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Planet Ponzi by Mitch Feierstein
CHARLES Ponzi, an Italian, landed in Boston in 1903 with $2.50 in cash. He died in in poverty in a charity hospital in Rio de Janeiro, but he left a legacy – the Ponzi scheme.
Desperate to get rich, Ponzi discovered that Italian prepaid stamps - the sort used to facilitate the return of mailed goods - sold at four times their price in the USA. So he sent for stock to sell in the USA, expecting profits of hundreds of percent.
Unfortunately, it was much more complicated than he expected, but that didn’t stop him telling others about his scheme and inviting them to invest with him. He promised to double their money in 90 days, and they came in droves. Ponzi paid out the profits after 90 days, despite never having bought any prepaid stamps ever again.
How did he do it? He simply paid out investors with funds taken in from new investors. As long as investors got paid, there were many new investors excited to get an effective 1 500% per annum when interest rates elsewhere where 5%. Charles Ponzi lived in grandeur as money flowed into his fund.
The problem was the liability side of the balance sheet. Effectively, every 45 days the liability increased by 50% while Ponzi raided the asset side.
It all had to end when investors could not be paid out, because new investors could not be found fast enough. It ended in tragedy for all those left in the scheme, losing all their money and often their homes as well.
And the Ponzi scheme was born. It has been repeated many times since with Bernie Madoff being the most recent, high profile example. All Ponzi schemes have the same structure which makes them very easy to spot. They have rapidly mounting debt and non-existent or inadequate assets.
They have deceitful or non-existent accounting, and exist where there is weak or toothless regulation. They thrive in a get-rich-quick culture combined with ignorant, lazy investors who can’t be bothered to do their homework on their investments. The greedier the investors the better, and they should also have a good capacity for self-delusion.
Feierstein is hardly concerned with the cheap little crooks like Ponzi and Madoff, who only stole a few billion - his interest is the big guys who use the same format schemes to cripple entire industries and even entire economies. The chief culprits are governments of large developed countries and bankers.
Feierstein is no conspiracy theorist, he is a very successful hedge fund manager and his book is based on sound research and statistics from completely credible sources, all cited and all accessible to the reader: the Federal Reserve Bank of the US; the OECD’s research findings; S&P data; the Financial Times; the Economist’s research; McKinsey Global Institute, and many more.
His focus is the US and Europe, with passing references to Australia (pretty clean,) Korea, China and South American countries.
Why should a South African read this book? Two reasons: the world economy is fully integrated and what happens to our trading partners will affect us very quickly, and we have lessons to learn for our country and our investments.
Feierstein describes a fictional character, Joe Schmoe, who has a job, some savings and gets married. He needs $10 000 to buy a house, but only has $2 000. He goes to his local bank for a loan. The bank manager investigates Joe’s work record, the stability of his employer and Joe’s character.
Based on this information and judgement he makes the loan. For his trouble and the risk he takes that Joe could turn bad, or his company fail, he charges interest on the loan. If all goes well, the bank makes a respectable profit and Joe has a home.
But that was then and this is now. Joe’s grandson, Joey, is unemployed and lives with his girlfriend in a rented trailer in a trailer park. Over a joint one evening Fat Boy, his neighbour, tells him that he has been given a 105% loan from the bank to buy his trailer and Joey should do the same.
The bank doesn’t care that they don’t have jobs or what they do with the extra 5% of the loan (in this case they are smoking it).
How can a bank afford to do this? First, bundle a whole lot of Joeys and Fat Boys together with others and “disperse” the risk by the “securitisation process” and on-sell it to others who again do some bundling and on-sell.
Then, create SIVs out of this and on-sell based on a AAA rating by a respected agency to be packaged in a structure called a CDO, which can then be bundled into a CDO-cubed, which can be insured against credit risk and default by a CSO.
Joey’s grandfather’s banker would be puzzled by this - after all, risk is risk and if you don’t know the strength of the collateral (Joey and Fat Boy’s character and career stability) all you have “dispersed” is your common sense.
I picked this example from the book only because the context is so well known and therefore easy to describe. There are many, many more examples in the book, ranging from pension funds to medical insurance.
This is a case book Ponzi scheme of gargantuan proportions, as described above, and like all Ponzi schemes has no happy ending.
And then there are government Ponzi schemes. The US government has run up huge debts bailing out delinquent banks, fighting non-essential wars, supporting spurious causes locally and in other countries. The US Federal debt is fast approaching $18 trillion - a sum so big it means nothing at all.
So what could you buy with it? All of the following: the world’s oil production for 2011; all the farms in the US; the sovereign debt of Spain, Portugal, Greece and Ireland; Apple, Microsoft, IBM and Google; all America’s military hardware; all the real estate of Manhattan and Washington - and you would still have change of around $16.5 trillion.
How does a country pay off its national debt? Only really by tax collection, or you can fake it by printing money.
The American government can’t collect nearly enough taxes in a weak economy, with too many of their companies of GE and Exxon Mobil size given breaks so they pay hardly any tax, and the richest 1% paying a smaller proportion of their earnings in taxes than do their secretaries.
This is not an American anomaly; most of the largest European countries and a cohort of others are just smaller imitations. Welcome to Planet Ponzi!
Why read this book? We are all in serious trouble, all of us on this interconnected Planet Ponzi. There will be no happy ending – there never is for Ponzi schemes.
The best we can do is to understand what is inevitably coming and take thoughtful, painful decisions that will give us some protection as a nation and as individuals. Ponzi schemes thrive on self-deception and this book is a good start to avoiding that.
Readability: Light --+-- Serious
Insights: High +---- Low
Practical: High --+-- Low
* Ian Mann of Gateways consults internationally on leadership and strategy.
CHARLES Ponzi, an Italian, landed in Boston in 1903 with $2.50 in cash. He died in in poverty in a charity hospital in Rio de Janeiro, but he left a legacy – the Ponzi scheme.
Desperate to get rich, Ponzi discovered that Italian prepaid stamps - the sort used to facilitate the return of mailed goods - sold at four times their price in the USA. So he sent for stock to sell in the USA, expecting profits of hundreds of percent.
Unfortunately, it was much more complicated than he expected, but that didn’t stop him telling others about his scheme and inviting them to invest with him. He promised to double their money in 90 days, and they came in droves. Ponzi paid out the profits after 90 days, despite never having bought any prepaid stamps ever again.
How did he do it? He simply paid out investors with funds taken in from new investors. As long as investors got paid, there were many new investors excited to get an effective 1 500% per annum when interest rates elsewhere where 5%. Charles Ponzi lived in grandeur as money flowed into his fund.
The problem was the liability side of the balance sheet. Effectively, every 45 days the liability increased by 50% while Ponzi raided the asset side.
It all had to end when investors could not be paid out, because new investors could not be found fast enough. It ended in tragedy for all those left in the scheme, losing all their money and often their homes as well.
And the Ponzi scheme was born. It has been repeated many times since with Bernie Madoff being the most recent, high profile example. All Ponzi schemes have the same structure which makes them very easy to spot. They have rapidly mounting debt and non-existent or inadequate assets.
They have deceitful or non-existent accounting, and exist where there is weak or toothless regulation. They thrive in a get-rich-quick culture combined with ignorant, lazy investors who can’t be bothered to do their homework on their investments. The greedier the investors the better, and they should also have a good capacity for self-delusion.
Feierstein is hardly concerned with the cheap little crooks like Ponzi and Madoff, who only stole a few billion - his interest is the big guys who use the same format schemes to cripple entire industries and even entire economies. The chief culprits are governments of large developed countries and bankers.
Feierstein is no conspiracy theorist, he is a very successful hedge fund manager and his book is based on sound research and statistics from completely credible sources, all cited and all accessible to the reader: the Federal Reserve Bank of the US; the OECD’s research findings; S&P data; the Financial Times; the Economist’s research; McKinsey Global Institute, and many more.
His focus is the US and Europe, with passing references to Australia (pretty clean,) Korea, China and South American countries.
Why should a South African read this book? Two reasons: the world economy is fully integrated and what happens to our trading partners will affect us very quickly, and we have lessons to learn for our country and our investments.
Feierstein describes a fictional character, Joe Schmoe, who has a job, some savings and gets married. He needs $10 000 to buy a house, but only has $2 000. He goes to his local bank for a loan. The bank manager investigates Joe’s work record, the stability of his employer and Joe’s character.
Based on this information and judgement he makes the loan. For his trouble and the risk he takes that Joe could turn bad, or his company fail, he charges interest on the loan. If all goes well, the bank makes a respectable profit and Joe has a home.
But that was then and this is now. Joe’s grandson, Joey, is unemployed and lives with his girlfriend in a rented trailer in a trailer park. Over a joint one evening Fat Boy, his neighbour, tells him that he has been given a 105% loan from the bank to buy his trailer and Joey should do the same.
The bank doesn’t care that they don’t have jobs or what they do with the extra 5% of the loan (in this case they are smoking it).
How can a bank afford to do this? First, bundle a whole lot of Joeys and Fat Boys together with others and “disperse” the risk by the “securitisation process” and on-sell it to others who again do some bundling and on-sell.
Then, create SIVs out of this and on-sell based on a AAA rating by a respected agency to be packaged in a structure called a CDO, which can then be bundled into a CDO-cubed, which can be insured against credit risk and default by a CSO.
Joey’s grandfather’s banker would be puzzled by this - after all, risk is risk and if you don’t know the strength of the collateral (Joey and Fat Boy’s character and career stability) all you have “dispersed” is your common sense.
I picked this example from the book only because the context is so well known and therefore easy to describe. There are many, many more examples in the book, ranging from pension funds to medical insurance.
This is a case book Ponzi scheme of gargantuan proportions, as described above, and like all Ponzi schemes has no happy ending.
And then there are government Ponzi schemes. The US government has run up huge debts bailing out delinquent banks, fighting non-essential wars, supporting spurious causes locally and in other countries. The US Federal debt is fast approaching $18 trillion - a sum so big it means nothing at all.
So what could you buy with it? All of the following: the world’s oil production for 2011; all the farms in the US; the sovereign debt of Spain, Portugal, Greece and Ireland; Apple, Microsoft, IBM and Google; all America’s military hardware; all the real estate of Manhattan and Washington - and you would still have change of around $16.5 trillion.
How does a country pay off its national debt? Only really by tax collection, or you can fake it by printing money.
The American government can’t collect nearly enough taxes in a weak economy, with too many of their companies of GE and Exxon Mobil size given breaks so they pay hardly any tax, and the richest 1% paying a smaller proportion of their earnings in taxes than do their secretaries.
This is not an American anomaly; most of the largest European countries and a cohort of others are just smaller imitations. Welcome to Planet Ponzi!
Why read this book? We are all in serious trouble, all of us on this interconnected Planet Ponzi. There will be no happy ending – there never is for Ponzi schemes.
The best we can do is to understand what is inevitably coming and take thoughtful, painful decisions that will give us some protection as a nation and as individuals. Ponzi schemes thrive on self-deception and this book is a good start to avoiding that.
Readability: Light --+-- Serious
Insights: High +---- Low
Practical: High --+-- Low
* Ian Mann of Gateways consults internationally on leadership and strategy.
