Nomi’s Note: I’m doing something a little different in Inside Wall Street this week. I’m giving you a sneak peek of my newest book, Permanent Distortion. It’s hitting shelves on October 11. But as an Inside Wall Street reader, I wanted you to be among the first to see it.
So, I’m sharing some of my favorite sections from the book. I hope they’ll help you make sense of the wild distortions we’re seeing in the markets today – and their root cause of greed, easy money, and just plain bad Fed policy. Read on… And let me know what you think at [email protected].
We all crave easy money. And plenty of it. If we didn’t, no get-rich-quick-scheme could be successful.
– Charles Ponzi
The earth may spin on its axis, but the world revolves around money.
Populism, nationalism, isolationism, corruption, trade wars, military wars, health crises, inequality, economic hardship, and financial market bubbles – all of them are connected to money.
Money doesn’t just drive a wedge between different classes, races, genders, and countries. It is the wedge.
In the 1920s, Charles Ponzi’s name became synonymous with the big swindle. His con was no random event.
Like any salesperson, con artist, or politician, he leveraged a unique feature of human nature: that in the end, we all want to be comfortable, secure, and in control of our destinies.
That means different things to each of us, depending on our circumstances, backgrounds, financial ambitions, need for survival, or appetite for greed.
What Ponzi did was use that basic desire and an unsettled environment to his advantage.
In the year 1920, the United States was facing an economic depression, the aftermath of a brutal world war, and a tragic global pandemic, the Spanish flu. People were tired, stressed, and eager to move on.
On that canvas, Ponzi painted a get-rich-quick scheme that contained a perfect cocktail of credibility mixed with enticing reasons to suspend judgment.
The period in which he incited such extreme responses was a key component of his initial success.
Today, we would call the enthusiasm Ponzi stirred up for his investment scheme – which involved buying international stamps for one price and selling them for more money to the US postal system – the fear of missing out (or FOMO).
Some of the folks in Boston who first bought into Ponzi’s scheme were rich, while others were poor. Their optimism brought them together.
Without the benefit of Twitter, Reddit, or the internet, a swath of disparate, or desperate, investors wanted to get in on his game. Equally, they wanted to believe in Ponzi’s ability to make them richer.
By duly paying the initial investors just as he promised, Ponzi successfully peddled the idea that he could make anyone a 50% return in 90 days. That was an enticing prospect since banks were offering a mere 4% return over a full year.
Plus, Ponzi, a once-poor immigrant from Italy, had been denied a loan from the very bank, Hanover Trust Company, to which he funneled a large amount of his proceeds. He used that rejection as a marketing ploy.
That rags-to-riches narrative gave him a David-versus-Goliath appeal that also embodied the essence of America’s promise to its newcomers and downtrodden. It enhanced their belief in him and what he was offering.
That faith was critical for his scam to work.
To provide his customers with maximum confidence, every detail – down to the selection of the name for the company that would house his stamp swindle – was carefully considered to inspire trust. Indeed, that was the entire point. And as he later wrote:
The Securities Exchange Company began its business career under the most favorable auspices. True, it had no capital. But it had no black eye either.
In an irony for the ages, the acronym for the US Securities and Exchange Commission, SEC, was identical to that of the company Ponzi crafted for his grift.
The government body was established under the Securities Exchange Act of 1934. Its purpose was to protect the public from fraudulent claims by public firms, though this was not always accomplished with the greatest of success.
Ponzi’s motivation stemmed from a desire to call out Wall Street and beat it at its own game. Once he started, he kept going. He explained in his autobiography:
I knew what I was up against if I stopped. I knew not what I might run across if I kept on. I had unlimited confidence in luck, as well as my ability to exploit it. And on I went headlong, like a bull in a china shop, to smash all precedents and principles of high finance as it was preached, but not practiced, in Wall Street.
His enduring place in history is instructive for reasons that transcend Ponzi’s scam. If we don’t ask questions or dig beneath accepted narratives about money no matter who spreads them, repeated crises are inevitable.
Whether espoused by fraudsters, financiers, or a monetary system skating on thin ice, embellishment and false promises can cause havoc.
Money doesn’t care about politics or activism. But how people create, use, or make it – now, that’s where things get interesting.
To the extent that it flows more abundantly into financial markets than into the real economy, it can be lost in a paper vortex, forever. But when money is flowing, it has the ability to manifest the appearance of easy solutions to complex problems.
Merriam-Webster defines “Easy Street” as “a situation with no worries: a situation of wealth and ease.”
In monetary policy slang, “easy policy” means that the cost of money is rendered cheap – interest rates are set low, at zero, or even in negative territory.
There have been two main periods of zero interest rate policy (on average) so far in the 21st century.
The first was the time between the financial crisis of 2008 and the end of 2015.
The central bank of the United States – the Federal Reserve (Fed) – acted as global leader on easy monetary policy by lowering rates to zero. It raised them slightly through the middle of 2019 before lowering them again.
The Fed provided massive subsidies for Wall Street and the financial system through an ongoing program of quantitative easing (QE) that grew, abated slightly, and then grew again.
The idea of cheap money being a remedy for economic or systemic banking problems was promoted by major central bankers in reaction to the financial crisis of 2008.
The concept was that private banks would lend out cheap money to individuals and small businesses, which in turn would use it in ways to stimulate the real economy. The truth is somewhat different.
During the period from 2008 to 2012, major countries’ central banks provided megabanks unprecedented assistance in the form of cheap money, bond purchases, and attractive loans.
Their actions effectively compensated the biggest Wall Street banks for taking on massive risk and for the losses that stemmed from their own mismanagement, greed, and fraudulent practices.
I detailed what transpired extensively throughout my book It Takes a Pillage. Without the combination of the Fed’s support, easy money, and the government’s largesse, heavily leveraged investment banks such as Goldman Sachs and Morgan Stanley could have failed.
Yet none of the largest global private banks – such as JPMorgan Chase, Deutsche Bank, HSBC, and Santander – were ever required to increase their lending to the Main Street economy and its small businesses as a stipulation for receiving their cut of an epic bailout.
They were never given the relevant oversight or incentive to help restructure individual loans battered by the broad economic hardship that stemmed from their own unsound lending.
Instead, Wall Street giants and their major corporate clients hoarded money and used significant portions of it to buy back their own shares, elevating their stock price and providing the illusion of financially healthier companies.
This had the effect of pumping up stock and executive bonuses linked to the price of stock. These firms effectively manipulated their stock prices with central bank support and paid themselves bonuses for doing so – as a result of a financial crisis.
They pulled off the perfect heist – out in the open. Nobody went to jail. No one was subject to real, long-term consequences.
In contrast, people the world over were subject to austerity measures that hurt students, the vulnerable, and lower-income earners the most.
Prices jumped for everything from food to transportation. Taxes were used to bankroll major corporations’ move back to health.
Calls to regulate banks by breaking them up were met with inaction and disdain. In fact, the Fed was responsible for making big banks bigger by virtue of its merger approval power.
The reason Ponzi schemes eventually crash and burn is that there’s not enough new money coming into them to cover the promises made.
Once central banks unleashed monetary policy to accommodate megabanks, subsidize Wall Street financiers, and bolster global markets, the very idea of free and open markets and laissez-faire investing died.
The threat of raising rates or ceasing to buy bonds could catalyze panic, instability, and chaos – so the threat was never issued.
No one wanted to call the Fed’s QE a Ponzi scheme. But it was.
Adapted from Permanent Distortion: How the Financial Markets Abandoned the Real Economy Forever. Copyright © 2022 by Nomi Prins with permission from PublicAffairs, an imprint of Perseus Books.
Nomi’s Note: Nomi here again. I hope you enjoyed this sneak peek from my newest book, Permanent Distortion. Unfortunately, since I first started writing the book, the distortions in the markets have gotten even more extreme.
That’s why last week, I put on an emergency briefing to tell you about what is hands down the biggest distortion today. Thousands of your fellow readers tuned in. And I even shared how to turn crisis into the opportunity to make as much as 1,000% as this historic distortion unfolds.
If you missed it, I’ve asked my publisher to make a replay available. But it won’t be online for long. Watch it here.