Wednesday, December 24, 2008

The Largest Ponzi Scheme in History

Time Magazine's "Person of the Year" award is traditionally awarded to the biggest newsmaker of each year in its closing weeks. I imagine that it surprised no one that this year's title was awarded to President elect Barak Obama. It is interesting that barely more than a year ago, Barak Obama was an obscure junior senator who was not a noisemaker – or newsmaker – on Capital Hill. Most of America, and certainly the world, had never heard of him.

Newsmakers materialize suddenly because news breaks suddenly.

Time Magazine's anti-climactic "Person of the Year" announcement was barely noticed. It barely made page 8. This is because a new newsmaker appeared out of nowhere and took a controlling interest in the front page news. Bernard L. Madoff. The 50 Billion Dollar Fraud. The largest Ponzi scheme in history. Not too late to win the 2008 "Monster of the Year Award".

The largest Ponzi scheme in history!

Or is it?

I am not so sure. I know at least 2 Ponzi schemes that are as substantial as his. Perhaps the numbers don't reach 50 Billion dollars. Or perhaps they exceed 50 Billion dollars.

What is a Ponzi scheme? It is when somebody who does not have his own capital and is not credit-worthy, borrows money from somebody else (or a group of people) and claims them as assets. This makes himself look like he is now credit worthy so he can borrow even more. And he pays his first creditor with what he borrowed from later creditors against the imaginary appreciation of value of his not-paid-for assets. At first, nobody notices that the assets are liability-ridden. Eventually, it is discovered that his current holdings are not really worth what he claims they are and are, in fact, worth less than his total liabilities. The game is over and the creditors lose.

A Ponzi scheme is a ticking time bomb. Something that is bound to self-destruct eventually.

Perhaps I could have explained this in simpler terms, but I purposely used this lengthy narrative to illustrate that there have been some very big Ponzi schemes in the past.

The first was the 1929 stock market crash.

What caused the 1929 stock market crash? It happened because hundreds of thousands of people who were not credit-worthy were buying stocks on low margins. That means they were buying stock without really paying for it or, in other words, borrowing the money that it costs. The idea is that all this buying drives up the value and gives a false impression that the assets are worth more than they are. So they "cash in" these assets and "buy" more for no money. They are really borrowing against the false value of the assets. They will pay for it with tomorrow's profits. It was no different than Madoff's except for 3 things: (1) It was a Ponzi scheme with collective ownership. Each person who bought on margin was his own Charles Ponzi. Because he depended on other people who bought on margin to make his assets appreciate. It was all of the investors bilking themselves as opposed to one person bilking everybody.(2) Secondly, the market merely crashed about 30-40% overnight. So, although it made people who already had no money in their pockets liable for stocks they first bought at 30-40% above their corrected value and sent them into debt, the money did not totally disappear. (3) It was all perfectly legal.

For these reasons, nobody wants to recognize it as a Ponzi scheme. But it was. I have no clue as to its total value but it was also probably in the billions of dollars.

It was a ticking bomb. Like any Ponzi scheme. Something that is bound to self-destruct eventually. Many pundits said so at the time. Few listened.

Likewise, what caused the current economic crisis? It was exactly the same thing except it wasn't stocks. It was real estate. People who were not credit worthy were buying houses and taking out "affordable" sub-prime adjustable rate mortgages. They were borrowing money to be paid by the projected appreciation of their real estate purchases. They are paying today with tomorrow's "income". But each person who bought with no money down was depending on a rising real estate market that was propelled by more people buying at no money down.

It was a ticking time bomb. Something that is bound to self-destruct eventually. And it was forewarned at least 9 years ago in a famous NY Times column during the Clinton administration. The Clinton administration was orchestrating a Ponzi scam much bigger than Madoff's. Another collective, self-inflicted Ponzi scheme. Just nobody wants to call it that.

If anything positive comes out of this catastrophe, it may be that, by its sheer magnitude, it will open our eyes to something we don't want to see. There are different types of Ponzi schemes. There is the sinister Charles Ponzi / Bernie Madoff Ponzi scheme where one charismatic charlatan preys on the unsuspecting. But there is another variation where we do it to ourselves.

Which is more dangerous?

I suppose those of us who haven't fallen for any Ponzi scheme can give himself a pat on the back.

Not so fast.

There is a another Ponzi scheme going on. One that dwarfs all three of these scams put together. And it's been going on for longer than we know. And it is a ticking time bomb that is bound to self-destruct. And all of us are in it.

Just most of us don't know that we are in it.

It is humanity itself. This whole world is one big Ponzi scheme. Remember that a Ponzi scheme is when we borrow today against tomorrow's projected income. It's good as long as the projected income comes, then we can pay off today's loan and borrow again against tomorrow's projected income.

G-d gives us life up front. And He gives us our allotment of years and He gives us our allotment of parnassah. We don't pay for it and we are not credit-worthy. And we have to find a way to pay for it. Why?

Because after 120 years, we are going to submit an application for another allotment. An allotment for "years" and "parnassah" in the afterlife. If we covered the cost of our short allotment here, we will have a credit standing to borrow more for a second "allotment". But, if we don't, we pay for today's free money with tomorrow's allotment. And we fool ourselves that it's worth more than it really is. But its a ticking time bomb that is bound to self-destruct. When that happens, all of the false inflated value evaporates and what remains is the part that we actually paid for. The amount of principle that was actually paid off.

So - life is just another Ponzi scheme. And just like all of the other Ponzi shemes that were forewarned and ignored, this one is also forewarned. Rabbi Akiva exposed this sinister scheme about 2000 years ago:

הוא היה אומר: הכל נתון בערבון, ומצודה פרוסה על כל החיים. החנות פתוחה , והחנוני מקיף , והפנקס פתוח, והיד כותבת, וכל הרוצה ללוות יבא וילוה, והגבאים מחזירים תדיר בכל יום, ונפרעין מן האדם מדעתו ושלא מדעתו, ויש להם על מה שיסמכו, והדין דין אמת, והכל מתקן לסעודה.

He (Rabbi Akiva) would say: Everything is given out with a lien. And a net is spread over all those who live. The Store is open and the Storekeeper is extending credit, and the Ledger is open, and the Hand is writing. And all those who wish to borrow may come and borrow. And the Collectors make their rounds each day, and they exact payment from a person with consent and without consent. And They have [the necessary proof] to uphold their demands. And the judgement is one of truth. And with this, each person is rectified for the banquet.

So now it looks like G-d is pretty busy. He is running a Ponzi scheme and He is running a Pyramid scheme. The Pyramid scheme is the way out of the Ponzi scheme. In a Ponzi scheme, everybody loses. In G-d's Pyramid scheme, everybody wins.

1 comment:

Moshe Kranc said...

I have something nice to say about Madoff, based on the Talmud. "Rabbi Abahu said in the name of Rabbi Lazar: We must be grateful to the cheaters among those who collect charity. Were it not for those cheaters, then each time a beggar asked a man for a donation, and the man refused to give, then that man would immediately be liable to punishment." (Jerusalem Talmud, Pe'ah 8:9).
אמר רבי אבהו אמר רבי לעזר: צריכין אנו להחזיק טובה לרמאין שבהן, שאילולא הרמאין שבהן היה אחד מהן תובע צדקה מן האדם ולא נותן לו מיד היה נענש. (ירושלמי פאה, פרק ח, הלכה ט)

I'd say that Madoff has given a free pass for years to come to anyone who refuses to donate to Jewish charities.

http://hasidicmanagement.blogspot.com/2008/12/few-observations-on-madoff.html