May 07, 2006

On Ponzi Schemes and the Housing Bubble


You hear me say that the housing bubble is just a ponzi scheme - the biggest ponzi scheme of all time, the biggest financial bubble in human history.

Well, let's look at what a true ponzi scheme is, and then relate it to the housing bubble:

From Wikipedia:

A Ponzi scheme is a fraudulent investment operation that involves paying abnormally high returns ("profits") to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business.

OK so far. "Abnormally high returns ("profits") - that sounds like our friend the bubble. Why work for a living when you can just buy a condo, and earn 20%, 50%, 100% in 2 years? Boy, those are some abnormal returns aren't they?

Especially when you consider the return is much higher than 20%, 50% or 100%. Say you buy a $500,000 condo in Miami, for 5% down or $25,000, and it goes up 50%, or $250,000, heck, even before you move in. So $25,000 to make $250,000, that's 10 times your money! Or a 1000% return! Now that would make Mr. Ponzi smile!

And who's paying those returns, those "profits"? Yup, you got it, the "subsequent investors" - the latecommers to the ponzi scheme, the new home buyers, the former renters, the folks getting in with no-down, no-doc, interest-only teaser-rate schemes.

But this is a "real business" isn't it? I mean, like shining shoes, or building widgets, right? Buying a house, that's work, man. I should get paid for my work and labor, right? OK, we all see now that this isn't a real business. There's no work involved. Just riches, or the promise of riches.

Wikipedia finishes with:

A Ponzi scheme must have abnormally high short-term returns in order to entice new investors. The high returns that a Ponzi scheme advertises (and pays) require an ever-increasing flow of money from investors in order to keep the scheme going.

For the housing bubble, the reason it's over now is that the new money in has dried up. The scheme blew up when the expectations of future rises blew up. Now the smart money is heading out, rushing out, and only the terribly stupid are still trying to get in.

So, class is out. I'd encourage you to read the whole wikipedia entry (and also their one for Housing Bubble), and do more research on historic ponzi schemes. This one will be written about for ages, and it's been a fascinating case study all along, but it's going to get real interesting now as it unravels.

59 comments:

Anonymous said...

putting the photos of lereah next to ponzi is brilliant

could this be more obvious?

Anonymous said...

good god that about sums it up as best as I've ever seen

i'm emailing this post to everyone I know

dude, you better get some security, every realtor and developer is going to be calling for your head for screwing it all up for them

David said...

We love u keith. :-)

Anonymous said...

Sounds a lot like social security too. Great returns for early investors, while the more recent ones will get squat.

Too bad unlike dear Charle's scheme, social security isn't a voluntary program.

Anonymous said...

Sequential Ponzi schemes - stocks, real estate, the dollar, the U.S.

Dogcrap Green said...

Houses are cheaper today than they were 15 years ago

panicearly said...

whats worse is ,
the real Charles Ponzi did not intend to bilk his investors.
He had a plan to convert US dollars into highly devalued Italian lira and purchase international shipping stamps
that were still being sold at pre devaluation prices, and sell them in the US to US export companies at a discount converting the stamps back to n by greed
dollars. He reasoned that he could sell them at a 10-20% discount in bulk and still make 400-500% profit.
So he offered up to 50% returns for 90 day investment. His plans never came together for the stamps,and with so many investors flooding in, he became trapped, but he never skipped out of town with the money either. And spent the whole time trying to figure a way out, till it just got too big. So there was some integrity in Ponzi as he never had an intention of stealing or runnign with the loot. He actually did not even lie, after the 90 days when investors came he gladly gave them 50% return, at which time, they immediatley re invested and the word spread like wild fire.

today with housing ponzi scheme, everybody is in on it to keep the game going. everybody is out for a buck,
Bush knows that the euphoria by easy lending keeps people think they are getting rich, greenspan helped with the distraction from the war
Realtors make their commision
appraisers are on the take
media make their ad revenues
and they pumped up the get rich stories

Brokers make their cut
lenders make their cut and send it up stream
fund managers make their cut by buying and trading the mbs
wallstreet loves the increase in trading
homeowners are giddy and their sex lives temporarily improved, the wives gotnew & bigger boobs and hubbys felt virile & proud.
ponzi would be dissappointed as
everyone knows his name but many
did not learn from his misadventure.

panicearly said...

sorry didnt edit my post

panicearly said...

oh another little interesting tid bit
Ponzi`s company name was,
brace yourself for this one...
here it goes...
Securities Exchange Co
this was before we had a SEC

Anonymous said...

A rhetorical question to ponder: Why is it an "investment" when you buy a condo and immediately flip it at a 28% price increase, but “price gouging” when the oil companies raise the price at the pump?

panicearly said...

maybe price gouging is for necessities we cant live with out.

ocrenter said...

for a perfect example of how to lose your shirt in this great Ponzi scheme, see the Final Update on the "Flipper in Trouble."

road hog courier said...

There was the USA Capital BK filing where investors were promised 12-14% returns for investing in some commercial properties secured by TD's. They were getting paid for a while till the whole thing collapsed and USA filed BK, causing individual investors(some retired)to loose as much as $200,000. Google USA Capital bankruptcy for the whole story.

Anonymous said...

Multi level marketing is a Ponzi Scheme.

Say a Cyberwize presentation the other day. That is definitely a Ponzi Scheme.

cereal said...

putting delereah next to ponzi is an insult to


well.......ponzi!

foobeca said...

Those two pics are begging for a chop.

bearmaster said...

I never thought of an asset bubble (with its accompanying mania) before as a kind of Ponzi scheme, but it sure fits the definition!

uknowwhoiyam said...

Neither housing, stock nor commodities bubbles qualify as Ponzi schemes.

uknowwhoiyam said...

anonymous asked:
Why is it an "investment" when you buy a condo and immediately flip it at a 28% price increase, but “price gouging” when the oil companies raise the price at the pump?

Good question, and it's anything but rhetorical.

People who call the 3% profit margin that oil companies like Exxon are making are - and I'm trying to be charitable - ignorant.

Only $0.10 of that $3 per gallon price at the pump is oil company profit.

foobeca said...

The housing, stock, and commodities markets can all be in essence ponzi schemes at certain points in time. Basically when it becomes a bubble, it is a ponzi scheme.

A house whose price is in line with the fundamentals is not part of a ponzi scheme. A company who returns good value to shareholders is not part of a ponzi scheme.

Anonymous said...

"Only $0.10 of that $3 per gallon price at the pump is oil company profit".

Yet, $0.50 cents goes to the government, the oil companies and the government point fingers at each other to avoid the real issue, "peak oil", we will be out of oil within the next 15 years, sooner if China and India continue to boom, and Americans keep driving their SUV's.

foobeca said...

How are we going to use the 1.3tril bbl of known reserves in the next 15 years? There's 50 years worth of oil at present consumption rates. And that assumes that there isn't a drop of new oil found.

And then there's the tar sands, which could be 3-4 trillion bbl of oil.

foobeca said...
This comment has been removed by a blog administrator.
uknowwhoiyam said...

Basically when it becomes a bubble, it is a ponzi scheme.

Dead wrong. It has to be fraudulent.

foobeca said...

It all depends on how broad or narrow you want to define "ponzi scheme." There's no doubt that fraud has helped inflate the bubble.

No one person has devised the housing bubble. It just sorta happened when the right ingredients came together-greed, sloth, easy credit, cheap credit, tax incentives, and ignorance. A ponzi scheme is usually planned and orchestrated by a person or group of people. So, in that sense housing is not a ponzi scheme.

So basically, ponzi schemes and bubbles have the same effects. They both require more and more investors (and money) to sustain the schemes. Neither actually produces any new real wealth, but steals it from unwitting new investors.

Bubbles also differ from ponzi schemes in their scale. This housing bubble dwarfs any bubble previous to it or any other ponzi scheme in dollar terms and the number of participants. There's literally hundreds of millions of people that have fallen prey to the bubble mentality in the US and around the world.

keith said...

this bubble met every criteria of ponzi scheme - didn't you read the definition?

if you want fraud, then look to the real estate industrial complex - the realtors paying off the appraisers, the mortgage bankers making the numbers "work", bob toll blabbing away and david lereah putting out deceiving and untrue reports

we're talking about system wide fraud on a historic scale

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