(Roughly) Daily

Who you callin’ a Ponzi?!…

The SEC’s web site has a helpful glossary in which it explains “Pyramid Schemes“:

In the classic “pyramid” scheme, participants attempt to make money solely by recruiting new participants into the program. The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same.

The fraudsters behind a pyramid scheme may go to great lengths to make the program look like a legitimate multi-level marketing program. But despite their claims to have legitimate products or services to sell, these fraudsters simply use money coming in from new recruits to pay off early stage investors. But eventually the pyramid will collapse. At some point the schemes get too big, the promoter cannot raise enough money from new investors to pay earlier investors, and many people lose their money. The chart below shows how pyramid schemes can become impossible to sustain:

It’s interesting, too, to consider this list, from The Bank for International Settlements, a list of the main components of the the $1+ quadrillion derivatives market:

1. Listed credit derivatives- $548 trillion;
2. The Over-The-Counter (OTC) derivatives- $596 trillion, including:

  • a. Interest Rate Derivatives- $393+ trillion;
  • b. Credit Default Swaps- $58+ trillion;
  • c. Foreign Exchange Derivatives- $56+ trillion;
  • d. Commodity Derivatives-  $9 trillion;
  • e. Equity Linked Derivatives- $8.5 trillion
  • f. Unallocated Derivatives-  $71+ trillion.

It’s when one puts the latter into the context of the former that it gets interesting: The GDP of the entire world is $50 trillion, so $1+ quadrillion is over 20 times global GDP.  For perspective, one can note that the value of all of the real estate in the world is about $75 trillion (though it’s falling); the value of all of the outstanding stocks and bonds around the world is a bit higher, just under $100 trillion (though also falling).  So…

The $1 quadrillion in derivatives is an order of magnitude larger than either all of the world’s real property combined, or than all of the world’s “traditional” financial assets put together.

What’s separates the derivatives market from a pyramid scheme?  Well, for one thing, most sellers in a pyramid know what they are (supposed to be) selling.  And most pyramid schemes don’t allow for selling the same asset back and forth among current members, simply inflating the value with each pass…  but then, most pyramid schemes aren’t intermediated by brokers and rating agencies prepared, it seems, to sacrifice anything on the altar of volume.

But one thing that pyramid schemes and derivatives have in common is that they become impossible to sustain.  At what point does the derivative market become unsustainable?  Well, the population of earth is about 6 billion people; so the derivatives market expanded to about $190,000 per person on the planet.  The point was somewhere south of there.

As we re-stuff our mattresses, we might check out a library book in honor of Sir Thomas Bodley, born on this date in 1545.  Bodley served a “Gentleman Usher” to Queen Elizabeth I… in which capacity he functioned as one of her diplomats and spy masters.  But on his retirement in 1597, he returned to his academic roots– to Oxford, where he had been a student, a Fellow of Merton, and an Orator–  and took on the rehabilitation of the university’s library (The Duke of Humphries’ Library, as it was known), which had fallen into disrepair.  Bodley invested his own fortune– along with funds from friends whom he cajoled to help–  and he contributed most of his own (compendious) personal library.  Critically, in 1610, Bodley secured an agreement by the Stationers Company (the Guild of printers and publishers who, with the Lord Chamberlin, effectively controlled all publishing in England) to “deposit” one copy of everything they published at what we now know as “The Bodleian Library”– thus creating Oxford’s library as one of the first “copyright depository” libraries (which it remains), and guaranteeing that its collection would be comprehensive into the future.

Thomas Bodley, at the Bodleian

Written by LW

March 2, 2009 at 1:01 am

Posted in Uncategorized

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