(NY Times, Mar 12)
RECKONINGS / By PAUL KRUGMAN
The Ponzi Paradigm
Charles Ponzi wasn't the first to try it, but he has
joined Dr. Bowdler
and Captain Boycott among those whose names will forever
be
terms of abuse. And the classic scam that bears his name --
using money
from new investors to pay off old investors, creating the
illusion of a
successful business -- shows no sign of losing its
effectiveness.
Robert Shiller's terrific new book, "Irrational Exuberance,"
contains a
brief primer on how to concoct a Ponzi scheme. The first step
is to come
up with a plausible-sounding but complicated profit
opportunity, one that
is difficult to evaluate. Ponzi's purported business involved
international
postage reply coupons. In a more recent example, Albanian
scammers
convinced investors that they had a profitable
money-laundering business.
From that point on it's all a matter of timing and publicity.
An initial group
of investors must be pulled in, large enough to attract
attention but not
too large; then a larger second group, whose investments can
be used to
pay off the first, a still larger third group, and so on. If
all goes well,
stories about how much early investors have made will spread,
attracting
ever more people, and the continuing success of the company
will silence
or drown out the skeptics.
In the United States, regulators -- who know very well just
how effective
such scams often are -- do their best to stop them before they
get
started. So you might think that Ponzi schemes are mainly a
historical
curiosity. But Mr. Shiller is not interested in history for
its own sake; he
uses Ponzi schemes as a model for something much more
important.
Imagine, just hypothetically, that a new set of technologies
--
technologies that are really, truly, deeply fabulous -- has
just emerged.
And suppose also that a number of companies have been created
to
exploit these new technologies, in the entirely honest -- but
very hard to
assess -- belief that they will eventually be able to earn
huge profits. For
the time being they earn little if any money; even if they
make an
accounting profit, they must continually raise more cash to
pay for
equipment, acquisitions and so on. Still, as the evidence for
a true
technological revolution mounts, the prices of their stocks
keep rising,
producing huge capital gains for early investors. And this
attracts ever
more investors, pushing the prices still higher.
If the process goes on long enough -- and there is no reason
it cannot go
on for years -- the doubters will start to look like fools,
and the bears will
go into hibernation. Everyone (well, almost everyone) may be
completely
sincere; nonetheless, in effect you get a Ponzi scheme without
a Ponzi, a
scam with no scammer.
Given the title of Mr. Shiller's book, you can guess the punch
line. He
makes a powerful case that the soaring stock market of recent
years is a
huge, accidental Ponzi scheme in progress, one that will come
to a very
bad end. The book actually focuses on the market broadly
defined (most
numbers are for the S.&P. 500), but it reads even better as a
tale of the
tech stocks. It's a book that I hope many people will read;
but I doubt
that many will be persuaded.
You see, right now bears have an extra credibility problem.
Not long ago
many people were skeptical not only about the prospects for
today's
technology companies but about the importance of the
technology itself.
(I plead guilty.) And every new statistic showing soaring
productivity and
earnings growth shows how wrong they were. As a matter of
logic you
can concede the reality of a technological revolution, even
while asserting
that the valuations of many technology companies are crazy;
but who will
listen?
It's also true that savvy investors (at least they seem savvy)
are following
the Levi Strauss strategy: Let others get caught up in the
gold rush, we'll
sell them the supplies. It is quite possible that the
valuations of companies
that sell Internet infrastructure make sense even if those of
the dot-coms
do not.
Still, as you watch those who missed out on the first few
thousand points
of the Nasdaq's rise feverishly try to make up for lost time,
you have to
wonder. Will people 80 years from now talk, without quite
knowing
where the term comes from, about being bezosified or
qualcommed?
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