My oldest son, Bert, is learning to drive. Every day, he drives to school and drives home, with old Enrico riding shotgun.
One thing I have continued to repeat to Bert to the point I am sure of nausea on his part is this: Assume everyone on the road is in a conspiracy to collide with you, but to make it look like an accident. Suspect everyone of waiting for an opportunity to run into you, or to make you run into them.
I have been spending a lot of time investing in small start-ups recently. I begin each due diligence with an assumption similar to the one I urge on Bert: I assume that the CEO is a liar, a thief, a fraudster, until proven otherwise. I take on the persona of an insane PI with an irrational grudge against the CEO: can I PROVE he’s a liar? Can I demonstrate that he’s a thief?
This is why I don’t get the people who were taken in by Bernie Madoff. He claimed to run the old split strike conversion option strategy, where you buy a given stock, and, for example, sell an out of the money call and buy an out of the money put. But simple math based on the huge quantities of money he was managing would have instantly revealed that this simply could not be true: the volume of options actually traded, at least publicly, were a tiny fraction of the volume that Madoff alone would have generated. Who could have been the counterparties on all these options trades? This would have been the very first question I would have asked.
Even without an answer from Bernie, one could have easily come up with the answer oneself: there could not possibly be any counterparties. You can’t slosh around that quantity of options without it showing up somewhere. Someone would be staffing gigantic teams of quants to crunch the numbers on the options trading, and these people have wives, husbands, boyfriends, girlfriends, homes, cars, condos in Manhattan, sewage, and bank accounts. This would be like me claiming to have 55 million barrels of oil stored in a big tank under my modest abode here in the Memorial Villages. Really, Enrico? What did you do with all the dirt you excavated?
Of course, it was a gigantic lie. There were no options. It was just a huge, long-running, incredibly successful pyramid scheme.
This kind of makes me cheerful. Here is yet another group of people voluntary setting their piles of cash on fire. We need all the asset destruction we can stand to stave off the hellish inflation we’re otherwise due for.