The Biggest Ponzi Scheme Of All by George Drake

When I taught in the K-12 system, every year there’d be a chain letter that came around the teacher’s rooms just before Christmas promising a great return on the investment of one or two bottles of booze. It was, reputably, illegal. It was undeniably a small-time version of the Ponzi scheme that Bernie Madoff recently made famous by virtue of how very successful his was.

I always hated seeing that letter show up for, as a mathematician, I understood perfectly how the scheme worked and was always distressed by the fact that someone else had started the letter before I remembered to get around to it. You see, the only way you make a profit is to be one of the first ones to buy into the scheme, and the only way to be reasonably certain of buying in soon enough is to actually start the letter.

Madoff worked his crowd for billions, even threatening to steal the name from Ponzi since Made-off, which I believe is how Madoff pronounces it, seems so much more appropriate. He was quite famous in the wealthy set for having returns on investments no one could rationalize without a wink and a nod. I suspect most of those who lost large amounts by investing with Madoff probably had it coming because they were assuming Bernie must be working with insider knowledge–itself quite illegal. That it turned out they got burned instead of the poor schmucks who didn’t have special contacts doesn’t strike me as so tragic. But I admit I don’t know the whole story.

Bernie’s five minutes of inter-societal fame set me to thinking, though. His scheme worked, as do all Ponzi schemes, by playing, however manipulatively, on the assumption that there will always be new buyers coming into the plan. The money the new subscribers bring in is used to pay the earlier participants a good profit. With the stock market, and the economy along with it, collapsing, I couldn’t help but think about how the housing market, before triggering this panic, was driven by the assumption that people would continue to buy houses at ever escalating prices and in ever increasing numbers. When the pool of buyers first began to run out, the lending institutions allowed the money to enter the system by lowering the criteria for making a loan. Eventually, that came down hard on everyone’s head and it’s easy to think “subprime mortgages” caused the collapse of the entire economy.

It surely exascerbated the problem, spreading the effects far and wide, but I don’t think it caused it. Of course, there were many contributing factors, but I think the overly optimistic expectation that you could just keep this up forever was the real culprit. The unstated, but essential, assumption in both the real economy and Madoff’s deception, was that growth was perpetual.

Then I had a really scarey thought. The entire basis of our capitalistic system is growth. Infinite growth. That’s a Ponzi scheme. That Madoff was able to keep his afloat for so long was due to his ability to continue to be believable to so many potential investors. What keeps capitalism afloat is our self-deception that we can continue to recklessly exploit our resources forever. And that’s becoming an increasingly hard sell.

When people stop buying into a scheme, the scheme collapses. Right now, people have stopped buying optional goods, not because they’ve realized they’re being Ponzied by the whole capitalism game, but just because they’re afraid they won’t be included in the income half of it much longer. As the economy grinds to a halt, the effect of this negative psychology is obvious. The last time we had anything like this degree of reluctance/inability to play was during the Great Depression. What eventually brought us out of it was WWII. The threat of being dominated by a hostile foreign power has a way of making the spending of money non-optional.

The lesson of the Thirties that government spending must be used to reestablish trust in the whole process seems to be pretty well taken, and, if it does the trick of restoring confidence, we may still come out of this with only a strong recession. But the problem remains. Sooner or later Ponzis collapse. The real challenge is how to extract ourselves from the scheme in the first place without resorting to another devastating world war, for the tools of that trade are, by now, far too advanced for us to let them loose.

With the booze letter, once you’d bought in at all, all you could do was eat the loses if that was what was coming your way. If you got in early enough, buying a lot of booze and then staying clear of the game would actually pay off. But if you were at all far down the list, the more you invested, the more you lost. I’m reminded of the first little wobbles one notices in the course of a spinning top’s eventual fall. It never really gets better once that happens. We’re beginning to have to scramble for resources to keep the system going, having to be more and more creative disposing of our waste and being repeatedly surprised by developments that seemingly pop up out of nowhere to gum up the works.

It looks more and more like this scheme is on the verge of winding down. The question that we need to grapple with is what to replace the old Capitalist’s notions with. And the sooner we start thinking about solutions in those terms, the more thoughtfully devised will be our answers.

If events don’t divert my attention, I’ll start trying to answer some of the questions this whole line of thinking brings to mind in my next entry. In the meantime, how about adding your suggestions/thoughts as comments? Thanks.

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3 Responses to The Biggest Ponzi Scheme Of All by George Drake

  1. Jon French says:

    Well, mortgage lending may have been the current ponzi collapse.

    Do you think that the social security ponzi will collapse in this go-round, or will it be able to go on a while longer? What will be the results?

  2. Hank says:

    George-Nothing says you can’t start your own chain letter right now.

    Jon-Social security will be able to maintain itself if the retirement age is raised enough.

    The housing collapse-I put the blame on the credit rating agencies (Standard and Poors and Moody’s etc.) They’re the ones holding the smoking gun. Those people should go to jail for taking junk investments and giving them AAA ratings. If the credit rating agencies hadn’t done that, no one would have purchased those worthless loans and this whole problem of bad mortgages would never have happened. It was only the phony AAA ratings that enabled banks to sell those loans and then turn around and make more bad loans and then sell them.
    -Hank

  3. Mike says:

    Thought you might appreciate this article from the NYTimes: http://www.nytimes.com/2009/03/08/opinion/08friedman.html?em

    Sound familiar?

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