The scale of Madoff’s alleged fraud — with estimated losses of $50 billion — belies its unsophisticated character. The operation appears to have been a “Ponzi scheme”, named after Charles Ponzi, who in the ’20s swindled tens of thousands of American investors while promising to double their money. It involved paying out supposed investment returns that were not genuine, but were merely the deposits paid in by other investors. The exposure of banks and investment funds to Madoff’s operations threatens huge losses for many already stricken institutions. And the affair has important implications for the future shape of the financial system. Madoff’s operations comprised a hedge fund and advisory business. Hedge funds are unregulated investment vehicles for very wealthy private clients...

The entire sector has been devastated by the financial crisis. The credit crunch has curtailed the ability of funds to borrow. Regulators have imposed restrictions on short-selling of financial stocks. And the opaque nature of hedge funds’ operations is likely to spur investors to withdraw money, because of the difficulty of distinguishing legitimate operations from crooked ones. If hedge funds start liquidating assets to meet investors’ desire for cash, then the financial markets will experience further turmoil.

From a leader in ‘The Times’, London