When a Ponzi scheme collapses, it loses 100%. I picked 95% drop and recovery because once a Ponzi scheme loses 95%, I'm not aware of any example where it doesn't proceed to a 100% loss.
I looked deeper into the Bernie Madoff scheme because we can all agree it was a Ponzi and because there's lots of easily-accessible info about it. Turns out, investors in the scheme "have recovered 75 cents on the dollar" thanks to the work of a large team of recovery lawyers. They might have done better investing with Madoff than some people did investing in bank stocks since 2008, lol!
That joke about banks isn't accurate. SPDR S&P Bank ETF (KBE) has a +50% gain since 2008 until now, which is better than a -24% loss. It's more fair to compare 2008-2018, where KBE only had a +5% gain.
Keep in mind the Madoff money was unavailble for over a decade. Someone who invested 3 years before the collapse thought they had a +40% return, only to be told they have zero. From 2006-2018, the S&P 500 returned +163% while the Madoff recovery fund paid out -24% losses. The FBI assigns time a value of zero, which creates a huge opportunity cost.
If you're trying to call this an exception to my 95% crash with no recovery, don't you have to claim the Ponzi scheme did not collapse, and was taken over by the FBI? Did the FBI continue Madoff's Ponzi scheme, or does the general rule I proposed still hold?
Lehman and AIG stock investments might have left a person with <75% today, depending on timing. Also, the FBI did not seize many of the assets until years later - so some victims probably benefited from the appreciation of stock and bond assets after 2008.
The Madoff example only illustrates how a Ponzi-adjacent scheme does not need to lose 95% of their assets to go bust. Madoff, like FTX and now a couple of other cryptobrokerages, was unable to promptly meet redemption requests because assets that were supposed to be inside the organization had been moved out of the organization. There were massive piles of assets; they were just in the wrong place when customers came in demanding cash the same day. As word spread that the organizations were not promptly meeting redemption requests, the bank runs accelerated.
Maybe the missing piece to the analogy is that we can imagine a world in which Madoff Securities or FTX kept large reserves of actual assets, instead of holding minimal assets to backstop their on-demand accounts.
What if, say, half of customer assets were kept quickly available for redemption and the other half were stolen? That probably would have been enough reserves to stop the bank runs and both schemes could have continued operating to this day. Madoff's error was to move his clients' assets into his personal accounts so that he could live a life of luxury off the personal accounts, when he could have just spent out of the Madoff Securities accounts and been more prepared for the 2008 wave of redemption requests. Likewise, FTX errored by moving a bunch of clients' assets to Alameda, leaving themselves unprepared for a bank run (and perhaps sparking the bank run when people saw them moving the assets). Getting caught amounted to having too many of the assets in an illiquid place, just like with bank runs on legitimate banks. Except with Madoff and FTX, that illiquid place was not a portfolio of loans, it was personal accounts.
Let's do another thought experiment. Suppose Madoff had kept 75% of customer assets in liquid accounts, knowing he was just one bank run away from being discovered, and wisely reasoning that his personal accounts would do him no good if he was ever caught. He could still print false account statements with made-up returns, could still fund redemption requests from new victims' money in normal times, could still run every other aspect of the scheme, and could still live like a king. It would still be a Ponzi, just more conservatively run.
When 2008 happened, suppose customers asked to immediately withdraw 70% of the original deposits in Madoff Securities. Madoff could promptly and immediately pay each account holder from the reserves, and that would have been sufficient to avoid a run (particularly because clients believed Madoff was running a collar strategy, with limited loss potential).
Behind the scenes this hypothetical Madoff Securities would have lost 95% of its clients' cash: 70% from redemptions and 25% from previous theft. The Ponzi scheme would have survived 2008 after losing 95% of its actual funds, might have attracted more money by reporting reasonable performance through the crisis, and might have only been found out after Madoff's death. This hypothetical post-2008 Madoff Securities would have only been as leveraged as Madoff Securities was in reality. The strong market performance after 2009 and low interest rates would have given Madoff cover to report very high earnings, attracting lots more capital, and report a full recovery.
Of course, financial scams are typically set up by greedy and reckless people who are disinclined not to personally use every dollar they pull in. The thought experiment shows it is possible for a Ponzi to lose 95% and come back completely. Madoff wasn't caught by the FBI or SEC after 16 years of on and off investigation; his undoing was a traditional bank run which he could have avoided. I'm sure he spent his last years in prison wondering why he didn't hold more liquidity.
