Ponzi, Madoff, and Franklin Roosevelt

In the past year, as the fog of unstoppable economic success lifted and some semblance of market clarity entered investors’ minds, a sobering phenomenon began to occur. It appears as though nobody had bothered to notice, during our extended surge of prosperity, that more than a few freeloaders had been discreetly riding the tidal wave at investors’ expense. After the discovery of Bernard Madoff’s $50 billion Ponzi scheme, many more suddenly surfaced, and suddenly the Securities and Exchange Commission was paying attention. In fact, 74 such schemes have been uncovered in the last two years, targeting an expansive range of people, from charitable institutions to deaf investors to retirement home residents. Throughout economic history, there have always been people who had the audacity to swindle money, but it is the ever-growing magnitude of recent endeavors that proves the most frightening. Such schemes are carefully formulated and conducted, in order to run below the surface of the roiling economic waters by which investors are captivated.

Charles Ponzi, caught in 1910, was certainly not the inventor of the ploy, but was the first person to accomplish the feat on a relatively large scale in the United States. Boiled down into its basic constituents, a Ponzi scheme requires a good salesman and a lot of suckers to take the bait. The operator takes money from people with promises of high returns, and pays them bits of their own money back as “returns” to satisfy them. As more people give money, the pool grows larger, and can keep paying these “returns” without ever physically investing a dime. In reality though, if everyone wanted their money returned at this point, nobody could retrieve the full amount of their investment, because part of it has already been paid to others, not to mention the often hefty salary Ponzi operators bestow upon themselves as a reward. The money pool can grow large enough that it can pay back in full those who back out, so as not to arouse suspicion from authorities, but the scheme as a whole resembles to a fire—it can only maintain its expansion as long as there is a supply of oxygen to feed it. Ponzi schemes can be massive, but they are fundamentally self-contained by the number of willing investors, and are therefore destined to die out after reaching critical mass.

But wait, why does this scenario sound hauntingly familiar? Perhaps it is because one such condition has been in operation since 1935, when it was signed into law by President Franklin Roosevelt. America has long been nervous about the fate of Social Security, and rightfully so. It is, essentially, one enormous nation-wide pyramid scheme, in which the first round of investors are paid by the second round of investors, for generations and generations. Having just discussed the inevitable outcome of such a process, the moment of truth has already arrived; there aren’t enough new donators to pay off baby-boomer receivers, and the timer on the bomb is ticking. Privatization of the system has been proposed, but running a business requires profitability, a trait Social Security structure clearly lacks. Are there other options? Short of pure government expenditure, no, not without sacrificing the whole program and starting over. Nobody would think to associate Madoff with Roosevelt, but unfortunately both designs have been fated to failure from the moment of inception.

Is Nationalization on the National Agenda?

Now that the health of Apple’s CEO, Steve Jobs, has faded once more into the background of economic news, a new source of gossip must arise to fill the role of the source of stock market volatility. Such conversation turned to plans of nationalization of floundering banks. The word itself resonates with a nerve-racking uncertainty, enough to instill fear in both types of investors: those that understand the process, consequences, and benefits, and those who yet do not. A surprising number of people hear the word ‘nationalization,’ imagine an economy dominated and controlled by government, and acknowledge such an outlook as a complete failure of America. For a nation built upon economic freedom, this scenario is a blatant nightmare. Sensing this was a touchy subject, both President Obama and Fed chairman Bernanke have been reassuring the general public that such drastic measures would not be necessary, and conveying that simply holding a minority stake in a bank is a superior solution, as opposed to bankruptcy or seizure. It seems that investors’ suspicions are unfounded, even though it does indeed seem as though banks are running out of options. Many have actually forgotten that the topic of nationalization has already come up at the onset of the financial crash.
Needless to say, Wall Street is not a fan of this chatter. In fact, a conflict of interest becomes evident, in that any investor with any stake in a bank stock dreams of a scenario where government would just toss billions to banks with no repercussions or stipulations. However, this situation would be counterintuitive to our assumed long-term goal of restoring financial stability, which would, overall, have a more beneficial effect than merely allowing bank stocks to minimally survive and scrape along the bottom. During nationalization, shareholders are given an offer they can’t refuse: the FDIC will pay each one a whopping $0.00 per share. Furthermore, the bank loses its executives and operates under complete governmental control, which contradicts our current motions of mere investment in a bank’s future. Why would such a course be considered as a viable solution?
As one example, consider the case of Sweden during the 1980’s. The nation’s collapse commenced in a shockingly familiar fashion; financial deregulation increased real estate lending without regard for the value of collateral, which could not maintain its ascension indefinitely. At one point, interest rates hit a mind-numbing 500%. In 1992, Sweden’s entire banking sector was nationalized, and absorbed into the governmental realm. All deposits were guaranteed, confidence in safety boomed, and the government had a direct stake in the success of each bank. When the economy had demonstrated a sufficient recovery, the majority of the banks were re-privatized, through which the government was able to salvage the bulk of its initial nationalization effort, and minimize net change in the deficit. Admittedly, a large cushion of capital is necessary to privatize each institution, and it is the government’s responsibility to generate those profits—a task federal administration is not accustomed to performing.
Clearly, nationalization can work as a viable solution to our financial crisis, but only if such strategies are imposed quickly. At this point, our banks are worth very little, and the government has already invested billions of dollars to keep them afloat—an effort which, though unorthodox and possibly inadequate, should not be wasted. Though I am a strong believer in the ability of markets to restructure themselves, nationalization may have been a feasible opportunity if applied early, but having come thus far, we’ve most certainly missed the boat. Given that our government is so averse to the concept, and substantial efforts have forced a massive bailout plan into action, the entire notion is effectively inapplicable.

Car companies: driving off a cliff?

Nothing epitomizes American manufacturing and industry more than massive car companies, most notably Ford, General Motors, and Chrysler. These businesses have been around for ages—GM just celebrated its 100-year anniversary—and have stood as an unstoppable wall of production power…until now. Ford has declared it has the cash to remain solvent through the end of 2009, but GM and Chrysler are teetering on the brink of bankruptcy, and after receiving $30 billion in bailout aid already, are requesting billions more. The government and general public have pointed fingers and argued that the car companies have been out of tune with demand, especially for small, fuel-efficient cars, and businesses that do not sell what consumers demand have already failed, in essence. In fact, two such brands, Saturn and Saab, have not been profitable in the last 20 years of their existence. Connecticut senator Christopher Dodd mentioned that the auto industry is “seeking treatments for wounds that, to a large extent, were self-inflicted.” The car companies counter that they had been on the brink of a comeback, but the credit crisis is at fault for breaking their momentum. How did this dramatic turnaround occur, placing Japanese automaker Toyota firmly in the top spot? Much of the answer lies in the organization of the automobile industry.
The strength of autoworker unions has bestowed benefits upon workers so all-encompassing, no other industry could bear the financial burden. After working at one of these companies for 30 years, a respectable length of time by any measure, an employee receives healthcare and pension for life, fully paid by the car company. Certainly, in the past, this was an important method of retaining employee loyalty and longevity for the automaker, but given that, after recent layoffs, GM currently employs 252,000 workers, such a comprehensive lifetime guarantee appears quite unsustainable. Is this single sector of our economy so essential that we must give complete benefits to those who are able to retire at age 48? I instinctively draw a parallel between such benefits and Wall Street bonuses; both seem unnecessary, yet both are so deeply incorporated into the core of the business that they cannot easily be extricated.
A look at the probable solutions reveal nothing that will easily shore up car companies’ failures. Though $25 billion in bailout loans was assumed to be the worst-case scenario one year ago, current requested aid for failing automakers has already reached $50 billion. Clearly, these companies need some manner of financial restructuring, and the best way to implement such a change is often bankruptcy. This would relieve automakers of the financial obligations they cannot pay. However, some estimates state that the failure of General Motors alone may cost up to $100 billion in taxpayer money, given that many consumers will shy away from buying cars from insolvent manufacturers. This will also create significant widespread effects, and even Toyota and Honda will struggle, because companies creating car parts may fail as well, many of which cater to multiple car brands. Unfortunately, neither course is a winning situation. Some argue that the loss of American auto companies will turn the United States into a country that doesn’t actually produce anything. However, our world is now an intricately linked global economy, as proven by the global collapse, and if the United States is destined to be a service industry, well, specialization is the key to economic efficiency after all.