Jon Stewart: “Is our economy Tinkerbell? If we stop clapping it dies?”

April 10, 2009

Jon Stewart to William Cohan, author of House of Cards (a book on Bear Stearns) in the April 9 epizode of The Daily Show:

“You report a lot on Bernie Madoff, who ran a Ponzi scheme which is a fraud: you just continue to get money and promise people returns when you’re not actually investing in anything…(looks down thoughtfully then looks up)…What is the difference between a Ponzi scheme and an investment bank?”

Huge laughter. The lead-up to this moment was Cohan’s critique earlier that banking was based on maintaining confidence–which allowed banks to taking excessive risks but left them vulnerable to the loss of confidence (when banks decided that a collateral put up by a bank was no longer good enough for a loan, they stopped lending to that bank and the investments collapsed), and that it’s “no way to run a financial system.”

Cohan’s reply was essentially that “in investment banking they were playing by the rules” while Madoff was “playing outside the law.”  He noted as evidence that there have been only two criminal indictments in the Bear Stearns case.

But this common answer completely eschews the technical and moral core of the question–why? What Jon Stewart got good mileage out of, and what he was dead serious about, is that if technically the two schemes are the same, it’s not clear why we categorize them differently as legal and illegal. What properties (should) make a financial construct legal?

A similar question was raised on this blog in an earlier post about Ponzi schemes, pension systems, and banks. The question seems to be, how is it determined that a financial firm “did not invest in anything”?

9 Responses to “Jon Stewart: “Is our economy Tinkerbell? If we stop clapping it dies?””

  1. Guillaume Says:

    The difference between a Ponzi schema and the pension systems is that in a Ponzi scheme, investors are lied to, whereas in a pension fund or the banking system, information is publicly available as to how they work and it is institutionalized.

  2. danielbeunza Says:

    The post is relevant. To many people, the crisis crisis and financial fraud cases have taken a “metonymical” nature, where a part is now being taken to be the whole. This is what Jon Stewart seems to be exploiting.

    But there is a huge difference between a Ponzi scheme and an investment bank. My coauthor David Stark and myself have been giving this a bit of thought in relation to the problem of systemic risk. Both Ponzi schemes and Bear Stearns-style counterparty can pose a huge risks.

    Sociologically, however, they operate on a different basis. Because a Ponzi scheme is a fraud, its sole existence is risky. The question, in relation to them, is why they exist. And the answer –if we are to theorize on the basis of Madoff– is a mechanism of embedded trust, whereby investment is mixed up with social relations. (There is more, of course to this story. A recent Wall Street Journal piece explained the vast expenditures in social luxury that Piedrahita, the Colombian distributor of Madoff’s funds, put in place).

    The problem with i-banking systemic risk is about interdependency. This is best understood with the sociological concept of Callonian entanglement. Investment banks are financed in a way that creates counter-party risk. This “entangles” multiple parties in often unpredictable ways, leading to a risk to the system as a whole. Hence the justification for the Fed’s rescue. And hence existing proposals to disentangle investment banks from their counterparts, going forward.

  3. zsuzsannavargha Says:

    Guillaume, information veracity is an issue, but interestingly just by having publicly available documents about investment banks doesn’t mean that anyone really knew (if we are to believe Michael Lewis, often not even the bankers themselves) what these companies were doing. As Daniel pointed out and as the tracing of trades shows in hindsight, the entanglements between multiple parties were intractable.

    Because both of these collapsed–fraudulent (Madoff) or legal (i-bank)–gives rise to the metonymic recognitions that Daniel rightly mentioned. What I think the moral outrage shows is that the underlying notion of “investment” turned out to be false: that investment is something substantial, perhaps even something productive. If we follow this point we soon get to another common view, both in social science and in public debates, that modern finance does not produce anything–thus at the extreme the question about investing potentially reaffirms the division between a virtual and a real economy.

    I wanted to take this question precisely in the other direction, to get away from simply referring to the hindsight judgment of criminality as the main difference between different financial arrangements, and to think about that fine line. I don’t think it’s clear how the different arms of Madoff’s firms were linked, how money moved from one to the next and which part was criminal. Similar is Sudhir Venkatesh’s point that focusing on above ground and underground economy precludes understanding of upholding them. This leads us to the mixing up of investment and social relations in the case of Madoff. Madoff exploited embeddedness in a highly skilled way but this is not unique to fraudulent schemes. After all, any company whose market-building strategy is based on clients’ social networks does the same. One recognizable technique to gain access to those networks is to perform scarcity–the investment club is exclusive.

  4. dani f. Says:

    A recent article about ponzi schemes in the new yorker says that in most ponzi-like stories the scammer thinks that the irregular situation will only be temporary, and will soon be able to come back to regular investments; then it gets derailed. I think what we can take from that story (as zsuzsi points out) is a closer connection between the legal and the illegal (and a dance around those boundaries) that we may expect (if what the article says is true, how many schemes successfully managed to come back to legality, functioning temporarily as a ponzi scheme?).

    Also, I think it is not just embedded trust what sustains ponzi schemes. To the eyes of the early investors who receive the promised returns, it is simply the fulfilled promise: it works. Madoff’s case is very famous now, but there have been lots of schemes targeted to lower income people around the world (last year there were riots in several Colombian towns about a ponzi scheme). Those stories must be very different from the glamorous stories about country clubs and play-hard-to-get that we read about Madoff.

  5. danielbeunza Says:

    That’s one damn good comment.

    I had not seen the New Yorker article, but am certainly going to take a look. I know, for example, that Nick Leeson’s fraud at Barings Bank started as a scheme to cover up temporary losses. So I am absolutely open to the theoretical possibility of a “dance.”

    The practical question is, how prevalent is it? And here, we go back to the denunciation implicit in the statement “investment banking and pozi schemes are the same.” Madoff, the argument goes, makes every financial institution suspect. For further evidence: just look at the size of the losses.

    The source of my disagreement is that this view oversimplifies the existing means and institutions designed to make fraud difficult. Fraud, in fact, far more rare on Wall Street than losses are. It also overlooks the other challenges and difficulties experienced by investment banks, which can lead to mounting losses, even in the absence of ethical shortcomings.

  6. zsuzsannavargha Says:

    Dani, thanks for pointing to the New Yorker article. That’s exactly the kind of issue I was thinking about, where actors often shift back and forth between activities categorized as legal and illegal. Madoff allegedly didn’t start out as a Ponzi scheme at all; on the other hand, as Daniel suggests there are abundant accounts of traders hiding their losses from their superiors on a regular basis.

    Daniel, I agree and that’s what I said above: outcome (the fact of the losses from both Madoff and investment banks) is certainly used as proof of inner similarity, along with newly emerging descriptions of how investment banks make their money.

    While Jon Stewart and others exploit this point to suggest that the entire financial system is a fraud, I hoped to make a productive point, that this is an opportunity for us to learn about circuits of monetary flow. To do that it is counterproductive to start from the position of denouncing either Ponzi schemes or investment banking. I guess my provocation didn’t work out the way I thought.

  7. dani f. Says:

    Here is the reference to the new yorker article, just in case:

  8. zsuzsannavargha Says:


    It’s also an interesting question why investors go with schemes that promise outrageous returns (e.g. Madoff’s was constant high return year after year, regardless of the fluctuation of the economy and of corresponding average returns).

    The answer might have to do with arbitrage. More precisely, actors’ understanding of how markets work, and their inability to calculate. Ponzi schemes are possible partly because investors are aware that some people sometimes are able to do arbitrage, to exploit price differences, if they are creative and that these opportunities only exist for short periods of time.

    However, the investors cannot see into the box of what the financier is offering, they only know that in markets there are openings for making extraordinary profit. They then (how?) come to see the investment not as a scam but as a credible opportunity. There is a mass effect here, since the more people join the more credible it is, and coincidentally, the more sustainable the scheme.

  9. Chris J Says:

    The idea of a dance is getting close to Minksy’s financial instability hypothesis that specualtive positions tend to turn into ponzi positions during stable times when risk is discounted.

    Minsky held that investment banks and ponzi schemes were very similar.

    Where a ponzi scheme pays interest out of capital the infrastructure, REIT and MBS portfolis which investment create have a more complex but related structure to a ponzi scheme.

    Many structured investments or portfolio’s of mortgage backed securities created during 2003-2007 were dependent on the ability to re-finance under conditions of asset price inflation. This enabled them to borrow more capital to give a distribution to investors against the increasing value of the asset. This is close to being a ponzi scheme because distributions are paid from debt rather than from internal sources of income. When the downturn comes the fund cuts the distribution and hopes that the income from the toll road/mortgage payments meet the cost of the debt they have accumulated. If it doesn’t then the fund has to start paying out equity capital to meet its debt and hope that it can last long enough to see conditions turn around before it runs out of equity capital.

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