Bernie Madoff’s Ponzi Scheme and the Stock Bubble
Bernard Madoff, former Chairman of the Board of Directors of the National Association of Securities Dealers, has just been arrested for operating a Ponzi scheme that lost perhaps $50 billion. His clients were supposedly sophisticated investors.
He reported a healthy rate of profit that was amazingly steady — so much so that it should have been a source of concern. His clients accepted the reported profits as real, making them more than satisfied with their investment. Only after the downturn caused people to make withdrawals did they learn that the investment was nothing but an old-fashioned pure amid pyramid scheme.
The difference between Madoff’s scheme and the stock market bubble is intentionality. In a pyramid scheme, someone knowingly promises higher profits, which can only be paid out from the proceeds of new “investors.”
A stock market bubble works in a similar fashion, except that no individual agent is organizing it. The stock price goes up, causing more people to throw money into the stock market, which causes the stock to grow, irrespective of further perspective of any underlying value. Everyone can become rich so long as enough new money exists to keep the game alive.