
Krugman: The Madoff Economy - tortilla
http://www.nytimes.com/2008/12/19/opinion/19krugman.html?hp
======
sanj
_"The answer, I believe, is that there’s an innate tendency on the part of
even the elite to idolize men who are making a lot of money, and assume that
they know what they’re doing."_

This strikes a chord with me. Stop chasing money. Chase changing the world.

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pg
He's mistaken. There is a real structural difference between a Ponzi scheme
and an investment fund.

And as for the high incomes of money managers, it seems reasonable to pay
someone a lot to manage a huge fund. So much is at stake that it would be a
false economy to hire someone cheap.

~~~
gojomo
But what Krugman is highlighting here -- and Nicholas Taleb has done in more
detail previously -- is that fortunes have been made pursuing strategies that
are net losers for investors and society.

All you have to do is make sure the giant losses occur just 1 year out of N.
It doesn't matter that the one year's losses wipe out the other N-1 year
gains; you've already collected your fees and quite possibly retired, and
there's no claw-back of your cut.

A reasonable aim of financial technology is to ameliorate the risks that could
obscure or destroy truly productive activities. But the same tools can easily
be used to do the opposite, construct net-wealth-destroying strategies which
enrich only money managers.

To cook up such a strategy purposefully is a crime, and the classic ponzi
scheme is the blatant extreme case. But many other strategies based on
collecting fees during the upswing of an unsustainable bubble, while being
insulated from the downswing, are close cousins of the full ponzi. That the
loot is laundered through ostensibly legitimate investments (like mortgage
securities this time around) is a convenient consensus cover story; it helps
even the perpetrators believe they are providing valuable investment services
rather than just a scam.

This view doesn't indict all investment activity/funds as being similar to
ponzi schemes. But an awful lot of this most recent financial-services boom
appears to have been like a ponzi skim.

(Despite the truth I see in this column, I would not trust Krugman's suggested
solutions, which are likely to be heavy on new regulation. Ultimately capital
has to learn to protect itself, with novel compensation schemes that
disincentivize the 'year N explosion' pseudo-ponzi strategies.)

~~~
pg
_fortunes have been made pursuing strategies that are net losers for investors
and society_

That seems unavoidable. It's the same in most industries. You have to pay top
baseball players high salaries, even though there's no guarantee they'll do
well after you hire them.

 _To cook up such a strategy purposefully is a crime_

Is it, actually?

~~~
gojomo
There are no guarantees, of course. Sometimes chance breaks the relationship
between results and rewards. And, sometimes crime pays.

But the degree matters. If looting and destruction is occasionally rewarded,
it can be a manageable expense. If it dominates the industry, even if not via
conscious malice, we've got problems. What if every high-paid 'top baseball
player' for 10 seasons running was a bust? Then something in scouting or
compensation would have to change, a lot.

 _Is it [a crime], actually?_

Yes. A manager who promises investors the possibility of positive return, but
knows he has purposefully designed things so that the investors are guaranteed
to ultimately lose, while the manager gains, has at the very least engaged in
criminal fraud.

So to pull off net-losing strategies within the law, a manager should deceive
himself as well as his investors. Fortunately for this class of managers, a
whole industry of external rationalizations was spawned by the potential
profits.

------
snorkel
Why is anyone who doubts the overall integrity of then investment industry is
getting downmodded here? The HN crowd is usually smarter than this. First of
all, downmods are for spam so stop treating this board like diggiotic
censorbots. Second of all, educate yourselves about the truth of the
investment industry. Or better yet try trusting your own money with it and
learn the hard way. Big brokerages buy large blocks of a stock which sends the
price up, then they call affiliated brokerages to advise all of their clients
to buy the same stock because the price is going up which sends the price up
more, then the big brokerage dumps their shares and keeps the profit. Pump and
dump. It's one of the many price manipulation games the finance services
industry plays against its own clients, it's illegal, and it happens every
trading day in full view of the SEC. Madoff proved the SEC are the Keystone
Cops. Suckers believe that brokers are paid according to the success of the
client's profile because that's what their brokers tell them. Dead wrong.
Brokers are paid according to the number of sales, transactions, and new
clients (suckers) they can reel in. So go ahead and downmod me. There's one
born every minute. Always more sheep to be shorn.

------
jpcx01
Krugman is missing the elephant in the room. The most obvious comparison to
Madoff's scheme is Social Security. New funds fuel current payouts, and the
entire system rests on the addition of new members (population growth) which
is why its insolvent as our population levels off in the next 30 years.

Luckily the government isnt crazy enough to promise extraordinary returns on
your social security contributions, however once the funds run out for the
current recipients, watch our forced contribution be raised sky high to keep
paying it out.

Bad times ahead. But thats the predetermined path for a Ponzi scheme, no
matter what the size.

~~~
captainobvious
Are you talking about medicare or social security? If we took a little under
half of the increase in defense spending in the ~2002-2006 period, social
security could be made solvent for the next 75 years:
[http://video.google.com/videoplay?docid=-6514572148606053094...](http://video.google.com/videoplay?docid=-6514572148606053094#18m55s)

It isn't exactly out of our capacity to do. We just have to stop blowing
things up and destroying wealth.

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byrneseyeview
It's interesting that Krugman, a Keynesian, is so down on Madoff. During a
recession, I would think that Krugman would want some form of economic
stimulus that causes people, in the aggregate, to spend more money compared to
how much they save. What better way to do so than a ponzi scheme, wherein
Bernie spends the money he knows he's stolen, and his investors spend the
money they think they've earned?

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tsally
Thank God someone finally said it. We need to take 95% of the financial
services industry and ship them off to a desert island.

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shard
I feel like he wrote the whole article just to get in his clever one-liner at
the end.

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mynameishere
_is Mr. Madoff’s tale from the story of the investment industry as a whole?_

This is a statement one might expect from a pure juvenile. No, Mr. Krugman,
the investment industry serves a viable purpose, in deep contrast with a Ponzi
scheme. There are good and bad methods in the investment industry, but Ponzi
schemes, in every instance, are indelibly insolvent, unproductive, and
unprofitable.

~~~
bokonist
I normally disagree with Krugman, but he's closer to the truth than you think.

A Ponzi scheme is defined as an operation "that involves paying abnormally
high returns to investors out of the money paid in by subsequent investors,
rather than from the profit from any real business. "

In 2007, the dividend yield of the S&P 500 was 1.5% People were not buying
stocks to obtain the cash flow of a real business. People bought stocks under
the assumption that eventually they could sell to someone else for a higher
price.

~~~
mynameishere
The "S&P 500" is not the same as the "investment industry" which is the
subject. Buying an asset with the expectation that it will increase in value
is not the same thing as a direct system of payments between clients with no
underlying assets. You're not really addressing my comment or Krugman's
article.

But that's not the point. The point is that Krugman's objects of comparison
share almost no correspondence. Even Lehman Brothers was substantially
profitable when brought down by one class of securities, the creation of which
was largely a government affair. It is important for everyone to understand
that Krugman is the worst kind of shill.

~~~
bokonist
_The "S &P 500" is not the same as the "investment industry"_

It's a big part of it, and the rest of the industry was operating in much the
same way.

 _Buying an asset with the expectation that it will increase in value..._

People expected the asset to increase in price. The only way an asset can
increase in price is if new buyers are willing to pay more money for it. If
this increase in price corresponded to an increase in the underlying cashflow,
that would be healthy. But the price of stocks were increasing at a far
greater rate than dividends were increasing. Therefore it was not healthy at
all.

Another way of putting it: if you bought a share a S&P 500 ETF, and knew you
could never, ever sell it, what kind of dividend yield would you demand? I
would demand at least a 5% dividend, maybe more. By that metric, the S&P in
2007 was overpriced by about 70%. That premium is based on the idea that
someone else would be willing to pay that price or more.

The S&P is not really a ponzi scheme. When a ponzi scheme is big enough, and
it is legal, we have a new name for it: money. S&P stocks were essentially
trading as private currencies. See my longer comment on this here:
<http://www.newmogul.com/item?id=2587>

_It is important for everyone to understand that Krugman is the worst kind of
shill._

He is a shill, but it's important to criticize him for the right reasons. The
elephant that Krugman misses is that from 1995-2008 the dollar was diluting at
~10% a year. When that happens, holding any asset other than the dollar -
stocks, real estate, gold, oil - starts looking like a great idea.

------
newt0311
Counter argument:
[http://econlog.econlib.org/archives/2008/12/madoff_as_metap....](http://econlog.econlib.org/archives/2008/12/madoff_as_metap.html)

~~~
gojomo
I hardly see that as a counter. Both Kling and Krugman are right! The
government is a ponzi scheme, _and_ lots of the financial sector has been
ponzi-like, too!

(And a point that Kling might make but Krugman tends not to: much of the
financial-sector ponzi-ism was propelled by government policy, which inflated
the housing bubble with tax benefits, Fed-lowered interest rates, government-
sponsored mortgage-underwriting, and regulatory favoritism for dubious
mortgage-lending. And policy which then further insulated finance institutions
from existential risk with the implied promise -- now delivered -- of giant
bailouts.)

------
davidw
I'm more inclined to agree with Krugman than mises.org or reason.com, but I
don't want to see any of them here.

~~~
pg
It's one thing to conclude one specific article is offtopic (in which case
please just flag it instead of commenting), but are you really saying that
nothing Krugman could ever write would be interesting to hackers?

~~~
davidw
I think a great deal of what Krugman says is interesting (perhaps minus the
Bush bashing, that just gets old), and occasionally something on reason.com,
too, for that matter. I also like to read Kling, Thoma, Cowen and Mankiw, as
well as The Economist's Free Exchange, and a few others from time to time. I
suspect that I'm not alone in those interests.

However, I very rarely submit the articles I find that I like. My fear is that
the ensuing discussions tend to be very much about ideologies and create lots
of heat, but little light - they're about 'firm beliefs' rather than something
that can ever really be proven in an internet discussion forum. These sorts of
discussions, in my opinion, attract people that want to talk about politics
and economics, which are sort of low-hanging fruit - everyone, not just
hackers, has opinions on them. Also, there is so much written about those
topics that it would be extremely easy to crowd out hacker/startup topics with
economic ones, even restricting economics/politics postings to relatively good
ones. My gut feeling is that if these articles prosper, this site will, with
time, decline. Your site, your call though - if you say economics and or
politics go, I will no longer comment or flag them. Maybe I'll even submit a
few of my own.

BTW, one of my favorite articles of Krugman's is this one:

<http://web.mit.edu/krugman/www/smokey.html>

~~~
david927
You're very protective of this community, David, and I appreciate it. But this
economic crisis is not only a once-in-a-lifetime event, but it has tremendous
consequences for start-ups.

It's better just to flag what you don't like. Personally, I find this article
to be both insightful and important.

~~~
davidw
> You're very protective of this community,

Heh, I suppose I get a bit wrapped up in it. Living in the middle of the
Tirolean Alps, and not speaking much of the local language (German), I don't
really interact much with hackers outside of this site, or pretty much at all
in real life, which is less than ideal - I'm a fairly social person. Hopefully
we'll be back in Italy in a few months and things will improve.

> But this economic crisis is not only a once-in-a-lifetime event, but it has
> tremendous consequences for start-ups.

Sure, but plenty of real, serious economists are still discussing the great
depression too, so I am quite sure that there will be enough discussion about
current events to last at least a generation. This article wasn't really all
that directly related to startups, either. I thought it was pretty evident he
wasn't talking about plain old stocks and bonds, but a lot of the wackier
things going on (CDO's, CDS's, hedge funds, etc...). Even there, though, he
was doing it in sort of a facile way that probably doesn't add much to the
debate.

~~~
david927
Prague isn't that far away, and remember that you and your family have a free
place to stay here anytime.

