Turn Stock Market into a Ponzi Scheme: The Easy Way

Today, Goldman Sachs comes out with an upgrade of Capital One bank and Wells Fargo.
The Banks rally 5%. Broad market rallies 1.5%.

[UPDATE: 10/18/2009 Two weeks after the revelation (below), stocks as measured by S&P 500 went straight up for 10 business days, gaining a total of 5% additionally. All conclusions below are confirmed. The only deviation I found was Bank of America reporting $2B Q3, 2009 loss, quite honest, huh. If you are still in stocks like I am, be cautioned!]

After a huge 50-60% run up of the stocks since March 12 2009, you'd think stocks are up for a correction. After the house selling Summer high, you'd expect banks are up for a rough Fall and Winter. After banks hiding their liabilities off the balance sheet a-la Enron, you'd think someday they'll have to show their 'toxic' hidden assets and account for them.

After the top contrarian trend-forecasting stars Dent, Celente, Prechter, and others are seeing an imminent downturn of the stock market, nope, it keeps going up.

But no, the day of reckoning ain't coming just yet. Why not?

I'm following the broad stock market more closely than usual because I found some extra stocks in my Roth IRA that I never sold. It's been 10 years since I seriously looked at the portfolio. It is basically all S&P 500 and guess what, it hasn't made me but a few percent profit after 10 years! Counting for true inflation, it's lost a lot.

Back to the topic. Stock Market a Ponzi Scheme? Madoff reincarnated on a huge scale? And it is easy to turn Stock Market into a Ponzi Scheme? What do you mean Matt?

For the longest time I couldn't understand why, in 2007, establishments such as Washington Mutual were still offering subprime loans to folks even though the subprime market was collapsing all around them. They are in the business of subprime loans and they don't see the calamity has already arrived? Strange. But it is possible to understand why now.

At the last week's IMF meeting, Janet Tavakoli, an expert on structured finance and derivatives, said (quote credit: prisonplanet.com):

Wall Street gave mortgage lenders large credit lines (similar to credit card debt) and packaged the loans into private-label residential mortgage backed securities (RMBS). Most of the RMBS was rated “AAA” … But many RMBSs were backed by portfolios comprising risky fraud-riddled loans. Most of the “AAA” investment was imperiled, and subordinated “investment grade” components were worthless. Wall Street disguised these toxic “investments” with new value-destroying securitizations and derivatives.

Meanwhile, collapsing mortgage lenders paid high dividends to shareholders (old investors) and interest on credit lines to Wall Street (old investors) with money raised from new investors in doomed securities. New money allowed Wall Street to temporarily hide losses and pay enormous bonuses. This is a classic Ponzi scheme…

A large share of certain banks’ tax-subsidized profits is due as reparation to unsophisticated investors, the U.S. taxpayers...By the end of 2006, public reports of implosions of large mortgage lenders eliminated CEOs’ plausible deniability. By January 2007, many (including me) publicly challenged the failure to account for losses. Instead, toxic securitization accelerated in the first half of 2007—classic malfeasance as a Ponzi scheme collapses…

Bottom line, in order to keep the Ponzi scheme running, it has to accelerate in the final stages. That is a sure sign of it being ready to collapse.

How to turn stock market into a Ponzi scheme? Easy. Couple of steps:

- Banks hide toxic assets off the balance sheets
- Mainstream Media publishes great outlook from well known names on how great the banks are doing (Goldman Sachs example, the bank books are looking great if you remove off-balance-sheet assets)
- Mainstream Media touts "Recovery"
- The FED keeps the rates at about 0% keeping bank loans expenses practically at zero
- The government allows printing of Trillions of Dollars through bailouts and stimuli packages, mostly going to the banks who turn around and play with the cash in the stock market
- The government publishes heavily doctored data on unemployment, so it doesn't look as bad as it is.

Well there are maybe a few more steps needed but you get the picture. And I can't give you more details, I'm not working at Wall Street!

Banks are "looking pretty", and "everyone knows", the way the banks go stock market goes.

However, remember, it is a Ponzi scheme. It is based on taking money from Peter and giving it to Paul. There is no value created or consumed. Eventually, this Ponzi scheme Stock Market will pop. But it may go (much) higher before it pops. And you and I won't know when that will be, because it is not you and I who are running the Scheme.

So if you are invested in a stock market, watch your investment carefully. It may rise substantially before it pops. If you have no patience and have better things to do, get out of the market and buy back at half the value or less. Or don't buy back, ever.