Kass: Madoff Was Made Up

Unlike Bayou, however, Madoff self-cleared -- this was red flag No. 4. -- so the far larger fraud than Bayou was more easily kept secret.

Madoff refused to provide account transparency. This was red flag No. 5. According to several friends of his, if an investor questioned his oblique and undisclosed investment methodology, he threatened to return the funds.

Apparently, Madoff's minimum investment requirement dropped considerably this year coincident with the market decline. This was red flag No. 6.

The disclosures of the alleged fraud at both Bayou and Madoff were accelerated by redemption requests. Madoff's firm received about $7 billion in redemption requests. While he was able in the past to cover withdrawals, $7 billion was too large to cover.

Madoff's investors included captains of industry, corporations (some of which are publicly traded) that used Madoff almost as a high-yielding cash management account, endowments, universities, foundations and, importantly, many high-profile fund of funds.

It appears that at least $15 billion of wealth, much of which was concentrated in Southern Florida and New York City, has gone to money heaven. Real estate has been dealt a fatal blow, both in the luxury residential markets as well as in the office market, where Madoff funds were likely used as debt collateral.

The disclosure of the possible fraud last night suggest to me that anyone on the fence regarding redemptions to the hedge fund industry over the next several months will likely put in their requests for capital withdrawal, as confidence in the system and in investment managers has been irreparably impaired.