Visualizing the Future #12: Ponzi Schemes or Financial Progress?

Tonight's post involves some sleight of hand.  If you've ever watch a shell game or 3 card monty, you know that being told you're going to be tricked doesn't help at all.  You're still the shill and you always pick the wrong shell.

So I'll explain the trick quickly.  Tonight, I will give you a brief introduction to the topic and hopefully, arouse your curiosity.  The rest of the trick will wait until tomorrow.  Here goes.

The last several years have sent shockwaves through the global financial system.  At their best, they have showed us the fault-lines in our economic models and the perils of complex derivatives, over-leverage and bubble thinking.  At worst, the meltdown points fingers of blame at every player in the economic world, from the homeowner taking a 0% loan knowing he had no job to the mortgage broker doing the loan, the banks buying it and repackaging it to the insurers underwriting tranches of them and hiding them "out back" where no one could see.  But this is a story as old as capitalism, a story of power and "progress", the rich, middle class and poor plodding clumsily forward together, lugging the engine of the economic state.

Bernie Madoff was something different altogether.  The level of his deceit was so pathological that it seems almost an accident that it occurred at the same time as the financial crisis.  Of course, to quote Warren Buffett, "You don't know who's swimming naked until the tide goes out".  And Bernie certainly was naked - a con man through and through.  He defrauded and bankrupted hundreds of those least able to pay; elderly couples, charities, even Elie Wiesel.  Horrible.

But here's where it gets weird.  When Madoff's scam was wound down, the largest beneficiary was discovered to be an accountant named Jeffry Picower.  He had earned annual returns of between 120% and 950%  over the years.  Being an accountant (and lawyer), it's clear that he operated an effective shell game, deftly moving funds  around various legal entities. When the Madoff judgement came down, Picower settled claims against him for $7.2 Billion.  That's an accountant who hasn't been charging by the hour.  

But before suffering a massive heart attack and drowning in his Olympic size pool, he and his wife left MIT a $50M gift which created the  Picower Center for Learning and Memory .  It is a world class operation, with 35 elite scientists studying the brain and seeking cures for Alzheimers.  They are doing noble work that will save lives.   And the Center has kept his name.  (Still know which shell the ball is under?)

I wrote a piece on the Future of Money in October's MEDIA magazine.  I'd like to leave you with a cliff-hanger quote from it and hope that in the comments, you'll discuss the differences between legal and illegal gambling and financial markets.  What rules matter most?  How about government versus organized crime?

Money emerged as a method for recording a promise to pay and was the first medium to communicate trust. As early as the 2nd Millennium BCE., Mesopotamian clay tablets recorded debts redeemable for grain. Encoded in such transactions was trust and belief in the fact that the promise of payment in grain would be upheld. In fact, the word “credit” comes from the Latin word “credo”, or literally “I believe”.  (Media Magazine, October 2011)

I  began yesterday regarding judgements of right and wrong or legality regarding gambling.  Gambling history, specifically in Vegas, is interesting. In the beginning, gangs and organized crimes ran the daily lottery in New York - the "numbers".  Then Vegas was developed, financed by the Mafia.  When it became more successful, the Mormons provided much of the funding.  By the 1970's, the Teamsters were underwriting much of Vegas' development.  Finally, the industry and the city acheived the most American of coronations and blessings.  They went Public, legitimized by Wall Street.  

I'll begin tomorrow discussing the image below.  It's a Lottery Ticket, issued to by the Continental Congress in 1776.  The country was raising money to fight the Revolutionary War against Britain. The buyer was individually taking a chance on the future.  He purchased the chance to individually win a bauble, and all together, the colonists raised the capital to win Liberty.  A Ponzi scheme or the basis of a nation?  Both.

Till tomorrow,

R

Comments

[Michael J.J. Tiffany]

Buying lottery tickets is widely ridiculed by intellectuals as irrational - "a tax on people who can't do math." But the expected utility of a lottery ticket can easily exceed its purchase price, because lotteries pay off in the short term while low(er) risk forms of "savings" do not. Consider a lottery that takes half the money and pays out the other half to the winner. The nominal "expected value" of a $1.00 ticket is $.50. But a lot of people would consider being a millionaire now (from the lottery) ten times more valuable than being a millionaire at age 72 (from the compound interest on the money otherwise spent on lottery tickets). Once again, the people at my local bodega show more wisdom that the ones at my local coffeeshop.

On balance, I bet that tight relationships and webs of trust are more inflation-proof than the dollar. But Madoff is a potent counterexample, since his success was based on exploiting those things. Still, I would bet on my community's fraud-resistance and future productive capacity over the future value of holding any particular currency.

[Reuben]

This is so awesome Michael.

Can you help by explaining this part of little more. I'm pretty sure I know what you're saying, but I like to be sure for me and for readers. (If I don't hear from you within an hour, I'll come down to Coney Island and have the folks at your local bodega explain it to me)

YOU WROTE " Consider a lottery that takes half the money and pays out the other half to the winner. The nominal "expected value" of a $1.00 ticket is $.50. But a lot of people would consider being a millionaire now (from the lottery) ten times more valuable than being a millionaire at age 72 (from the compound interest on the money otherwise spent on lottery tickets)"