This Can't Really Be the Economy...

I'm not an economist. I've never studied economics, beyond reading The Complete Idiot's Guide to Economics [1] about a year ago. I've read about derivatives [2], and had my mind blown by the concept of securitization [3]and the idea that people not only sell debt, but chop it up into little pieces, mix those pieces up, and then resell them to other people. (And, wait a minute, debt has value?)

And, all with no regulation or oversight?

Now, after following economic news this past year, it's like somebody pulled back the curtain and revealed the economy as little more than floating game [4] of craps [5]. And I find myself thinking, "You gotta be kidding me, right? This can't really be the economy. Can it? We gotta have something else, because you know what this sounds like to me [6]?"

[7]

"Ponzi" Schemes

Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. Ponzi thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons. Ponzi told investors that he could provide a 40% return in just 90 days compared with 5% for bank savings accounts. Ponzi was deluged with funds from investors, taking in $1 million during one three-hour period—and this was 1921! Though a few early investors were paid off to make the scheme look legitimate, an investigation found that Ponzi had only purchased about $30 worth of the international mail coupons.

Decades later, the Ponzi scheme continues to work on the "rob-Peter-to-pay-Paul" principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses. For more information, please read pyramid schemes in our Fast Answers databank.

http://www.sec.gov/answers/ponzi.htm

But, like I said, I'm not an economist. So I thought, "Is it just me? I gotta be missing something," because even though it sounds like a ponzi scheme to me, a lot of very smart people seem to think this is a perfectly sensible basis for an economy.

Me, I always thought that to form the basis of an economy, you had to have people who make stuff — stuff that other people could actually put to use — and sell that stuff to other people. But this is so much of part of the foundation of our economy that we've got to go billions of dollars into hock to keep afloat the people who drove their companies into a ditch and took the economy with them.

People like Bernard Madoff, whose hedge fund fraud [8] is a candidate for the record books.

Or maybe not [9].

Not so fast, says Janet Tavakoli, president of Tavakoli Structured Finance. On her company’s Web site, Ms. Tavakoli suggests that Mr. Madoff has some competition for the top prize.

"The largest Ponzi scheme in the history of the capital markets is the relationship between failed mortgage lenders and investment banks that securitized the risky overpriced loans and sold these packages to other investors — a Ponzi scheme by every definition applied to Madoff," she wrote. "These and other related deeds led to the largest global credit meltdown in the history of the world."

...The $1 trillion in write-downs that the banks have suffered since the credit crunch began last year dwarfs the $50 billion that Mr. Madoff supposedly said had been swindled from his investors.

Ms. Tavakoli argues that these two money-losing debacles have a few things in common — including a major lack of transparency.

So, it's not just me.

It sounds like Tavakoli was right, too. The full price tag for the bailout thus far comes in at $8 trillion [10]. Now, there's only been about $2.9 trillion of that amount has been spent, loaned or otherwise handed out, but we don't know who got it or on what terms [11], and the Fed won't tell us [11].

The Federal Reserve refused a request by Bloomberg News to disclose the recipients of more than $2 trillion of emergency loans from U.S. taxpayers and the assets the central bank is accepting as collateral.

Bloomberg filed suit Nov. 7 under the U.S. Freedom of Information Act requesting details about the terms of 11 Fed lending programs, most created during the deepest financial crisis since the Great Depression.

The Fed responded Dec. 8, saying it’s allowed to withhold internal memos as well as information about trade secrets and commercial information. The institution confirmed that a records search found 231 pages of documents pertaining to some of the requests.

...Congress is demanding more transparency from the Fed and Treasury on bailout, most recently during Dec. 10 hearings by the House Financial Services committee when Representative David Scott, a Georgia Democrat, said Americans had "been bamboozled."

Makes sense, to me. I don't know much about Ponzi schemes or pyramid schemes [12], but it seems that in both cases the payouts always go to those at the top, and come from as the bottom (in this case, the rest of us), who generally don't know exactly who's the top or how much they're making off with.

How much the aptly named [13] Mr. Madoff (prnounced, I kid you not, MAY-doff)  made off with [14] is being investigated.

A busy stock-trading operation occupied the 19th floor, and the computers and paperwork of Bernard L. Madoff Investment Securities filled the 18th floor.

But the 17th floor was Bernie Madoff's sanctum, occupied by fewer than two dozen staff members and rarely visited by other employees. It was called the "hedge fund" floor, but federal prosecutors now say the work Mr. Madoff did there was actually a fraud scheme whose losses Mr. Madoff himself estimates at $50 billion.

...And the 17th floor is now an occupied zone, as investigators and forensic auditors try to piece together what Mr. Madoff did with the billions entrusted to him by individuals, banks and hedge funds around the world.

This is the question that's bothered me about the bailout. If companies are hundreds of billions of dollars in the hole, provided those dollars actually existed in the first place, then the money has to be somewhere. Right?

Maybe,  maybe not. But regulators knew he was making tons of money, even when other firms weren't doing so well, because Madoff bragged to the SEC about how much he earned [15], even as he advised them on oversight. Somehow the SEC overlooked his shenanigans [16].  But that's mostly likely because of his close ties to regulators [17].

How did we come to build such a significant chunk of our economy on this?