Bailout seems to be the word in 2008: Everyone is getting one, or is giving their case for why they need one. In the latest bailout request, the Alternative Investment Management Association (AIMA) is asking for aid for the investors burned in the $50 Madoff investment scam according to Reuters. On the news we have heard heartfelt stories of retirees who lost everything, but then again these were supposed to be sophisticated investors. What should we do?
For those who are unfamiliar with the Madoff investment scandal, Madoff Securities is a hedge fund which set up a big ponzi scheme and scammed investors out of approximately $50 billion. To invest in hedge funds, investors are required to be accredited, which means they have at least a net worth of $1 million or make at least $200,000 a year ($300,000 if married). These types of investments require accreditation because they are considered riskier and more complicated and they are not bound by the same SEC regulations as common investments are.
The fact that these accredited investors would even ask to be bailed out by American taxpayers is preposterous. Considering that millions of people are out of work and millions of retirees already have nothing to live on aside from their social security checks, how can these wealthy people possibly want hardworking Americans to cover their losses? The government didn’t bailout investors in traditional stocks that went bankrupt. They didn’t bailout the workers in Enron who had their entire retirement account invested in Enron stock and lost everything. Sure, it sucks that these people were scammed, but it is hard to feel sorry for them when they have a lot to begin with and they knew that their investment was inherently risky.
Compounding that, I was blown away to learn that some of these people invested every penny of their wealth in these funds. If someone has $2 million and plans to retire on that money, how can one possibly think that it is okay to invest it all in the same fund? That is just ridiculous. I wouldn’t even invest all my money in U.S. treasuries, let alone some hedge fund. This should be especially true for people nearing retirement: The closer you get to retirement, the less risk you should be taking with your money. This means that diversification is absolutely vital, and very, very little of your portfolio should be invested in things like hedge funds. I do feel for these scammed investors, but, firstly, they should have known better, and secondly, they are now in a situation similar to that of millions of other retirees, except that these investors probably have other assets of value and are still better off than most.
If we aren’t willing to spend $15 Billion to bailout the auto industry, then we can’t spend billions to bailout wealthy hedge fund investors who got burned. The AIMA had to know that there was no way they would get it. This action will only cause a PR problem for hedge funds and might lead to increased regulation in the industry. This is could be a good thing or a bad thing depending on your perspective, but it is safe to say that most hedge funds would rather not deal with more regulation or scrutiny. At the end of the day, though, if so-called “sophisticated investors” are making stupid mistakes like this, then I would have to question the criteria being used.