Madoff wanted to grow his trading business, and a good way to do that was to expand his market-making business. But that meant going up against the New York Stock Exchange, the heart of the club. At the NYSE, a few firms controlled market-making, executing most large trades while getting rich on the spread. Madoff was one of the first to see that technology could match buyers and sellers more efficiently and cheaply than a human trader shouting orders amid a blizzard of paper on the floor of the exchange. By 1970, Madoff had hired his brother, Peter, who proved gifted at designing trading technology, and soon Madoff’s automated-trading systems began siphoning trading volume, and profits, from the NYSE. “They offered us all sorts of deals,” said Madoff, but he didn’t bite. Dick Grasso, head of the exchange for eight years, paid Madoff a backhanded compliment by calling him his “arch-nemesis.”
By the late eighties, Madoff was getting rich as a market-maker. “I was making at one point over $100 million a year,” he told me. As his innovations spread to the mainstream, Madoff attracted some of Wall Street’s most prestigious firms, including Goldman Sachs, Merrill Lynch, Morgan Stanley, and Smith Barney, all of which went into business with him.
The story Madoff told me is that he became a criminal near the peak of his legitimate success. He’d always continued to trade with other people’s money, an activity that eventually fell under a separate investment-advisory business. His largest clients had invested with him for decades, records later showed. In the early days, Madoff mostly employed technical and fairly low-risk arbitrage techniques built around his market-making business. “I always had a good feel for the direction of the market because of the order flow I was seeing,” he said. In the eighties, he said, he produced consistent returns of 15 to 20 percent, and he insists he did it legally. (The trustee representing Madoff victims says he can’t find records that Madoff ever traded, though the records are incomplete.) By the late eighties, he had, he estimates, $3 billion to $4 billion under management.
After the crash of 1987, Madoff’s investment-advisory business had an early scare. The panic set in gradually. Some of his big clients got spooked, Madoff told me, leaving him to unwind long-term hedges on unfavorable terms, which depleted his capital—“they betrayed me,” Madoff said. And his stalwart old trading strategy, built on arbitrage, no longer worked as effectively as it had—for one thing, spreads were narrowing, in part as a result of the technology he’d helped introduce. He’d come up with a new trading strategy based on index options. But the new strategy needed volatility to work, and in the early nineties, the recession had settled in. “The market went to sleep,” said Madoff. He had too much of other people’s money and not enough to invest in.
That is when, he says, the scheme began in earnest. Madoff started borrowing from his investors’ capital to pay out those solid returns. The returns, false though they were, were their own advertisement. New money started pouring in, saving him in the near term. And this was a different sort of money, the kind that came from bankers who wouldn’t have given Madoff the time of day earlier in his career. “The chairman of Banco Santander came down to see me, the chairman of Credit Suisse came down, chairman of UBS came down; I had all of these major banks. You know, Safra coming down and entertaining me and trying [to invest with Madoff]. It is a head trip. [Those people] sitting there, telling you, ‘You can do this.’ It feeds your ego. All of a sudden, these banks which wouldn’t give you the time of day, they’re willing to give you a billion dollars,” he explained. “It wasn’t like I needed the money. It was just that I thought it was a temporary thing, and all of a sudden, everybody is throwing billions of dollars at you. Saying, ‘Listen, if you can do this stuff for us, we’ll be your clients forever.’ ”
So Madoff took the money. While he waited for the market to wake up, he parked their billions in treasuries earning 2 percent a year, while generating statements that maintained they were earning about 15 percent—fantastic money in a slow market. He couldn’t bring himself to tell them that he had failed. “I was too afraid,” he said.
But Madoff distributes the guilt. “Look,” he said, “these banks and these funds had to know there were problems.” Madoff told them absolutely nothing about how he made those returns. “I wouldn’t give them any facts, like how much volume I was doing. I was not willing to have them come up and do the due diligence that they wanted. I absolutely refused to do it. I said, ‘You don’t like it, take your money out,’ which of course they never did.”