Wednesday, December 17, 2008

We are all Ponzis now....

Peter Schiff takes a crack at the Bernard Madoff Ponzi scheme, and draws unsettling comparisons between it and the housing collapse:

Madoff’s inspiration came from Charles Ponzi, the Italian-born American immigrant who promoted an investment plan in the early 1900s’ that traded postal coupons. Rather than paying investors from legitimate investment returns, Ponzi hit upon the innovative idea of paying out early investors with money collected from new investors. By creating an illusion of success, interest in his investment plan ballooned. Over time the schemes have become known by many other names, such as chain letters or pyramid schemes. They are united by the fact that they always fail in the end.

When the influx of new investors inevitably slows to the point where distributions to current investors can no longer be maintained, investors look to withdraw funds. When this happens, the entire structure falls apart. The profits received by those who “invested” early as well as any funds skimmed off by the promoter, are offset by all the losses of those who came late to the party.

To a large extent, the same concept has driven the major asset bubbles of the last decade. Given the ridiculously high valuations seen by tech stocks and real estate during their respective booms, the only way the bubbles could be perpetuated was if newer “investors” could be found to pay even more outrageous prices (the greater fool). But when these new buyers balked, the whole structure crumbled. Although there was no Ponzi or Madoff to orchestrate these manias, the entire financial and economic apparatus of the country had successfully convinced the public that “investments” in tech stocks and condominiums were bullet proof and that the supply of new buyers was endless.
Schiff doesn't stop there, however. He takes it one step further, leveling the Ponzi scheme accusation next at Social Security:
The Social Security Administration runs its “trust funds” with precisely the same methods used by Madoff and Ponzi. As money is collected by from current workers, the funds are then dispersed to those already receiving benefits. None of the funds collected are actually invested, so no investment returns are ever generated. Those currently paying into the system are expected to receive their returns based on the “contribution” made by future workers. This is the classic definition of a Ponzi scheme. The only difference is that Ponzi didn’t own a printing press.
From there he tackles the national debt and the risk we run in this Ponzi economy of foreign creditors trying to sell of their investment in the US. It's pretty scary stuff.

I reccomend reading the whole thing, and everything else that Schiff writes on the subject. After all, he was right long before anyone else was. He saw this whole mess coming years ago, and said so unflinchingly, despite constant criticism.

What are the implications of this? Is our entire economy a house of cards? It seems more and more that way. And as much as I don't like the concept of bailout, I sure as hell don't like the concept of losing our last major manufacturing base.