"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.''Bernard L. Madoff is accused of running a Ponzi scheme, in which he used money of later investors to pay off earlier investors. It appears that many hedge funds had entrusted money to him. Small investors will be hurt by this only indirectly since his investors were either wealthy or were institutions. Hedge funds are an investment opportunity for the rich, not for ordinary people.
Periods of market stress are the times when fraudulent firms and schemes often come to light. It is easier to hide fraud in bull markets. Perhaps this is another element of feedback in downturns.
Update 1: Here is an AP article on the range of people affected