The Ponzi Market Is Alive and Well Today

A century after the dawn of the 'Ponzi scheme'... The Ponzi market is alive and well today... From airlines to SPACs to JPMorgan Chase... Charles Ponzi's hero... The table is set once again to crush unwitting investors...

Charles Ponzi's family couldn't take the delinquent's antics any longer...

Every time the petty crook from Parma, Italy was arrested for stealing, committing forgery, or gambling illegally, his relatives were forced to pay the fines to bail him out.

So in November 1903, they shipped Ponzi off to America with $100 in his pocket.

Of course, true to his form, Ponzi lost all but $2.50 of the money to a Sicilian gambler on the boat to the U.S. He boasted during the trip of wealth, education, and achievements that he did not truly possess.

Ponzi's shipmates joked that if he learned to lie like that in English, he'd do well in America.

But Ponzi's new start in America was much like his old life in Italy... Over the next several years, he was jailed in Montreal for forgery and in Atlanta for smuggling illegal Italian immigrants from Canada into the U.S.

In January 1920, Ponzi started a new venture that he called the Securities Exchange Company...

Ponzi came up with his harebrained idea while opening the mail a few months before that. It centered around the usage of international reply coupons ("IRCs").

To this day, IRCs can be used to purchase the minimum necessary postage to send a letter to another member of the Universal Postal Union, a United Nations agency that coordinates postal policies among all the member nations.

After World War I, currency values and postal rates varied widely among countries...

Ponzi believed he could use IRCs purchased in one country to buy stamps of greater value in another... which would help him generate a large profit. It didn't work in practice because the overhead ate up the profits, but that didn't stop Ponzi from using the idea to take advantage of greedy, unwitting investors...

He attracted them with the lure of large, quick profits... and then defrauded them by using the money from later investors to pay off earlier ones. It forever attached his name to that type of fraud... I (Dan Ferris) am sure everyone reading today's Digest knows about a "Ponzi scheme."

The scheme grew rapidly... By July 1920, Ponzi operated offices in several states, helping him to bring in $1 million per day. The former Italian lawbreaker lived lavishly, invested in a bank, and became known to some folks as the "wizard of finance."

But then, even quicker, Ponzi's scheme fell apart... A series of newspaper articles that summer expressed suspicion and concern. Six banks failed in its wake. Ponzi pleaded guilty in November 1920 at the urging of his young wife and spent about three and a half years in prison.

Still, Ponzi didn't learn his lesson after doing hard time in federal custody for the scheme...

Out of prison, Ponzi ran another fraudulent scheme selling swampland during the Florida land boom in the mid-1920s. He then attempted to flee the country aboard a ship but was arrested in New Orleans and shipped back to Massachusetts to serve out his final prison term.

Ponzi was eventually deported in 1934, returning to Italy for a brief period before moving to Brazil. He spent his last years alone and living in poverty... In 1949, almost completely blind and partially paralyzed, Ponzi died in the charity ward of a Rio de Janeiro hospital at age 66.

Today, 100 years after Ponzi launched his most famous scheme, it still bears his name...

Running a Ponzi scheme is a stupid, desperate act.

To pay the first investor and take a cut for himself, the schemer needs to find two new investors... then four... then eight... and you can see how quickly it gets out of hand.

Ponzi schemes always fall apart when the perpetrator fails to get enough later investors to bail out the earlier ones. But they tend to go on longer than you'd ever expect... That's because early investors – pleased with the perception of steady, large profits – tend to leave their "profits" to be "reinvested."

Imagine someone who thinks himself so worthless that he can only get money through force or fraud. It's a disgusting thought... and leads to an equally disgusting reality.

Bernie Madoff stole between $50 billion and $65 billion from clients of his investment firm before being caught in 2008. It's considered to be the largest Ponzi scheme in history.

Madoff and Ponzi were found out in a similar way...

If Ponzi's claims of $8 million in transaction volume for IRCs were true, it would've meant 160 million IRCs existed at that time. But in truth, only a few thousand were kept on hand in New York – one of the busiest post offices in the world. Meanwhile, Madoff drew suspicion by claiming to trade options in greater volumes than ever traded on the exchanges.

Ponzi schemes are conspicuous for the massive footprints they fail to leave.

Ponzi-like shenanigans pervade some industries...

Take small-cap mining exploration companies, for example...

Don't misunderstand me here, though. A few of these little companies are run by incredibly talented, successful individuals who will treat investors' capital as well as they treat their own. I know some of them personally, and they're stellar individuals... In fact, they're the people who educated me about the widespread fraud in their own industry.

But the overwhelming majority of those tiny little exploration miners have a Ponzi-like quality... even if they're not technically frauds. The early investors are the geologists, promoters, and brokers who form the company and float the shares.

Promoters touting big mineral discoveries run the share price up in the stock market. Then, early investors dump their shares at a profit into the rise caused by the promotional bluster. And later investors are left holding the bag when drill results disappoint (as most do).

The airline industry has a distinct Ponzi-like odor these days, too...

Airlines were decimated by heavy-handed responses to COVID-19 by governments around the world. With air travel virtually nonexistent, they weren't bringing in any money.

The U.S. airline industry requested a $50 billion bailout on March 16. That same day, Bloomberg reported that the biggest U.S. airlines – the same companies needing a bailout – had used 96% of their free cash flow to buy back shares over the previous decade.

As part of the CARES Act signed into law a couple of weeks after that, airlines got the full amount they requested ($25 billion in loans and $25 billion in grants) to keep workers on the payroll. The loans must be tapped by September 30.

It's one thing to bail out employees who were hurt by the shutdowns. But it's another to bail out bondholders and shareholders – people who knowingly put their capital at risk.

If only the airlines knew ahead of time that they would be getting bailed out this year, they could've borrowed to the hilt and bought back much more stock. That could have pushed their share prices higher, helping executives to "earn" more compensation in the form of stock options.

No worries. They'll remember next time... And after this bailout, a next time is guaranteed.

This is just bad economics. As 19th century French economist and writer Frédéric Bastiat said in his essay, That Which Is Seen and That Which Is Not Seen...

The bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come – at the risk of a small present evil.

Saving a few airline shareholders from having their investments wiped out in a bankruptcy is a "small present good" in the grand scheme of things. We should be more like true economists, pursuing "a great good to come" – a fair and level playing field in financial markets, where underlying fundamentals allow true price discovery for all assets.

Let the "small present evil" of another round of airline bankruptcies begin.

Other hospitality-related companies received COVID-19 bailouts, too... But most Ponzi schemes don't get bailed out and do involve outright fraud or other improprieties. A recent market darling's fall from grace appears to provide a perfect example...

If one short seller is correct, electric-vehicle maker Nikola (NKLA) may have committed massive fraud...

The stock market quickly assigned a $27 billion market cap to the brand-new, unprofitable company after it went public in June. That's roughly equal to 117-year-old carmaker Ford Motor (F). But the big difference is that Ford is profitable, while Nikola has zero revenue.

Nikola's stock soared as high as $93.99 per share during the day on June 9. But recently, the bottom has dropped out... Shares currently trade for less than $20 after a short seller at Hindenburg Research alleged numerous improprieties in a report on September 10.

For example, Hindenburg concluded that a video alleging to show one of Nikola's electric trucks in motion really just showed the vehicle gliding downhill in neutral.

The company actually defended itself by saying the video never said the truck was moving under its own power... only that it portrayed it "in motion." The fact that Nikola published a video of a prototype that doesn't actually work yet was lost on company executives.

Hindenburg's report accused Nikola founder Trevor Milton of making "dozens of false statements." It also noted that, "We have never seen this level of deception at a public company, especially at this size." In turn, Milton resigned Monday. The U.S. Securities and Exchange Commission and the Department of Justice have both launched investigations.

No bailout is forthcoming for Nikola's unwitting shareholders...

If you bought the stock above its current price, I have no reason to believe you will ever exit with anything but a loss. And I suspect the losses will continue to grow as Hindenburg's long, highly detailed report is fully digested by the market in the days ahead.

Nikola is perhaps the perfect emblem of the current market frenzy...

Earlier this week, a CNBC article pointed out that the stock caught investors flat-footed in three separate areas of wild speculation all at the same time...

1. Electric vehicles,
2. Special purpose acquisition companies ("SPACs"), and
3. The rise of retail traders, like Robinhood.

SPACs – also known as "blank check" companies – are shell companies with no operations. They raise money and go public with the intention of acquiring a business, usually in a specific industry. Investors provide capital without knowing what business they'll wind up in.

Nikola went public by merging with a SPAC in June. The stock soared as high as 170% immediately, briefly eclipsing Ford Motor's market cap, even though it isn't expected to earn any revenue until next year. (I'll believe that when I see it.)

This is a record year for SPAC issuance... A total of 112 SPACs have raised more than $42 billion so far this year, compared with 59 SPACs that raised nearly $14 billion last year.

In some ways, the SPAC boom can be viewed as a good thing. Some experts will tell you that this path makes it easier for private companies to go public... It's much easier for a company to merge with an existing SPAC than to go through a regular initial public offering.

I don't doubt that the SPAC structure itself could be useful. Nor do I doubt that SPACs can help you make a boatload of money if you know what you're doing. In fact, I'd bet real money that somebody at Stansberry Research or one of our affiliates is sifting through all the nonsense right now... and finding a hidden gem or two.

But it's not at all controversial for me to argue that this year's flood of new SPACs is a typical sign of wanton speculation... or that most SPAC deals underperform. Just think about if you met someone who said...

Hey, I'm raising a bunch of money. I have no idea what business we'll wind up in, but it'll probably be something associated with transportation, maybe electric vehicles... something really cool like that.

But look, either way, you just give me the money today. And I'll get paid a bunch as long as I find an acquisition target. If I don't find a target that's good enough in a certain period of time, I'll give the money back. OK?

Now, what do you think the odds are that the SPAC sponsor won't find an acquisition target? I'll say probably somewhere between zip and zero.

It's an agreement to give your money to someone who, if they're honest, will admit the money will burn holes in their pockets. And in order to not let that hole get too big, they'll spend it all!

If a zillion Robinhood traders weren't trading stocks in their jammies at home, I doubt we'd have a SPAC boom...

SPACs are ideal for impatient traders like that who want to buy something... anything. A company that just raised a bunch of cash and promises to invest it really fast into something – anything – sounds great to the Robinhood crowd.

Many people will tell you that SPACs' less-than-stellar reputation has improved since their advent in the 1990s. But in my mind, the basic proposition has not changed one bit... You give someone a bunch of money, and they have zero incentive not to invest it.

Spending money always feels better than not spending to such people. Do you really want your capital invested under that kind of incentive?

Like I said, I'm sure a lot of folks will push back on my dislike of SPACs...

But nobody can argue with the fact that most SPAC deals don't turn out well... or even that frauds – possibly including Nikola – have occurred before and will occur again.

Greek music-streaming service Akazoo went public via SPAC about a year ago. And it soon turned into a fraud Charlie Ponzi would have been proud to have done himself...

The company claimed that it had 5.5 million subscribers. But unfortunately, most of them didn't actually exist. That's brazen stuff... just the always-smiling, always-confident Ponzi's style.

And as the Financial Times reported in August, all the initial backers of Modern Media Acquisition – the shell company that merged with Akazoo – lost every penny as a result of the fraud from Akazoo's previous management. The stock was delisted from the Nasdaq back in June.

Despite a few high-profile successes – like DraftKings (DKNG), which is a five-bagger since merging with a SPAC in April – most SPAC deals over the past few years recently traded below $10 per share, the usual price that SPACs first sell their shares to the public.

Fraud, lousy deals, poor share price performance... No thanks.

But from Charles Ponzi's perspective, nothing can beat JPMorgan Chase (JPM)...

According to the United Nations' Financial Stability Board, JPMorgan is the largest systemically important financial institution ("SIFI") in the world. That means JPMorgan CEO Jamie Dimon would be Charles Ponzi's hero, if only Ponzi were still alive to bask in his glow.

You see, there's no way any central bank or government in the world will allow a SIFI to fail... They'll find a way to bail them out every time. And in turn, that secures Dimon's vast fortune...

According to FactSet data, Dimon owns about 8 million shares of JPM stock, worth more than $740 million today. Not only is JPM the world's largest SIFI... Dimon is apparently a systemically important banker, his fortune guaranteed by the Federal Reserve.

Now, I'm not accusing JPMorgan or Dimon of fraud at all.

But his and his company's incentives are arguably worse than all the SPACs (not one of which is big enough to warrant a bailout, COVID-19 or not). The fundamentals at JPMorgan probably aren't as wonderful as Wall Street would like you to believe, either.

JPMorgan currently has $3.2 trillion in assets, and its quarterly filings run just over 200 pages. What are the odds anybody on the planet – including Dimon – really understands what the company owns or how much risk it's taking? Probably somewhere between zip and zero, I'd guess.

Given the Fed's ability to print all the money JPMorgan needs to stay afloat, you could argue that Dimon has realized Ponzi's dream of endless easy money... earned without fear of legal retribution or risk of loss.

To the right kind of crook, it's beautiful, man... just freakin' beautiful.

Why talk about all this now?

That's simple... It's my job to remind you, dear Digest readers, of all the ugliness lurking in the system when nearly everybody else today wants to tell you to just buy, buy, buy.

Someone must warn you about the things that no one else wants to imagine can happen.

If the stock market were down 50% and nobody could talk about anything but frauds, scandals, and reasons to never touch stocks again... I wouldn't be reminding you of the enduring saga of Charles Ponzi, Bernie Madoff, or the Ponzi-like deals and scandals of the past year.

But with investors going ape over electric-vehicle makers run by shady individuals (that includes you, Tesla) suckering legions of gullible investors and junky SPAC deals blowing up amidst fraud (Akazoo) and alleged fraud (Nikola)... the market falling, yet still within 6% of the most expensive all-time high valuations in its history... and Dimon running around waving his backstopped generational wealth in your face...

I'd much rather remind you that investments that people fall in love with in frenzied, expensive markets always... always... always disappoint them.

It can even happen if you're buying a truly great business... People who bought Amazon (AMZN) near its dot-com era top in December 1999 had to wait until October 2009 to break even. And you can bet most of those folks sold out at a loss long before that ever happened. People who bought Cisco Systems (CSCO) back then still haven't broken even.

And today, the scene is set once again for unsuspecting investors to be crushed in the coming years...

Economist and asset manager John Hussman of Hussman Funds said the most reliable long-term measures of valuation are so high right now that he was forced to adjust the Y-axis on all the charts he has used for years. He's also adjusting his expected return graphs since...

The resulting extreme in stock market valuations has also driven likely 10-12 year S&P 500 nominal total returns below zero.

In other words, stocks are currently more expensive than they've ever been in history. And they're priced to lose you money over the next decade or longer.

As Hussman bluntly said in his most recent market commentary... Yikes.

I've said it before, and I'll say it again... I don't do predictions. It's not my style to pretend to know exactly when the bubble will burst. But I do hope you'll do yourself a favor today...

Keep some powder dry and some capital in vehicles like gold and bitcoin – where the Ponzi schemers can't get to it.

New 52-week highs (as of 9/24/20): none.

In today's mailbag, an argument for a smaller world population after our international editor Kim Iskyan mentioned declining fertility rates in several countries in yesterday's Digest... and another thought on in-person campaign rallies. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"You guys, yesterday, California Governor [Gavin] Newsom said and signed order to ban internal combustion engines by 2035. OK, someone later might come along and rescind that law/order. Not the point. The liberals believe in climate change, they are going to pass into law, arcane measures to decrease carbon and (hopefully) methane gas emissions into the atmosphere because they believe it's causing CC.

"Any reasonable thinking person can see that reducing the carbon/methane is not going to significantly change CC, because that is not the root cause, TOO DAMN MANY PEOPLE ALIVE ON THIS PLANET IS THE PROBLEM. So, if world populations are shrinking, that means less people on the planet, less resources used, less oil burned, less everything and CC will slow down.

"Now personally I don't believe CC exists, but, this planet was never designed to house 7.4 billion people. It comfortably can house about 3-3.5 billion people, we can grow enough food to feed that many, we cannot possibly provide the necessary 'stuff for all those folks' someone loses, and the losers don't take it kindly, they fight wars over stuff.

"We need the population to be what it was in the 1950s, and for it to be stable. Then the earth can deal with all the crap we put in the ground, and enough plants will regrow, that the CO levels will be stabilized, the ice caps will refreeze, etc.

"10,000 years ago the northern hemisphere was covered in ice, people were not alive, no heavenly body crashed to earth to warm it, but warm the earth did. Tell me what caused that warming, and don't blame mankind, we were not even alive?" – Paid-up subscriber Monty B.

"To Corey, You don't have to wonder about how campaign rallies would compare if both candidates were doing them. Biden ('Mummy-Man') and his 'handlers' know he does not possess the mental capacity and wherewithal to try one, and that it would be a miserable failure compared to Trump. That's why they don't even try.

"This will be played out in spades in the first debate, if it even occurs. I'm guessing the Biden team will come up with some excuse to not show up, like Biden being exposed to COVID." – Paid-up subscriber Randall B.

Good investing,

Dan Ferris
Vancouver, Washington
September 25, 2020