Flimsy Sanity: Know Your Schemes

Flimsy Sanity

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. - Friedrich Nietzsche

Sunday, September 28, 2008

Know Your Schemes

*A Ponzi scheme is a fraudulent investment operation that involves promising or paying abnormally high returns ("profits") to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business.

The catch is that at some point one of three things will happen:
1. the promoters will vanish, taking all the investment money (less payouts) with them;
2. the scheme will collapse of its own weight, as investment slows and the promoters start having problems paying out the promised returns (and when they start having problems, the word spreads and more people start asking for their money, similar to a bank run);
3. the scheme is exposed, because when legal authorities begin examining accounting records of the so-called enterprise they find that many of the "assets" that should exist do not.

* A pyramid scheme is a form of fraud similar in some ways to a Ponzi scheme, relying as it does on a disbelief in financial reality, including the hope of an extremely high rate of return. However, several characteristics distinguish pyramid schemes from Ponzi schemes:
o In a Ponzi scheme, the schemer acts as a “hub” for the victims, interacting with all of them directly. In a pyramid scheme, those who recruit additional participants benefit directly (in fact, failure to recruit typically means no investment return).
o A Ponzi scheme claims to rely on some esoteric investment approach, insider connections, etc., and often attracts well-to-do investors; pyramid schemes explicitly claim that new money will be the source of payout for the initial investments.
o A pyramid scheme is bound to collapse a lot faster, simply because of the demand for exponential increases in participants to sustain it. By contrast, Ponzi schemes can survive simply by getting most participants to "reinvest" their money, with a relatively small number of new participants.

* A bubble. A bubble relies on suspension of belief and an expectation of large profits, but it is not the same as a Ponzi scheme. A bubble involves ever-rising (and unsustainable) prices in an open market (be that shares of a stock, housing prices, the price of tulip bulbs, or anything else). As long as buyers are willing to pay ever-increasing prices, sellers can get out with a profit. And there doesn't need to be a schemer behind a bubble. (In fact, a bubble can arise without any fraud at all - for example, housing prices in a local market that rise sharply but eventually drop sharply because of overbuilding.) Bubbles are often said to be based on "greater fool" theory.

* Robbing Peter to pay Paul. When debts are due and the money to pay them is lacking, whether because of bad luck or deliberate theft, debtors often make their payments by borrowing or stealing from other monies they have. It does not follow that this is a Ponzi scheme, because from the basic facts set out there is no indication that the lenders were promised unrealistically high rates of return via claims of unusual financial investments. Nor (from these basic facts) is there any indication that the borrower (banker) is progressively increasing the amount of borrowing ("investing") to cover payments to initial investors (as, again, Ponzi was not the first to do).

The confidence men (con artists for short) say "you can't cheat an honest man" because they nearly always use greed as their bait. As long as everyone stays confident that a system works, it can go on. That is why it is so essential that investor confidence needs to be restored before people find out that it is all unsustainable air and we are a country that produces little but wants to live well through gambling and exploitation. The game is over and like all schemes, the winners got in early and are by now off sipping margaritas on their yachts. Like Joseph Kennedy supposedly said just before the 29 crash, he knew it was time to get out of the market when the shoeshine boy was giving him stock tips. If I could require the reading of just one book for every human, it would be Extraordinary Popular Delusions and the Madness of Crowds (written in 1852). It is a catalog of mass human greed and folly through the ages.

If only that 700 billion was used to rebuild our infrastructure by hand so many people had real work and we were back in the world of reality (like the WPA program). If they put that money into the base, it might percolate up, but they will give it to the top, still believing that it will trickle down. Nothing new here, it is the same song that has been going on for centuries, the perpetrators just tweak the verse a little so people think it a new tune. They will never learn from this because it is the human nature to never be satisfied, i.e. other animals will never build a home larger than they need.


  • At 6:27 AM, Blogger ryk said…

    I read somewhere an idea to take the $700 billion and use it to upgrade the national power grid, which would create a lot of jobs and simultaneously start moving us toward an energy independent electric future. It sounds like a great idea to me, but the conservatives have labeled it socialism and therefore out of the question. Drill, baby, drill is the capitalist way. Feh.

  • At 6:53 AM, Blogger Nader Enthusiast said…

    Ryk: It would probably be just the next new bubble with contracts awarded to the same corps who diversify.

    I hate to admit that McCain had a good idea, but I liked his idea of a reward for someone who comes up with a better battery.

  • At 4:06 PM, Blogger ryk said…

    It is a good idea, but if the "free market" these assholes are always touting actually existed that reward would take care of itself.

  • At 4:25 AM, Blogger Nader Enthusiast said…

    It is kind of sad, but I used to read biographies of inventors and most had the inventions stolen or "business partners" ripped them off and the majority die in poverty.

    Our country likes bounties. I don't know how many millions for Osama and they paid a bounty on most of the prisoners at Gitmo. Maybe we should switch everything to the bounty system. We could get rid of the police force and just give neighbors bounties for turning each other in, (though that actually didn't work at Gitmo since most of the detainees were innocent) etc.

  • At 11:53 AM, Anonymous R J Adams said…

    Ah, but we're not animals. Didn't you hear, we're the pinnacle of God's creativity. As such we have to show ourselves off in big mansions - built to the glory of God, of course.

    On the subject of batteries: while more efficient batteries are good, electric cars are a waste of time so long as the electricity used to charge them is produced by fossil fuels.


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