The investor who spotted Madoff’s fraud early has a whole new worry

Edward Thorp is an investing and mathematical legend — from spotting Bernie Madoff’s fraud as well as identifying Warren Buffett’s investing acumen early, to coming up with blackjack game theory.

Of all the tales he was regaling in an hour-and-half interview, the 89-year-old was asked by Tim Ferriss, an early-stage investor and prolific author, what he was learning about now. It was a sobering if measured reply — the inductee to the Blackjack Hall of Fame said he was reading about what’s going on with American society.

“What may happen, I don’t think we can predict for sure what’s going to happen, but we can map out scenarios,” he said. “You could have an autocratic country where a minority pretty much rules everything and dictates to everybody else. You could have a turbulent country where a large part of the country, maybe a majority, is badly upset and just wants to bust everything up and start over somehow.”

“You could have the choices I just described — a devolution, evolution or revolution,” Thorp said.

Thorp also was measured in what can be done, saying there’s not much anyone can do on a grand scale. Essentially, there’s no hedge if the U.S. falls apart. “I think the best thing we can do is teach everybody to think for themselves, so they just don’t take what they’ve told in the press, or in other forms of media, the internet, Twitter, so on, they just don’t just take that and soak it up and believe it, but they question it, and ask whether in fact it might not be true, and what the motives are for the people who are putting these things out.”

Thorp’s comments came as the House Select Committee investigating the Jan. 6 attack on the Capitol is continuing.

Thorp did explain how he spotted the Madoff fraud, a story that’s been told before but perhaps here with more color. “Back in 1991, I was invited to review the portfolio of McKinsey and Co. back in New York, and they had a profit sharing and a pension plan,” he said. “But there was one very strange investment, they had it printed out one or two percent a month, every month. They had a record going back into the late 1960s, supposedly, and I said, ‘How do they do this?’ And they said, ‘Well, we don’t know exactly, they tell us that they won’t explain what their method is but we can show you our accounts.’”

To make a long story short, he discovered that the options strategy the firm said it was using would lose in a down month — but the firm would win every month. “And the reason they went up every month was because a mysterious trade was put on, involving S&P 500 index options, and it was always in the right direction.”

Peter Madoff, Bernie’s brother, at the time was running the firm and wouldn’t let Thorp visit. So first, Thorp found about a quarter of the purported trades didn’t happen anywhere. He then called on a contact at Bear Stearns, to ask who was on the other side of 10 options trades Madoff supposedly made. “So they researched the trades and they came back and said, ‘No, can’t find any trace of any Madoff and Co.”

While McKinsey did, with some persuasion, agree to stop investing in Madoff, Thorp said a fund of hedge fund investor who he told the full story to kept investing until the end.

“So the whole point of this is here’s the person who had all the information, it was explained very clearly, and he just didn’t believe it,” Thorp said.

The full interview is here:

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