Bernard Madoff, former chairman of the NASDAQ Stock Market Inc. (NDAQ), was turned into the authorities by his sons last Thursday after his hedge fund, Bernard L. Madoff Securities LLC, was declared an insolvent “giant Ponzi scheme,” with estimated losses of $50 billion.

Madoff had provided investors with modest, steady returns, claiming to be making money by trading in Standard & Poor’s 500 Index options, and closing all positions prior to mandatory reporting dates so that investors had no window into the fund’s holdings.

Apart from individuals, charities and numerous "funds of funds" investing in hedge funds, such as HSBC Holdings PLC (ADR: HBC) and Banco Santander SA (ADR: STD), lent billions to investors participating in the Madoff fund, secured only by holdings in a fund that is now insolvent.  The debacle is likely to strengthen criticism of the U.S. Securities and Exchange Commission, for its failure to protect investors, and to cast doubt on the hedge fund sector and on “alternative investments” in general.

It is not surprising that the recent unpleasantness on Wall Street has exposed a gigantic undefined scheme. It wasn’t even really even surprising that the Ponzi-scheme losses were an enormous $50 billion: After all, 13 years of excessive money creation have allowed bad Wall Street behavior to grow like weeds, so you’d expect the inevitable Ponzi scheme to be huge, like an out-of-control, possibly radioactive bindweed.

However, it is surprising that the major investors in Madoff’s scheme were not a bunch of suckers he met at a country club, nor a set of unworldly charities seduced by a smooth sales pitch (though both of those were involved), but instead were actually undefined, the most obnoxiously professional of professional investors. This raises a hugely heretical question: Is it possible that hedge fund managers aren’t the “best and the brightest” after all?

The Life and Times of Charles Ponzi

The original Ponzi scheme was a much smaller-scale operation, with losses of only few million. In the disturbed years after World War I, Charles Ponzi got the idea that postal reply coupons could be purchased in Italy and exchanged for U.S.