careful not to outperform by too much, thus allowing his credibility to be maintained.

To his clients – many of whom were his friends and the charities they ran – he wasn't a scam artist, simply a money manager who was just a little bit better than his peers. Like investors throughout the ages, they wanted the inside track, and believed Mr Madoff had it. The exclusive, word-of-mouth nature of his following only added to his allure. But in the end, even so deft a scheme could not defy the laws of financial gravity. And in many respects, the rise and fall of Bernard Madoff mirrors that of USA Inc.

To a degree matched only in Britain in the developed world, the financial sector has become the driving force of the American economy. Money, not manufacturing, is where the riches are. The financial sector generated huge profits, salaries and bonuses, even as the rest of the economy stagnated. It contrived ever more sophisticated products that seemed to spin money out of thin air.

The subprime mortgage mess that detonated the present crisis was little more than a Ponzi scheme. The first people involved – the mortgage agents and brokers, the people who bundled the dubious loans – did fantastically well. The latecomers, who found themselves owners of these securities when the music stopped, lost their shirts. The whole rickety edifice was built on a myth, that property values would go on rising for ever – just as Ponzi's miraculous returns were supposed to last for all eternity.

Facilitating everything was easy money and even laxer regulation, promoted not only by the feckless George Bush but by the Clinton administration before him. Gordon Gekko's creed, "Greed is good", summed up Wall Street in the rip-roaring 1980s; that morphed seamlessly into the Bush mantra that the markets are always right. Warning signals about Mr Madoff's operations go back a decade, but the Securities and Exchange Commission, supposed to be the watchdog of the markets, did nothing. Even the SEC effectively admits that its performance was a disgrace. In this sense, too, the story of Bernard Madoff is the story of our times.

But what will it change? There will be sound and fury in Congress, and much wringing of hands. Fine books will be written, too, as the cry of "Never again" goes up. But similar things will happen again. Sooner or later, markets will take off once more, and new Madoffs will come along. Both orchestrators of frauds and those who buy into them are driven by forces no legislation can vanquish.

Investors, even the banks and venerable financial houses that are presumed to know about such things, will forever be gripped by the herd instinct, an urge for the fast buck and an ability to forget that ancient verity: when something seems too good to be true, it is.

The perpetrator of the fraud is propelled by an equally irresistible dynamic. Theories already abound over Mr Madoff – how he was able to "compartmentalise" his life, and seem outwardly utterly normal, despite the massive internal stress from the fraud. Perhaps he thought he was cleverer than everyone else. Maybe he was just a gambler by nature.

But the basic dynamic is, if anything, simpler. There's a wonderful line in the thriller movie Transsiberian, spoken by a Russian anti-drugs cop: "With lies you may go ahead in the world, but you may never go back." In other words, once you start a scam, it's impossible to end it. Bernie Ebbers of WorldCom, Jeffrey Skilling and the rest of the Enron gang, the self-styled "smartest guys in the room", even the brooding Roberto Calvi of Banco Ambrosiano in an earlier age – all were trapped in their own frauds. And so, surely, was Bernard Madoff. Once he had started, there was no way out.

The fallout: One by one, the victims come forward

Steven Spielberg The 'ET' director's charity, the Wunderkinder Foundation, has lost an unknown amount to Madoff.

Nicola Horlick So-called Superwoman famed for juggling a City career with five children. Her Bramdean fund was among the first to declare exposure to Madoff, with losses of £10m.

Emilio Botin Boss of Spanish bank Santander, which lost more than £2bn to Madoff. After Santander, owner of Abbey, was named "bank of the year" in July, Botin gave a speech on how to be a good banker, saying: "If you don't understand an instrument, don't buy it."

Arpad Busson Smooth hedge fund playboy, currently engaged to Uma Thurman. Had £145m invested with Madoff.

Mort Zuckerman Owner of New York's 'Daily News' lost $30m from his charitable foundation. Is planning to sue Madoff.

Christopher Cox Chair of the regulatory body Securities and Exchange Commission, widely criticised for failing to spot Madoff's multibillion-dollar fraud. Steps down in January.