I have been watching the Madoff affair with morbid fascination. I also bought and am currently reading a book on the original Ponzi scheme some 90 years ago – it is superb, and I will post its review here a few days later.

Meanwhile, I just saw the best summary of the ‘affair’ so far in my favorite magazine – The Economist (http://www.economist.com/). Here is an excerpt (AE):

“There are no heroes in the Madoff story; only villains and suckers”

On the face of it, the attractions were clear. Mr Madoff’s pedigree was top-notch: a pioneering marketmaker, he had chaired NASDAQ, had advised the government on market issues and was a noted philanthropist. Turning away some investors and telling those he accepted not to talk to outsiders produced a sense of exclusivity. He generated returns to match: in the vicinity of 10% a year, through thick and thin.

That last attraction should also have served as a warning; the results were suspiciously smooth. Mr Madoff barely ever suffered a down month, even in choppy markets (he was up in November, as the S&P index tumbled 7.5%). He allegedly has now confessed that this was achieved by creating a pyramid scheme in which existing clients’ returns were topped up, as needed, with money from new investors.

He claimed to be employing an investment strategy known as “split-strike conversion”. This is a fairly common approach that entails buying and selling different sorts of options to reduce volatility. But those who bothered to look closely had doubts. Aksia, an advisory firm, concluded that the S&P 100 options market that Mr Madoff claimed to trade was far too small to handle a portfolio of his size. It advised its clients not to invest. So did MPI, a quantitative-research firm, after an analysis in 2006 failed to find a legitimate strategy that matched his returns