In the artillery barrage of punditry laid down to provide cover for the GOP's big save-the-government-deficit-reduction proposal
, let us duck our heads and ponder a small, but oft-used phrase that's increasingly common: Ponzi schemes. The phrase occurs in a piece
in which Harvard economist Kenneth Rogoff, writing in the Financial Times, warns like Paul Revere that the government has a debt problem. He's undoubtedly correct, but simply clanging a brass bell and telling us that that someday we're going to look really dumb, like those French kings in the 18th century, if we and those welfare-loving Europeans don't do something about this that's big and quick isn't much help. Could the answer be privatizing Medicare? Rogoff doesn't say, nor does he offer a deadline. For a sophisticated economist, this is a pretty crude argument. It suggests that the only option is extreme austerity -- he likes the U.K. approach -- and he warns that once the horse of fiscal distress is out of the burning barn, well, then it's too late. We're horseless. And the barn is on fire.
It is good to know that the economics profession is still confident in making big predictions. On the other hand, how can anyone argue against such a broad statement couched in the future tense? As another economist once said, in the long run we're all dead, or, as Joe Nocera offered up in his new New York Times ope-d on General Electric so eloquently, "yadda, yadda, yadda
But that's not my point. I'm more interested in Ponzi schemes. To make his argument that we better do something fast, Rogoff offers up the ever-popular monarchical French as an example of what can go wrong. When in doubt, hammer the French. "Even if today's government bonds seem pristine by the standards of pre-revolutionary France, future scholars will see our tax system as Byzantine labyrinths funneling money to special interests, creating staggering inefficiencies," he writes. "They will surely be incredulous to see pensions and health insurance financed via Ponzi schemes as transparently unsustainable as the 1700s South Sea bubble."
Now Rogoff here is engaging in a kind of rhetorical contagion. He is linking pension schemes, which presumably includes Social Security, Medicare and Medicaid, with "Ponzi schemes" and with "bubbles." Ponzi schemes are, of course, illegal, and associated with Bernie Madoff's vast bilking of rich people and owners of sports teams. The South Sea bubble had certain shady aspects to it, but it was mostly a speculative mania, not a deliberate scheme to rob folks by promising large rewards to attract new investors, the money for which would be used to pay off the old. The South Sea bubble formed around the British (not the French) creation of a monopoly trading company, the South Sea Company, which was designed to use its public shares to buy British government debt and convert it to a lower interest rate. The South Sea Company thus resembled a government-sponsored enterprise like Fannie Mae far more than a Madoffian scheme. And indeed, there is a clear difference between a speculative bubble and a Ponzi scheme. For one thing, a bubble is legal, if dangerous, while a Ponzi scheme is clearly a fraud. A bubble does involve "a greater fool theory," but it arises from essential aspects of the marketplace: There is no Madoff or Ponzi (though attempts are regularly made post-bubble to find one); market participants engage in the mania that drives prices to unsustainable heights. Indeed, by arguing for a linkage between Ponzi schemes and bubbles, Rogoff is suggesting that the market itself is a kind of illegal enterprise. Or perhaps he is joining in on the kind of witch-hunt favored by, among others, Matt Taibbi.
Then there's his third term, pensions, by which Rogoff really means all the social welfare schemes that have been erected since the '30s. But once again, his analogy breaks down under observation. There are aspects of Social Security that superficially resemble a Ponzi scheme, notably the intergenerational transfer mechanism in which younger workers pay for retirees. Is this the same as Madoff paying off older investors from the proceeds of the new? Well, no. Social Security is a social compact: The intergenerational mechanism has long been transparent; indeed, it has long been one of its chief virtues. What makes a Ponzi scheme fraudulent is a combination of opacity and duplicity. Madoff claims high returns, which turned out to be fiction, and his operation was, of course, deeply secret. As a result, a Ponzi scheme is always a con game. Is Social Security inevitably a con game? Not particularly. Participants know how it's supposed to work. And (this is important) its collapse was inevitable. If Social Security's transfer of funds from one group to the other was a con game, then every analogous transfer -- dividends, bond payments, cash flow and interest-only tranches, taxes, mortgages -- is also a problem. But the program is broke, right? Well, no. The real problem with Social Security is a) shifting demographics (too many seniors) and b) the annual theft of the Social Security surplus by the government. Even Alan Greenspan saw it as a mechanism that could be tweaked and function effectively for decades.
But Rogoff isn't just talking about Social Security. He includes "pensions and health insurance financed via Ponzi schemes." Medicare, of course, is funded differently from Social Security, though in general, both involve an intergenerational transfer. But with Medicare, the situation is far more complex because not only does the program suffer from the demographics of a growing senior population, which requires more healthcare, but from a chronic inflation of costs driven in part by new technology, but mostly by the widespread distortions of a system that's fatally half public, half private. And again, just because the system is breaking down -- and it is -- does not mean that somehow there was a deliberate conspiracy to convince one part of the population to support the other.
And just to prove how infectious all these Ponzi references are, Bloomberg Businessweek features a story "Pension, or Ponzi Scheme?
," which examines public-sector pensions. The headline is meant ironically. The magazine argues that there's nothing Ponzi-like about public pensions if they are carefully designed and prudently funded.
But Businessweek does implicitly make another point: A poorly designed social welfare system can come to resemble a bubble, which is also not a Ponzi scheme. In a bubble there is a widespread acceptance of the terms of the deal, and a widespread optimism that deters any negative thoughts about the future. We march on blindly, buying dot-com stocks by the bushel and ignoring the looming demographic crunch. And then comes the correction: We realize we have made errors, misjudgments, bad calls. But as painful as that correction is, the underlying notion that fuels so many welfare schemes -- that the society as a whole shares in the burden of providing security for those who are, for whatever reason, most vulnerable -- is not a fraud that Charles Ponzi would ever take credit for.
A Ponzi scheme is one man -- or one organization -- deliberately defrauding the public. In a bubble, we are the market. And in a widely accepted welfare scheme like Social Security, political and economic choices are made to tie the generations together. Economics divorced of politics has a tendency to break everything down to atomized individuals. Fund your own retirement. Take care of your own. Keep what you kill. Any other kind of transfer, from rich to poor, from young to old, is viewed as theft and blamed on poor Ponzi. - Robert Teitelman