In December of 2008, Marc Dreier was arrested for perpetrating an incredible Ponzi scheme. As this riveting Vanity Fair article details, Dreier's tale mirrors the sequence of events, both practical and psychological, that seem to always play out in these schemes. Quoting the article:
Great things were always expected of Marc Dreier, and he expected them for himself. He needed the hotshot litigating career and a life stuffed with rich men’s toys. He needed a Hamptons beachfront house. Thus began a four-year Ponzi scheme—involving audacious impersonations and $380 million stolen from 13 hedge funds—which all unraveled just days before the Madoff scandal broke, bringing the 59-year-old attorney a 20-year prison sentence.
First, the perpetrator is always at some pivotal point in his life inducing consideration of something nefarious. In this case, Dreier was undergoing a mid-life crisis brought on by the unfulfilled expectations of a prodigious Harvard graduate and the jealousy of his peers that had seemingly achieved so much more.
Second, the scheme is always believed to be only a quick fix or a temporary means to some legitimate end. In Dreier's case, after being denied loans to start his own law firm, he believed that the first theft would enable him to start the business and that he would ultimately return the money he stole.
Third, the first amount was not enough to "fix" the problem and the thief finds the temptation to steal again irresistible. After creating a phony $20 million note which he sold to a hedge fund, Dreier simply did it again. He was able to create money out of thin air, a power that few would be able to resist.
Fourth, the thief achieves some sort of nominal "success" in terms of creating the perception that he has achieved something real and to some extent actually does succeed in creating some actual business. This temporary "success" creates delusions of grandeur. As Dreier expanded his firm with stolen money, he brought in real lawyers who generated real revenue and even opened a Sushi restaurant in Los Angeles. In fact, the legal community took notice of this interesting new model - the so-called "Dreier Model":
Within the legal community, Dreier was viewed as a rising star. He told anyone who would listen that Dreier L.L.P. was a new kind of law firm, one where lawyers could work with freedom, unburdened by old-school bureaucracy and administration, all of which Dreier handled himself. In a 2007 article for The National Law Journal, Dreier argued that the “Dreier Model,” as he christened it, freed attorneys from petty bickering over profits and allowed them to operate as true legal entrepreneurs.
Sixth, something happens to stop the spigot and the house of cards begins to crash down. To the bitter end, the thief resorts to ever more audacious maneuvers to keep the scheme going although he senses that the game is over. I won't ruin the article for you - just read it.
Seventh, the perpetrator is arrested and sentenced to prison where he discovers what is truly important in life, repents his sins, and spends his remaining days in a semi-trance depressed, humiliated, and suicidal.
What struck me in analyzing this pattern was that it is exactly the pattern followed by the Federal Reserve system in creating the boom-bust cycle.
The Federal Reserve is able to create money out of thin air just as Dreier did when he sold fake notes to hedge funds. The credit expansion, meant only to temporarily ameliorate or "smooth out" an economic downturn, initially masquerades as actual investment capital, lowering interest rates and stimulating capital investment. As this fake money filters through the monetary system where it is mulitiplied by fractional reserve banks, businesses and consumers find themselves awash in easy money and use it to fund virtually every desire. Rather than a system built upon thrift and hard work, easy money creates a kind of moral decadence as everyone and anyone gets money for nothing - one might say that people are "freed from the petty bickering over profits".
Of course, at some point the party must stop. Prices begin to rise and to head off an inflationary panic, the Fed closes the spigot of liquidity. The hangover begins. Investments once thought to be profitable are seen as malinvestments and must be liquidated. Firms and individuals must deleverage to raise cash as loans are called in. Waves of bankruptcy's exacerbate a downward spiral. Ultimately, such a process is necessary and vital to restoring economic growth upon a foundation of real capital, savings, and productivity.
It can be seen that the only difference between the individual perpetrator of a Ponzi scheme and the Federal Reserve is that the former properly receives condemnation, scorn, and a prison sentence whereas the latter receives the imprimatur of Nobel Prize winning economists and encouragement from the government to simply continue the scheme. Economists do not call the Fed's inflation of the money supply and manipulation of credit the "Dreier Model", they call it Keynesian economics.
Unfortunately, I do not see Paul Krugman, Ben Bernanke, Barney Frank, or Timothy Geithner sharing a cell with Marc Dreier or Bernie Madoff anytime soon.