Okay, let’s point out the obvious: the fact that Bernie Madoff was a crook was known to every competent financial professional. If they didn’t know that, it was because they weren’t competent or they didn’t want to know and if they didn’t want to know, they weren’t competent. It is impossible to make 1% a month, every month. Impossible.

Professionals know this, so they assumed Bernie was was crook, they just assumed he was a more sophisticated crook than a Ponzi scheme artist: they believed he was doing insider trading or some such. And he probably was, for many years, because a Ponzi scheme can only run for so long. But eventually he didn’t make his returns, and he had to start using premiums to make them up. And from there, each month he would have fallen further behind. This was inevitable, again, because it is impossible to make 1% a month consistently, forever. You will eventually not succeed. This leads to the most important rule of buying or investing in anything, the one rule you must remember if you want to not be taken in by crooks like Madoff (or something like Enron):

If it’s too good to be true, it’s too good to be true.

Rule #2:

There’s No Such Thing As a Free Lunch.

What is going to become undeniable over the next couple of years (it’s already obvious) is that the majority of "profits" generated in the last 10 years weren’t. They weren’t real. They didn’t exist. They were based on fraud.

The vast majority of Collateralized Debt Obligations (CDOs) were based on mathematical models that didn’t work, and that couldn’t work, because they assumed there would never ever be a recession again. Not a depression, just a recession. As my friend Stirling Newberry used to say "the next recession is like death, it’s a metaphysical certainty. We don’t know when it will happen. We know it WILL happen." The majority of mortgages were sold with a risk model that assumed that housing prices would never decline and that there was no housing bubble. Again, these were fraudulent assumptions. Anyone who wanted to know we were in a bubble knew, anyone who didn’t know was a crook or incompetent.

The worst thing about this is that an honest business can’t compete with a crooked one. You can’t make the same profits as a corporation whose business model is based on fraud. So bad business forces out good business. Everyone is either forced to engage in fraud, or forced to only do the small segment of business which legitimately has very high returns. Normal businesses which don’t engage in fraud or aren’t in extremely high margin niche businesses are either forced out of business or can’t get credit. And business models which only return 5% to 8% a year, which in non-fraudulent, ordinary times, are excellent returns, are never even funded, since all the money is rushing into CDOs, credit default swaps, and crooked businesses which promise higher returns.

Because they aren’t funded we lost huge amounts of real economic growth and in exchange got empty returns which once they were undeniable lead to this financial crisis and economic downturn. In fact, in a real sense, we were in a recession for years, we just didn’t know it. The majority of profits the economy was living off of, simply didn’t exist.

Madoff is just the most egregious example. But he is emblematic of an entire economic era: an era based on widespread fraud and crookedness, and of everyone agreeing to pretend that the profits were real when they knew they were too good to be true. On aggregate, market participants were beating the market. That’s not possible. That’s too good to be true. For years the majority of corporations would beat expectations. That’s not possible. That’s too good to be true.

It was "too good to be true". It was not possible. The majority of it was based on fraud.

And the vast majority of people in business were complicit. If they didn’t know what was happening, they were either incompetent, or they didn’t want to know. And if you’re a small investor who lost a bundle with Madoff or somewhere else, the reason you lost it is in part because the big boys all wanted in on the crooked deal, rather than to point out it was a crooked deal.