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DOWNTIME Part 1 – How the World Fell for It

How do thousands of the world’s supposedly most brilliant investors fall for a con like Bernard Madoff and lose their shirts and slacks? The puzzle is not to explain how one person can be such a great con. There was nothing genius about his plan. His form of pyramid scheme, known as a Ponzi scheme, is one of the most common financial fiascos in the world, known to all investors. The puzzle, then, is to figure out how so many experienced, highly credentialed and successful investors could become so utterly conned with such ease? Madoff is just a figurehead for what has happened to the entire planet during the same timeframe. The greater puzzle, then, is to discover how a whole world could have become so confounded.


The answer for Madoff and his investors lies in the fact that Madoff pulled off his pyramid investment scheme during a boom in which nearly all of the Wall Street insiders and political leaders were willing to believe that vast profits could go on forever by just making credit freer. It was a credit pyramid where eventually the ability to take on more debt had to run out. Making credit freer really translates into printing more cheaper money. That’s what credit does in the Federal banking system. It’s the government’s way of injecting printed money into the monetary system through banking credit.

During normal economic times…. Right away I’m in trouble because most people think “normal economic times” are what we had through most of the last decade. But real normal times are when banks have regulations that require (here’s an old-fashion word) collateral, and… well, we won’t go there just yet. During normal times when banks actually weigh risks with formulas, rather than try to insure it away with odd insurance schemes no one understands … during times such as that … some investors would have been skeptical and wondered what Madoff’s trick was. They would have asked questions and probed. Someone would have seen what was happening and blown a whistle long before Madoff’s pyramid reached such Titanic scale. But, as we roared into the new millennium, Madoff didn’t need to explain to anyone how his investments worked. After all, no one understood how a lot of things worked in the financial markets anymore. It was enough that they were clearly working because people were making big profits off of them.

The Goliath gurus like Madoff and Greenspan were trusted. No one questioned those who appeared to know how to take the hoards to vast and dizzying heights of economic gain. No one wanted to throw cold water all over the party guests. It was fun, the drinks were pouring, why ask tough questions? The world was in a feeding frenzy. Madoff didn’t get away with his scheme for so long because he was bright or because all investors were stupid. He got away with it because no one was paying attention to business. It turned out that the emperor wasn’t the only one with no clothes. All of his advisors were naked and didn’t know it as well. In fact, his whole kingdom was naked because nearly everyone participated by overextending their credit … living off of debt, instead of wealth … leveraging their daily lives.


At the bottom of this worldwide meltdown is one simple word: denial. The few voices that spoke about the dangers of economic growth fueled by endlessly cheaper and cheaper credit were not heard. Keeping this pyramid scheme climbing through ever growing consumerism meant the nation had to keep consumers consuming beyond their cash means for consumption indefinitely. Anyone should have seen that was a pyramid that had to eventually reach its pinnacle. Once presidents had built bull markets by deregulated credit, the only way to keep consumers spending was to keep extending their leverage. If they ever stopped increasing their debt, the rate of growth that depended on that constant debt increase would have to stop, too. Denial didn’t want to think about that or even hear it. Denial doesn’t give a second thought to anything that doesn’t fit in its distorted view of reality.

The denial worked because nearly everyone in the world was willing to believe that housing prices would go up forever. If the U.S. government had listened to the what-ifs (what happens if housing prices actually go down for a little while?), then it would have known it had to keep in place the longtime standard regulations on home loans that were based on percentages of income compared to other household expenses, and reasonable down payments, and maybe even non-adjustable interest. All of those rules existed for the sake of avoiding surprises in loans down the road and providing a buffer in case housing values slid a little. Those regulations came into existence precisely to avert the enormous meltdown we are now experiencing.

Denial is what any of us engage in when we decide to have something we want without regard to excess. It’s what we do when we say the extra desserts won’t hurt me, the extra drink won’t affect my driving, the extra-marital affair won’t have any repercussions in my marriage. Denial is what I kept hearing in the financial news months ago when I saw this economic collapse coming and heard others still speculating as to whether or not we were in a recession. Of course we were in a recession! You could feel that in your bones. It’s just that the economic indicators — the gauges on the economy — had gotten a little sticky and were a little slow to respond. By the time the gauges began to move, the U.S. had entered its economic China Syndrome. Denial is what I heard when one of the Goliath gurus said, after the fall of Bear-Stearns and J.P. Morgan, “This is nothing. In 1987 we saw hundreds of financial institutions collapse. This is only two financial institutions.” For a giant, you sure are dumb, I thought, In ’87 we saw hundreds of mom-and-pop savings and loans on the periphery of our economy go bankrupt. That’s like losing fingers. This time we’ve just seen two vertebrae in the center of our economic spine turn to dust.

Denial came in the form of a major presidential candidate telling the nation that its economy was fundamentally sound, when the fundamentals of the economy were the very thing that was least sound of all.


Now that the economic power plant has melted down, the denial is over, right? We’re all looking for straight answers to get us out of this mess, right?


People want the up times back, and there’s no stopping them. No one wants to bear the pain of the kind of correction that could set the world aright again. Therefore, all the governments in the world are looking at essentially fixing the problem by resurrecting it. The primary solution offered to a situation that developed out of cheap and easy credit, which intoxicated consumers and investors to the point of delirium, is to get the cheap-and-easy credit lubricated and flowing like it used to so the good times can roar again. The solution put forward by all the economic giants of government, guided by all the same Wall Street Wonders who created the mess, is to do more of the same — to get consumers who are not spending enough to pump the economy up by buying cars and homes they clearly don’t need. To do that, they have to get people to consume on credit again. That’s Plan A.

The other part of that solution is to give consumers a little tax break — Plan B. Even when the government is looking at the most outrageous deficits the world has ever seen any nation take on, the Bush Administation wants consumers to take on more debt by decreasing its revenue so that consumers will have more money to rev the economy back up. The catch there is that the consumers are still buying everything on credit; it’s just that it’s the government’s debt. None of that’s going to work. That’s why the tax break earlier in 2008 didn’t save us. I said at the time, it was foolhardy and predicted it would scarcely create a bump in the recession, but no one listens to me. (Of course, there was no reason they should because I’m not one of the Goliath gurus.) No one — least of all taxpayers — wanted to hear that the tax breaks wouldn’t work. Taxpayers like breaks like school kids like snow days. Government, on the other hand, had no creativity to offer anything that was not in its standard play book. Yet, old Band-aids aren’t going to work for major spinal injuries.

So, the international effort to prop the economy back up by getting credit flowing as easily as it was (which was the only reason houses were able to climb so far past people’s means in the first place) is just more denial. Denial is like that. It filters what we see so that we can believe the good times will keep rolling and so that we won’t have to deal with down emotions that we don’t want to face.

If the Goliath financial gurus that the world’s mightiest emperors keep listening to weren’t so nakedly wrong, we wouldn’t be in this mess. (Nothing like a world full of naked giants and, even at that size, no one notices they have no clothes.) So, with all of the financial wizards all over the world blatantly and grossly wrong, I decided that being a big name does not give one a clear view of the truth. Since there is no possible way that my observations could be further off than all of the financial behemoths in the world fused into one vast and writhing collective of twisted wisdom, I decided to start a column called “Downtime.” It’s time for this little David, an average guy with some common sense, to pick up a few common stones and start sinking them between the eyes of giants. “Downtime” is going to be a nearly daily combination of financial news and commentary that sees through the huge cloud of denial that is still swirling around the world.

That means it will be for a limited audience because it will be of interest only to those who are willing to see the present downward spiral for what it is and to drop all denial about what works and what doesn’t work for righting so many wrongs. So, if you don’t think an average Joe who is not a plumber could possibly be worth listening to when we clearly need the world’s mightiest minds to stop this juggernaut from eating the earth, go back to your 401K and continue listening to the great gurus that got it where it is today.

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