How in 2000 and again in 2007 the Stock Market was a Ponzi Market

On October 20, 2007 Ponzi manager Bernard Madoffsaid, "In today's regulatory environment, it's virtually impossible to violate rules." About a year later, Madoff—who once headed the NASDAQ Stock Market, told investigators he had lost his investors $50 billion in a Ponzi scheme. He had convinced his followers that he was safe and they should always invest more and never take their money out of his management. If you questioned him or took money out he threatened to dump you because he had an exclusive clientele and not just anyone could join.

The stock market was a full blown Ponzi scheme in 2000 and again in 2007 because investors bought and held. People did not sell out of the market because the market could go up indefinitely as long as new suckers continued to be drawn into the market. Value was no longer measurable in earnings or PE. Value was measured by the last year’s stock market gain and by optimistic company forecasts. Any company or analyst that gave a Pollyanna forecast was applauded and any company or analyst that did not was vilified. Jim Cramer would crucify analysts who did not upgrade the stocks he pushed.

This was nothing new. It happens with every bubble, it happened with the DOT-Com bubble/energy derivatives scandal in 2000 and it happened with the mortgage/derivatives scandal in 2007. In both cases no one at the top could even explain how the profit model worked. In 2000 the con men said internet profit was not important, only market share mattered in the new age business model. In 2007 they said profit was not important, we had discovered a way to give everyone who wanted a house a chance to buy one using leverage. It was the right thing to do and they said it was racist or redlining to require people be qualified for mortgages. And if you said the system was corrupted or out of control Barney Frank and the head of Freddie got very angry with you and would not let you do mortgages.

They were all bullish through half of the decline. Jim Cramer, on Mar. 11, 2008 said, "I think Bob Steel's the one guy I trust to turn this bank around, which is why I've told you on weakness to buy Wachovia." Two weeks later, Wachovia came within hours of failure as depositors fled. Steel agreed to a takeover by Wells Fargo. Wachovia shares lost half their value from Sept. 15 to Dec. 29.

Just as Mr. Madoff pressured his clients to stay fully invested, Mad Money, Bob Brinker, Fast Money, Motley Fools, and almost all the analysts were saying that anyone who thought he could decide when to sell out was a fool to think we could compete with the wizards of Wall Street. And we were especially foolish to think we should get out of the market with interest rates at only 3%. Yet today, now that the horse is out of the barn many accept the bearish advice of Jim Cramer and sell on every market advance to get cash because Jim Cramer says you need cash for the next five years of dooms days. Today some of those who took Mad Money and Motley Fool advice have lost 40% to 60% of their funds and sell on those advances as Jim advises and they buy treasuries that currently give them no interest at all.

We can expect the Mad Money and Fast Money of CNBC (who are now all predicting another -90% type doomsday) to miss about half the market rally before they declare the market bottomed last November. But we instead look forward to a $999Billion stimulation package being designed to make mortgages solvent from the bottom up because none of the $700Billion bank bailout seems to be trickling down yet.

If you follow CNBC advice and sell too late when the market has made half its downward move and then buy back on their advice after the bottom when the market has moved halfway back up… you end up getting back into the market exactly where you got out. That means their advice is worthless and you would have been just as well off doing nothing rather than following them.

The first people to recognize a Ponzi stock or real estate scheme are always considered fools by people brain-washed into buying and holding. When high multiples and forward earnings projections are fabricated on the fly to justify higher stock prices you can usually see that the people are buying due to price appreciation not increased company profitability. Price appreciation without improved profitability requires a Ponzi scheme where people are induced to buy more and hold. Once people begin withdrawing every Ponzi scheme collapses. They must always collapse.

Several years ago I bought a fund group that Bob Brinker recommended. One time I asked to sell some of the fund. They would not do it unless I put it in writing. It took about three weeks to execute so I decided to sell everything I had placed with them. If you think you are treated with an exclusive arrangement where they severely discourage selling you might want to get out. True value or lack thereof can be hidden indefinitely when there are no liquidations.

The Asian markets closed up another 3% today while European and American markets are slower to recover as predicted. We expect the news media and analysts will be quite bullish by inauguration day. Right about then we expect people will start falling over themselves trying to get back in the market. In about three months we expect the stampede to level off and we should consider reallocating investments by then.

Good luck with your investment journey