The Stock Market is a Ponzi
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Mark Cuban, writing at his blog, confirms that we can model the stock market as if it were a Ponzi scheme.
"I've said a lot of this before.
The stock market is by definition a ponzi scheme.
As long as money keeps on coming in, then there is someone to take the stocks from the sellers. If the amount of money coming in is reduced, the stocks, indexes, et al go down.
What if, for who knows whatever reason, the amount of money going into stocks declined significantly ? Who would buy stock from the sellers.
I mean goodness gracious, you could see something disastrous happen.
Like the Nasdaq dropping from 5000, to under 2000 in just a few years.
Its happened before, it can happen again."
The reason that this is important is that we tend to think that although the stock market may border on irrational, it is not inherently a criminal exercise.
But what if it were? What would it look like? How much differently would it appear to us?
The reason for this type of counter-factual thinking is well understood by scientists, philosophers, and indeed anyone who models the social world: let us assume that world is completely different than we assume it to be, deduce phenomena that would appear in the far away world, and then see just how close we are to the supposed far away counter-factual world.
We are fortunate too have a number of excellent books on Charles Ponzi, his own diary, and years of bubbles to study.
One feature of Charle's Ponzi scheme was his payment to his salesmen. For every $100 scrip they sold, they were immediately paid $10.
Ten dollars was a lot of money. It basically signaled the huge risk involved in taking a long position in Ponzi's SEC.
Ask yourself: are the bid/ask spreads in the purchase of sub-prime mortgages both reasonable and transparent?
If not, you just might be dealing with a Ponzi.
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Comments
Thanks, Davis for pointing out how unclear I have been in this post.
I don't believe that most of the companies on any stock exchange are ponzi schemes; but I do believe that every public company can be usefully modeled as a probabilistic ponzi scheme - a scheme which has a chance of becoming a ponzi.
A public company has the privilege of printing money, their stock certificates. The stock gives you a residual claim on net income. But every time the company raises money through the stock market, they are essentially borrowing from the future company they hope to be. Many of these borrowings are nutsy - nothing more than paying the present by stealing from the future.
The F Macs are perfect example of this. They continued to lend against crap collateral, knowing that the Fed would have to effectively backstop the bonds - because if the implicit guarantee of the Fed is worthless, the explicit guarantee is worthless also.
They were stealing from the future, in this case future taxpayers, in order to pay the present, in this case dividend payments, interest payments and compensation. To steal from the future to pay the present is the very essence of the ponzi scheme.
I hope this is clearer - even if you don't agree!
Posted by: admin
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September 8, 2008 11:49 PM
Wow - I normally agree with most of your posts, but this time I think you may be wrong. The stock market isn't a ponzi scheme because businesses can make money and can do things like pay dividends and buy back their stock. At the end of the day it comes down to the quality of the company that you are buying. If you are investing in a hyped up business or one that doesn't add value, then I can almost see your argument, but when a company has a product or service that makes money and they then use it to benefit their shareholders, it's very different, then a typical pyramid scheme. Since I make my living in the market, it may color my view, but I think that you may be committing a fallacy by classifying the entire market as a ponzi scheme when this classification is really only appropriate for a small portion of over hyped companies.
Posted by: Davis Freeberg | September 8, 2008 10:43 PM