Our Economy a Ponzi Scheme?

Ponzi Schemes: The Haul Gets Bigger but the Fraud Never Changes, Eduordo Porter in today's NYTimes...(this will be the last today from the NYT, I promise).

And Mr. Madoff’s strategy doesn’t just recall that of snake-oil peddlers of yore. It is strikingly similar to that of the brokers and the financiers who built lucrative legal businesses convincing investors that something — Internet stocks, American homes, Dutch tulips — would appreciate forever for some superspecial reason.

What’s a Ponzi scheme but an illegal ruse to entice the gullible with the promise of too-good-to-be-true returns in arcane investments using an intimidating cloud of abstruse financial lingo? Ponzi frauds have the defining characteristic that returns to the first batch of innocents are paid from the money invested by the second batch. That sounds a lot like today’s American real estate market.

And Ponzi frauds often have similar ends to our increasingly frequent bubbles. Not only do they both usually collapse, but so many rich and influential French investors were taken by John Law’s fraud in the 18th century that the government felt compelled to bail them out. According to Utpal Bhattacharya, a professor of finance at Indiana University, it exchanged the investors’ worthless stock for bonds secured by Paris’s municipal revenues.

There are, of course, important differences between fraud and standard financial practice. Crucially, bubbles are powered by fools of increasing gullibility, who are willing to pay an even greater price to buy an asset from the fool that bought it in the preceding round. Ponzi schemes only require that their investors be foolish.