Ponzi notions: What's Ponzi and what's not

by: Paul Rosenberg

Sun Mar 14, 2010 at 11:00

Every great American boom and bust makes and breaks its share of crooks. The past decade -- call it the Ponzi Era -- has been no different, except for the gargantuan scale of white-collar crime.

Downtown Williamston is located at the intersection of Grand River Avenue (M-43) and Putnam Street (Williamston Road). As of the 2000 census, the city population was 3,441. Williamston is most notable for its antiques markets, and it has been promoted as a quaint, small town just outside the larger city of Lansing.

and looks like this:

Definitely not Wall Street.

The article explains:

The more typical marks of the Ponzi Era, though, aren't as easy to see. Williamston, Michigan, for instance, lacks towering skyscrapers, Italian sports cars, million-dollar mansions, and massive security systems. A quiet town 15 miles from Lansing, the state capital, Williamston is little more than a cross-hatching of a dozen or so streets. A "DOLLAR TIME$" store sits near Williamston's main intersection -- locals affectionally call it the "four corners" -- and its main drag is lined with worn brick buildings passed on from one business to the next like fading, hand-me-down jeans. It's here, far from New York or Antigua, that thanks to two brothers seized by a financial fever dream, the Ponzi Era made its truest, deepest American mark.

Jay and Eric Merkle, active church members and successful local businessmen, were well known among Williamston's residents. In 2004, the brothers discovered that an oil-and-gas venture, which they had invested in and which promised them quick, lucrative returns, was a scam. They'd been duped. Their next move should have been simple: turn in the crooks and get on with their lives, their pockets a few dollars lighter. Jay and Eric, however, grasped the spirit of their age and made another decision entirely -- they teamed up with the guys who had ripped them off, in the process switching from prey to predator.

That first venture actually floundered, but in 2005, court records show, they started their own Ponzi scheme, Platinum Business Industries (PBI).  Based in Williamston, PBI claimed it was socking its investors' money into lucrative oil and gas exploration opportunities in Oklahoma and Texas, and it promised the investors absurdly high returns -- 6% a month, or 72% a year. Despite such promises, the brothers assured town locals handing over their hard-earned dollars that little risk was involved.  Even if the energy exploration didn't pay off, the land acquired by PBI was valuable and could be sold to offset any losses.

Like Madoff in Palm Beach, the Merkles in Williamston exploited local ties -- church and family -- to reel in new investors; and like Madoff's investment fund, PBI, too, was a complete sham, and a classic Ponzi scheme -- that is, an investment scam in which existing investors' returns are paid for with money from new investors.  In the case of PBI, there was no energy exploration in Oklahoma and Texas.

Some of the money they received from later investors the Merkles used to pay off earlier ones and give their scheme the look of success. But in their case, there was a rub. The Merkles were distinctly creatures of the Ponzi Era: they evidently couldn't help themselves.  Even as they ran their own Ponzi racket, documents show, they were getting fleeced.  What they weren't paying out in fake returns the Merkles bet on high-yield, get-rich-quick schemes in the U.S. and abroad that had nothing to do with oil and gas -- and other Ponzi schemers and con artists were robbing them blind.

When it all collapsed, tellingly, the Merkle brothers doubled down for one more round:

Their financial crime spree collapsed in 2008. Dead-broke, with investigators closing in, they told investors that various foreign governments and banks had frozen their assets.  The brothers then asked them to wire more than a million dollars to Nigeria, Ghana, and other countries as "fees" to release their money, even as they warned them against cooperating with an FBI investigation. Then, on a brisk autumn day in October 2008, the feds arrested to the two brothers; the game was up. In all, via PBI and other scams, they had duped more than 600 investors out of $50 million, robbing some of their life savings.

One does have to wonder if there's any real difference from the Merkle brother's last spree and the big bank spree of the last year or so.   Presumably the Merkle brothers weren't as successful-but that could always change in the months or years ahead.  But what comes next, in bold is equally, if not more important:

When compared to Madoff's or Stanford's heists, that sum was little more than pocket change. But the Merkle brothers caught the true, democratic spirit of a decade of an unrestrained magical thinking that infected rich and poor, successful and ne'er-do-well, the financially savvy and neophytes who couldn't tell a stock from a bond. Think of their story as a parable for the Ponzi Era: they were taken, decided to become takers, took others, then got taken again.  In the rush for the pot of gold at rainbow's end, they bet everything Main Street had to offer, believing they could get away with it.

The pervasiveness of the Ponzi mentality is well worth reflecting on, and I recommend the piece for your consideration.  But I also want to raise a caution.  Just as the Ponzi fever spread, so too, in it's wake has spread the sense of disillusionment-as well as the widespread use of the term, Kroll argues, noting three disparate examples: Tim Pawlenty describing "not just Social Security and Medicare but all federal government spending as the 'Ponzi scheme on the Potomac'," analysts describing the inexorable rise of China asa massive Ponzi scheme, even climate science expert Joe Romm blogging at ClimateProgress "Is the global economy a Ponzi scheme?" warning that:

You can get this burst of wealth that we have created from this rapacious behavior. But it has to collapse, unless adults stand up and say, 'This is a Ponzi scheme. We have not generated real wealth, and we are destroying a livable climate...'"

The very diversity of the uses the term is put to is precisely Kroll's point.  But it's also precisely the caution I want to raise.  The use of the term "Ponzi scheme" is itself spreading like a Ponzi scheme, clouding people's understanding with the very sort of false clarity about how the world works that Ponzi artists strive to cultivate in their marks.  Libertarian conservatives have been calling Social Security a Ponzi scheme for decades now, it didn't just start in the wake of Bernie Maddoff. The original "logic" here was quite simple:  First, misrepresent social insurance as a form of private investment, and then complain that (a) it provides a bad rate of return on investment on the one hand and (b) it's a Ponzi scheme on the other.

In fact, it's not even clear how much misrepresentation was involved, and how much was simply due to ignorance. Certainly those who presented themselves as authorities were lying about something-either their grasp of the subject area (they were ignorant) or the nature of social insurance generally and Social Security in particular. Nonetheless, those who did push this view of things were part of the broader movement to privatize government functions and deregulate markets and as such were part of the perpetrator class that is primarily responsible for the financial crash, the bubble mania that preceded and precipitated it, and the current recession and age of recrimination.

The fact that they've not been held accountable for any of it, but are instead using the crisis to up the ante and apply the "Ponzi scheme" meme to all of federal government just shows that they're made of the same stuff as the Merkle brothers, doubling down as their world falls apart, still looking to scam their way out of a tight spot, still upping their level of destruction.

The situation with China is a good deal more complicated.  On the one hand, the off-shoring of US industrial capacity was a Ponzi scheme relative, in that it represented a financial decision promising a return that could not logically be realized in the long run, but that could be kept going in the short run, at least for "good enough" appearances' sake.  This is not a Ponzi scheme proper, but it is a close enough relative to be worth considered as provisionally similar and deserving of special study in order to further elucidate.

But that only speaks to the US role in helping to create first Japan, then the other "Asian Tigers", and finally China as industrial powers based on exports to the US.  What about those countries themselves?  They, too, are functioning in economically unsustainable ways, but this does not immediately prove that the same sorts of self-deception were involved.  After all, it could well be sufficient for them to think, "Well, this can never last, but for a good long time, it can help us develop economically in ways we could never do otherwise, so let's just do that now, and worry about what comes next later on."

Whatever manipulations China is now involved in, its basic development logic seems much more likely to come out of this sort of reasoning-and what I know of Chinese history (I'm no expert, by any means)   supports this view.  This doesn't mean I'm arguing that China couldn't suffer a Ponzi-like crash. But it does mean that there's a good deal else besides a Ponzi scheme going on there, and we're fooling ourselves if we try to convince ourselves otherwise.

Finally, the applying the "Ponzi scheme" meme to our current economic system as a whole vis-a-vis unpaid externalized environmental costs is a good deal more problematic.  The Ponzi model is one that promises ridiculously high returns on investments, and that's certainly the case with our environmentally unsustainable practices as a whole.  But the underlying mechanisms of how those promises are not met, and how hidden costs are incurred constitutes a very different model, a very different sort of understanding in order to come to grips with what needs to be changed, and how to go about changing it.

For that reason, I think it's important that people should refrain from using the "Ponzi scheme" meme to talk about anti-environmental economics.  It can be okay to use language like "Ponzi-like promises of impossible returns that hid the full picture of what's going on."  But this should only be used as a transitional device to steer the discussion to more solid footing in terms of externalized costs and the destruction of unpaid-for ecosystem services, as well as inter-generational obligations, and other positive motivatios for more just, sustainable and broadly beneficial types of activity.

In short, we need to resist the Ponzi-scheme temptation to take yet another shortcut to realize our dreams.