You want a Ponzi scheme? I’LL Show You a Ponzi Scheme.

If Mark has his way, Rick Perry’s assertions that Social Security is a Ponzi scheme will not get thrown down the memory hole.  Unfortunately, our last Ponzi scheme is already hurtling downward.

If you think about it, a large part of American (and global) prosperity rests on a real Ponzi scheme: the financial system.  I’m actually not being hyperbolic here.  In order to make credit circulate through the economy, banks must have less money on deposit than they have out on loan.  If a panic occurs, then bank runs result.  That’s why central banks were created: to be the lender of last resort.

That’s just the basics.  But if you push it even a little harder, then the House-of-Cards nature of the system gets even bigger.  Bankers have an inherent incentive to leverage far higher than they should, and it gets worse the more they get into trouble: if everything goes belly up, they can only lose their holdings (this is especially true if there is limited liability), but if everything goes well, then they make a killing.  So it is inherent within the structure of incentives for banks to take unreasonable risks.  In fact, if they don’t take unreasonable risks during good times, they will lose market share, and thus their jobs: “as long as the music is playing, we’ve got to keep dancing,” Merrill Lynch CEO Stan O’Neill famously observed.

As Hyman Minsky pointed out several decades ago, the very stability of the system creates instability: as growth and credit occur, everyone’s incentive is to keep extending credit, and then hoping to get off before the whole thing crashes.  This is not some pathology: it is inherent in the system.

To the extent that there is a “solution” to all of this, it is to regulate the system to prevent the risks getting out of control, e.g. leverage requirements, cordoning off sectors of the system to avoid contagion (i.e. Glass-Steagall), compensation regulation, and above all, transparency.  And all those are things that Rick Perry and the Republican Party oppose: the GOP is the nation’s biggest political promoter of Ponzi schemes.

It’s almost classic Rove: attack the other guy for your own weakness.  Except that Perry is too crazy/stupid/egotistical even for Rove.

In 100 years, if America lasts that long, historians will look back on this era to determine what caused someone like Perry — or a party like today’s GOP — to become major political forces.  And I’m not sure that they will be able to find a rational answer.

Author: Jonathan Zasloff

Jonathan Zasloff teaches Torts, Land Use, Environmental Law, Comparative Urban Planning Law, Legal History, and Public Policy Clinic - Land Use, the Environment and Local Government. He grew up and still lives in the San Fernando Valley, about which he remains immensely proud (to the mystification of his friends and colleagues). After graduating from Yale Law School, and while clerking for a federal appeals court judge in Boston, he decided to return to Los Angeles shortly after the January 1994 Northridge earthquake, reasoning that he would gladly risk tremors in order to avoid the average New England wind chill temperature of negative 55 degrees. Professor Zasloff has a keen interest in world politics; he holds a PhD in the history of American foreign policy from Harvard and an M.Phil. in International Relations from Cambridge University. Much of his recent work concerns the influence of lawyers and legalism in US external relations, and has published articles on these subjects in the New York University Law Review and the Yale Law Journal. More generally, his recent interests focus on the response of public institutions to social problems, and the role of ideology in framing policy responses. Professor Zasloff has long been active in state and local politics and policy. He recently co-authored an article discussing the relationship of Proposition 13 (California's landmark tax limitation initiative) and school finance reform, and served for several years as a senior policy advisor to the Speaker of California Assembly. His practice background reflects these interests: for two years, he represented welfare recipients attempting to obtain child care benefits and microbusinesses in low income areas. He then practiced for two more years at one of Los Angeles' leading public interest environmental and land use firms, challenging poorly planned development and working to expand the network of the city's urban park system. He currently serves as a member of the boards of the Santa Monica Mountains Conservancy (a state agency charged with purchasing and protecting open space), the Los Angeles Center for Law and Justice (the leading legal service firm for low-income clients in east Los Angeles), and Friends of Israel's Environment. Professor Zasloff's other major activity consists in explaining the Triangle Offense to his very patient wife, Kathy.

22 thoughts on “You want a Ponzi scheme? I’LL Show You a Ponzi Scheme.”

  1. Well, yes sort of. Banks create money they don’t have. Banks, The federal reserve, the US central bank, creates almost all of it’s money on the promise of the borrower to repay. See doc “money as debt” , for a good explanation.

    A real ponzi scheme is a deliberate fraud, and promises massive returns and is not invested in anything, while the social seeurity funds are invested in treasury bills see Venn diagram of overlap and differences.

  2. Well, no, not really.

    Look, I’m all in favor of a serious examination of our financial system. But “Ponzi Scheme” has a definition: the funds collected from the newest members are used to reward the members who joined earlier. The people who have joined later have nothing of real value to show for their joining; the fund itself has nothing of any value, all the money is either skimmed or handed over to the early joiners.

    Social Security might in fact to be considered something of a Ponzi Scheme under the first part of that definition, but not the second, and in any case there is no-one doing the skimming and it’s set up to be sustainable (with some tinkering, perhaps).

    The banking system is very problematic, in ways you touch on. It is perhaps a Scheme, and a Bad Thing. But that doesn’t mean you should misuse the name “Ponzi”.

  3. I’m not sure I buy the idea that banks are intrinsically a Ponzi scheme. I’ll grant you that a great of investment banking 1980-2008 definitely was (and probably still is, just waiting for the next collapse), but isn’t the idea of a Ponzi scheme that you’re deceiving people into thinking what are actually just new suckers are “returns?” The key point of a Ponzi scheme, I would say, is that the pool of suckers must continually expand, or the whole thing goes down. Regular old banks are certainly vulnerable to runs, but they would seem to be stable with a fixed pool of depositors, so long as everyone doesn’t come for their money at once.

  4. One hundred years from now a backward view would bare for all to see the results of a loss of “collective wisdom” among the electorate while a general economic malaise took root among the ill-informed, given to emotional fear traded freely on 24/7 broadcast machines by vested interests continually attempting to mollify the hoi polloi into voting against their interests time and again!

    The Republican Brand peddles in a myriad of contemporary canards whether they be Ponzi in nature, or simply political lie-a-thons – all for the benefit of
    hoodwinking the low-information voter, yet again, into participating in a vicious cycle that produces elected apologists for the schemers among us!

    Where’s Jed Clampet’s banker when we need him?

  5. “..Ida May Fuller worked for three years under the Social Security program. The accumulated taxes on her salary during those three years was a total of $24.75. Her initial monthly check was $22.54. During her lifetime she collected a total of $22,888.92 in Social Security benefits…” A thousand to one is pretty good – she died at 100 and had paid into Social Security for three years from its enactment to her retirement. My own dad got four or five times more out than he had put in. Will I even break even? Taxing current workers to pay retirement benefits works a lot better when there are a lot more current workers than retired people: if benefits are to be maintained even at current levels we will have to get more income for the fund in future, and with 2.1 kids per woman now this will be harder in future than it is now as we bask in the reflected glow of 1950 and almost four kids per woman. Ponzi scheme? No, not really, but FDR was relying on peoples’ feelings of entitlement to make it very hard to repeal, even when the demographics were not so good.

  6. I agree with Warren Terra and Ryan that banking isn’t technically a Ponzi scheme. But it is inherently unstable and is something that can only exist if given special legal protections. In fact, that’s why some of the real nutballs on the right are opposed to banking of any kind.

    To take the second point first. I’m not a CPA, but it seems to me that by the standards applied to other business entities, banks are technically insolvent unless they’re not doing any lending, ie not acting like banks. They were among the first kinds of businesses that needed the special protection given by charters.

    On their inherent instability, this country’s experience with having lots of banks goes back to the early 1800s. Their issuing of bank notes and loans was a big factor in our economic cycle, which was fast growth that became frothy and then fell apart in a crash. This happened about every 20 years. Each up cycle built an edifice of vastly extended debts that eventually couldn’t deal with something that slowed down the flow of payments and set off a wave of bankruptcies. 1819, 1837, 1857, 1873, 1893, and smaller ones along the way.

    What you have to do is restrain the leverage, and as you say, separate deposit banking from investment banking. That sets up a constant fight between regulators and bankers who want to swing their elbows a little bit more. Bankers are a little like farmers who produce commodity crops. It’s really in all farmers’ interests to limit production so prices will tend to stay higher, but each individual farmer wants maximum production in order to maximize the income on what they do grow, and since they all do it, prices are lower than they need to be. Bankers all want to leverage for maximum gain and the system can handle a few doing it, but when they all do it the system can’t handle it.

    They need a nanny even if they don’t understand it themselves. But now they have so much money to throw around at lawmakers and regulators that they get their way, and we all suffer as a result.

  7. dave schutz says:

    “..Ida May Fuller worked for three years……accumulated taxes…….$24.75……she collected a total of $22,888.92…….in….benefits…”

    Joseph Schmutz worked for 36 years and accumuluted $197,637.00 in SS taxes…..He collected a total of $0.00 in benefits, having died a widower as he approached retirement age.

  8. NYShooter,

    Joseph Schmutz worked for 36 years and accumuluted $197,637.00 in SS taxes…..He collected a total of $0.00 in benefits, having died a widower as he approached retirement age.

    Poor Joe. What an unlucky guy. He also paid $20,000 in fire insurance premiums over many years and his house never caught fire. Seems like things just didn’t go his way.

  9. dave schutz: …if benefits are to be maintained even at current levels we will have to get more income for the fund in future …

    My least favorite old coot, Alan Simpson, talks a lot like that. “We” have to do this or that, says Simpson, to make Social Security solvent for the next 75 years. It never seems to occur to him that the Americans who will begin collecting SS in 75 years from now have not even been born yet — let alone had a chance to vote amongst themselves over the question of how to divvy up the quadrillion dollars of GDP they will produce in their lifetimes between their health care, their military, their infrastructure, and their retirement. “They” will not be “we”.


  10. Will I even break even?

    Were your parents or grandparents forced to move in with you when they could no longer work?

    Did you live in a community in which childless old people were commonly destitute, and often homeless?


    You already broke even.
    That’s what you paid for.
    Anyone who tells you different is selling something.

  11. There’s something wrong with that Ida Mae Barker story. I don’t know what the rules were 50 years ago but at this point you have to earn $4500 or more every year for at least 10 years to be eligible to get anything from SS at retirement based on your earnings. You could get benefits based on about three years of earnings if you became disabled after working only three years at a very young age. If, like “Joe”, I die just before I might collect on any of the money I’ve paid into SS, I don’t begrudge it going instead to someone who was too disabled to work for the last 80 years of her life. I think I will have gotten the better deal by far.

  12. JZ: “In order to make credit circulate through the economy, banks must have less money on deposit than they have out on loan.”
    That’s not right. Bank balance sheets include huge quantities of bonds and T-bills, not just loans, which are normally much less than their liabilities. The instability comes from something else. Banks are financial intermediaries; and they transform short-term liabilities (deposits) into medium-term assets (loans and bonds), or the other way round, depending on how you look at it. This is an inherently risky activity that violates a standard rule of financial prudence. So every bank is a house of cards held up by the duct tape of confidence. That’s why bank HQs are so impressive, going back to the fifteenth-century pile of the Monte dei Paschi of Siena. Trust us! Look at the marble! We will never fail!

    (Half-hearted apologies to commenters that only bloggers can add pictures to comments. A bit like being a bank really.)

  13. Bernard- Exactly! SS is an insurance plan not an investment.
    I wonder if people lose sight of that because, unlike most insurance there is no fixed premium payment. The thing that most wrankles the Righties about it is the ‘from those most able, to those most in need’ aspect. Just too ‘communistic’. Too darned ‘Christian’.

  14. Well, no, not too darn Christian. I mean, I may be an atheist, but I was a Christian years ago, and made myself rather familiar with it’s doctrines before I left. (Felt I had to know what I was rejecting.)

    What’s missing from government aid, to be “Christian”, is the denial of choice on the part of those paying for it. Charity consists of giving your own stuff to the poor, not taking it from somebody else with violence threatened if they don’t hand it over.

    It is a rather fundamental difference.

  15. I think you missed the single most important way to manage bank-run risk–the FDIC.

    The problem with regulations is that it’s tricky to keep them from preventing the last crisis–for example, the whole mortgage securitization business got started in an attempt to reduce risk (and it did reduce the risks to banks that were being looked at–geographical concentration, which clobbered the Texas banks in the 80’s, and interest rate changes, which destroyed the S&L system.)

  16. One point of clarification – many Republicans, myself included, believe that GLB, which overturned Glass Steagall, was a very bad idea and believed it then. And we will acknowledge that this was GOP deregulatory legislation that Citigroup promoted.

    That doesn’t change my deregulatory bias. Call it the exception that proves the rule.

  17. Ida May was the first person to recieve a regular Social Security check.

    The rules have changed since them.

Comments are closed.