Thursday, December 18, 2008

Bailouts / Ponzi Scheme

As the U.S. government is looking for something or someone to blame for the housing and banking debacle,  finally it seems that they have chosen Bernard Madoff as one of the many scape goat's in a supposed Ponzi like scheme.  

Today's schemes are often considerably more sophisticated than Ponzi's, although the underlying formula is quite similar and the principle behind every Ponzi scheme is to exploit investor naïveté. 

Back in May, four months before it collapsed, American International Group Inc. increased its dividend at the same time it unveiled plans to raise $12.5 billion in capital. Later, when its cash ran out, AIG got a government bailout, the size of which has expanded to about $150 billion.
It might not have been such a bad thing for those shareholders that invested in the last round of $12.5 billion in capital.  It has been shown that entering a Ponzi scheme can be rational even at the last round of the scheme if a government will likely bail out those participating in the Ponzi scheme.  

Fannie Mae, Freddie Mac and Citigroup are just a few firms that have required taxpayer bailouts to the tune of hundreds of billions of dollars.  They were not running a traditional Ponzi scheme but their scheme collapsed under its own weight, as investment slows and the promoters start having problems paying out the promised returns. 

It seems that many companies have a business model that resembled  a Ponzi scheme.  Ponzi hired a publicity agent, James McMasters.  The so called legit companies did too. However, Ponzi's publicity agent quickly became suspicious of Ponzi's endless talk of postal reply coupons, as well as the ongoing investigation against him. He went to the Post, calling Ponzi a "financial idiot." The paper offered him five thousand dollars for his story, and ran a headline on August 2 declaring Ponzi hopelessly insolvent.  We have all heard the world insolvent recently in the news.

When a Ponzi like scheme is exposed, legal authorities begin examining accounting records of the so-called enterprise and they find that many of the "assets" that should exist do not. 

In Michigan a company and A.J. Obie, two firms with the same managers, Sixteen hundred investors lost approximately $50 million.  In what was described as the largest reported 'Ponzi' scheme in the history of the state.  The scheme led to the passage in 1987 of the MBLSA (Mortgage Brokers, Lenders, and Servicers Act)."

Another Ponzi like scheme, Lou Pearlman's scam involved bilking investors out of their savings with a fraudulent savings and loans program claiming it to be FDIC insured though it was not. 

Fast forward today Ponzi’s schemes are very much alive.  Wall Street and its bankers, mortgage lenders, and soon to be automakers were all caught running Ponzi like schemes.  

2 comments:

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