Wall Street has a bit of Ponzi in Them

The problem for the press is what to do with the recent news from Wall Street. Put it in the crime section? Or the health section? As we guessed, more and more often, the ‘financial’ news is becoming a matter for the cops. This from the Associated Press:

“A handful of state securities regulators and a couple foreclosure-blighted cities have fired the opening shots with lawsuits trying to prove that investment banks and big lenders are guilty of more than just bad business decisions and failing to foresee looming mortgage troubles. Some regulators say greed and fraud underlie much of the subprime mortgage mess that has spread across the broader housing market, triggering a spike in foreclosures.

“Aside from the civil cases, the FBI is looking at possible criminal action, focusing on what Wall Street firms knew about the risks of mortgage securities backed by subprime loans, and whether they hid risks from investors.”

As we pointed out at the end of last week, all the latest products of Wall Street had a bit of Ponzi in them. Ponzi was a schemer from the early 20th century who figured out that he could pay people a high rate of return… entice more money into his hands… and pay the first investors’ yields with the capital investments from the last. It worked beautifully for people who got in early. But Ponzi schemes always blow up. The problem is essentially the same in all extraordinary financial episodes – from the South Sea Bubble to the Dotcom Bubble… to the Housing Bubble.

“Finance” itself adds very little to the world’s wealth. And the returns from “finance”… or, broadly speaking, from investing… can never actually exceed the real rate of wealth creation in the economy – at least, not for very long. Most financial activity is merely shuffling money from one person to another… giving the financial industry an opportunity to collect a toll along the way. But when a Bubble gets going, it begins to look as though there is a lot more wealth available to shuffle. The act of financing, itself, causes the value of the thing financed to rise. The first people in – who bought at low prices – make money. People coming in after them think they are buying into a booming market and bid up prices. What they are really doing is transferring money to the early investors – just like the late arrivals to a Ponzi scheme.

George Soros described the process as follows:

“Boom-bust processes usually revolve around credit and always involve a bias or misconception. This is usually a failure to recognise a reflexive, circular connection between the willingness to lend and the value of the collateral. Ease of credit generates demand that pushes up the value of property, which in turn increases the amount of credit available.”

Prices are neither fixed, nor random, is how we put it, but subject to influence.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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