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.

16 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

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?

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."

degoboy 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.

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!

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.

blogger 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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