Friday, December 26, 2008

Bernie Made Off with Billions

Bernard Madoff made off with about $30 billion. People are really upset and accusing him of fraud. They claim that he was operating a Ponzi scheme. So what is all the fuss is about.

Here is the relevant legal background. The economist Eric Posner wrote,

I deposit some cash with the bank, I don’t retain my property interest. Instead, I’m making a loan to the bank and I obtain a contractual right to repayment on demand. If I demand my cash (plus interest, if any) and the bank fails to pay me, then I can sue it for breach of contract and demand expectation damages…. I have to race other creditors for its assets; otherwise, my contract right is converted into a claim in bankruptcy, and I have to share with other creditors.
The most important legal decision on this topic is Foley v Hill
Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it . . . . The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal....
Bernie Madoff’s activities seem to comply with these statements. It seems that once people deposited money with him, he was entitled to treat it as his own property and “do with it as he pleases”. All that the law requires was that he make the interest payments, he contracted to make. The law does not specify that he must employ the money in a particular way. Provided he returned any money entrusted within the contractually specified number of days ore receiving a redemption notice, he was not breaching the law. Bernie Madoff did nothing illegal, until he stopped meeting requests for redemption of funds.

Just kidding!

Posner’s quote above was a response to suggestions by Walter Block that fractional reserve banking is immoral. I quoted the decision in Foley v Hill in response to comments on a post disagreeing with the practice where banks treat demand deposits as their assets.

The similarity is quite disturbing. If what Bernie Madoff did complied with modern banking law, something is seriously wrong with modern banking.

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