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Taipan Daily: The Greatest Ponzi Scheme Ever
by Adam Lass, Senior Editor, WaveStrength Options Weekly

Over the past few days, Justice has written of the horrifying frauds that have been perpetrated on the U.S. public of late. He’s done a wonderful job exposing the grimy details of Goldman Sachs’ glorified three-card Monte con, wherein they racked up immense profits by shorting the very assets they were pitching to clients.

Justice notes that the Goldman lawsuit may lead to the complete unraveling of trust on Wall Street. While this may indeed be true, I would posit that trust has always been a cyclic commodity on the Street.

There have been seasons when we thought these guys were geniuses capable of reinventing the world. No seemed to mind much in 1998 when these bright fellows got together with the geeks in Silicon Valley and converted half-baked cocktail napkin scrawlings into trillions of dollars in fictive wealth. Nor did I hear but so many complaints back in 2006 when Wall Street’s mortgage bond shell game enabled folks to sell $100K shoeboxes on tenth acre lots for half a million dollars.

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The Worm Turns

And then there are the dour moods that follow close on the heels of market crashes, episodes when we wouldn’t hand those guys a cup of water if their shoes were on fire. In 1869, following Jake Cook and Jim Fiske attempt to corner gold and the ensuing “Black Friday” crash, the worst thing you could think to call a gentleman was “market plunger.” In 1998, the term “Smartest Guy in the Room” was high praise reserved for the traders who literally inventing money. By 2001 it was the worst pejorative.

Indeed, these memetic shifts come and go with such fair regularity, they can be tracked and incorporated into mathematical models of the cycles that dominate our affairs. The rise in the ascription of pejoratives to financial barons usually precedes a period of primarily symbolic purges.

For example, in the previous failing cycle, the public was easily mollified by seeing such minor luminaries as Martha Stewart hung out to dry for the sin of trading on pillow talk, while such folks as Jim Cramer, Henry Blodget, James Glassman and Abby Joseph Cohen – the cadre that actually talked Middle America into plopping down its collective life savings on vapor ware – retain their positions of heady responsibility.

The Greatest Scam Ever?

Still, there was something Justice mentioned in his column on Monday that particularly caught my ear. Specifically he referred to the illusion of a recovery that is being purchased at the expense of our children’s future security as the worst sort of Ponzi scheme. This thought bears some further examination.

Charles Ponzi mistakenly receives credit for inventing pyramid schemes of this nature. Back in 1920, he was engaged ostensibly engaged in international reply coupon arbitrage. But with so many players interested in funding his gaming of the postal system, Ponzi soon abandoned any actual attempts to “invest” the incoming money in speculations of any type. Rather he simply began to pay off early participants with the cash he took from latecomers.

Cons of this nature are inherently unstable. The ever-increasing gobs of cash they require eventual draw attention from either suspicious investors or the law. In Ponzi’s case, the financial press got wind of the whole deal and Ponzi’s Old Colony Foreign Exchange Company collapsed as desperate participants rushed to withdraw what funds they could before the cops swept in and shut the whole thing down for good.

Too Smart to Fail?

Sound familiar? You’d think that this very well-known tale would have clued a few folks into what was coming coming down the pike when Bernie Madoff promised them the moon and stars.

But no one ever thinks this sort of thing can happen to them. They are too smart, too well educated to fall for these traps.

Or not.

Because Ponzi isn’t the first guy to try to pitch this particular shell game. Most of the folks who bought into both Madoff and Ponzi’s efforts were reputed to be relatively well educated. One might presume that they had read Charles Dickens’ 1857 novel Little Dorrit, wherein Mr. Dickens describes a similar rip-off at fair length.

This Time It’s Different!

Not only does education offer little protection, one might even posit that it gives a false sense of security. For example, there are some very well-educated types in Washington right now that think that they have actually improved on Ponzi’s scheme in such a fashion that THIS time it might actually work.

One problem with cash pyramids is the geometric increase in the amount of cash required to pay off each exiting tier of “investors.” No single operator could handle up that much cash. In the end, they are always buried under an ever-more unwieldy operation.

Ah, but sovereign governments deal in enormous volumes of cash all the time. Heck, if they need more they can either borrow it from future generations, or simply print as much as they need.

Indeed, perhaps the new appellation for a very well-educated Ponzi-scheme operator ought to be “central banker.”

“It’s Not Illegal When the President Does It.” – Richard M. Nixon

Another problem is legality. These days, most such scams are shut down by the cops before they can consume all available cash.

But “legality” is, after all, just a question of laws, as interpreted primarily by government lawyers. If the folks perpetrating the scheme have successfully penetrated the highest levels of government, than who’s to say what is illegal and what is merely “economics”?

I won’t even start on morality.

Simply Impossible

I suppose in the end, it all comes down to physics. In physics, we can state categorically that there is no such thing as perpetual motion. Every self-contained system is confronted by little robberies of energy that will eventually cause it to grind to a halt.

Economic Ponzi systems are no different. For example, we are already seeing the current one begin to fray at the edges. Over the past few days, we have heard that two of our largest banking institutions, Citigroup (C:NYSE), and Bank of America (BAC:NYSE), turned rather spectacular profits in the first quarter of 2010.

Now both organizations note that the main business of a bank – the lending of depositors’ cash to folks looking to buy houses and build small businesses – hasn’t been going so well these days. Indeed, the mortgage side of the house at BofA has set aside some $9.8 billion to cover continuing loan losses.

No, most all of these “banks” profits – some $7.2 billion – have come from active trading in the bond and stock markets. This answers a central question many of us on this side of Wall Street’s glass window have been asking as the markets spiked day after day after day: “Who the heck is buying this stuff?”

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The Next Mood Cycle

It clearly hasn’t been Main Street doing the investing or taking the gains. In fact, when you look to the more prosaic indicators of Middle American mood, you find things turning rather sour.

The April reading from Thompson Reuters/University of Michigan’s indexed poll of consumer sentiment has come in at its lowest levels in over a year. Pew’s poll on government trust topped that: It places sentiment regarding the competence of our leaders at a 50-year low.

In point of fact, we are seeing all the usual signs of a failing Ponzi scheme, with nervous “investors” looking to withdraw their deposits, only to find not only is there no payoff available, there will most probably be the opposite of profit, i.e. massive costs for decades to come.

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