Bernie Madoff's Ponzi Scheme is Cleaned Up While the Federal Scheme Keeps on Rolling

How much would you pay for Jesse James' revolver? He was highly felonious, robbing numerous banks and taking a role in many murders. But his revolver, if it ever were auctioned, would probably sell in the millions. Crime, as long as it's notorious, confers value. We saw this last weekend.

The federal marshalls' auction of Bernie and Ruth's paraphernalia produced some surprisingly large bids. A pair of diamond earrings thought to be worth $21,400 went for $70,000. Bernie's Mets jacket went for $14,500. A wooden duck decoy thought to be worth $60 went for $4,750. A pair of boogie boards estimated at $90 went for $1,000. Someone even paid $500 for a table made from a tree trunk, saying he hoped Bernie had stashed some money inside it. (This is a long shot; Bernie didn't have to salt away money since he could always rip off another investor if he needed more cash.) All told, the auction yielded over $900,000, well over the $500,000 or so that was expected.

Some of the aggressive bidding could come from the eBay effect--put "Madoff" into the Search function on eBay and you'll see a few of the auctioned items already for sale. Since you can't flip houses today, try Bernie's and Ruth's belongings. Other buyers may be biding their time, as the continuing Madoff saga leads to more prosecutions, further revelations and enhanced value for his erstwhile possessions. Still other buyers may hold onto their acquisitions, feeling good about owning something that once belonged to someone who was seriously bad.

Meanwhile, back at the ranch, the U.S. government continues to operate the biggest Ponzi scheme of all. The official federal debt will probably end the year over $12 trillion, around 90% of the U.S. Gross Domestic Product. Ten years ago, it was under 60% of GDP. By 2011, it will probably exceed 100% of GDP. And we're not counting unbooked liabilities from Social Security, Medicare, Medicaid, Fannie Mae, Freddie Mac, FHA and continued bank bailouts. Let's not even go there because the RAM in most personal computers can't handle numbers that large.

America's government debt will never be repaid. It's gotten too big. The government pays debt coming due by finding new lenders or convincing holders of old debt to roll their investments over. The government is lucky that the dollar is the world's reserve currency, or it would be up a poorly lit creek. (For more on this point, see http://blogger.uncleleosden.com/2009/11/is-federal-government-tempted-by-moral.html.)

Using new loans to pay off old loans isn't by itself illegal. Many corporations do that with their bonds and commercial paper. All banks fund daily operations that way. A Ponzi scheme differs from legitimate enterprise because the bad guys don't use the money they take in to operate bona fide businesses. They pocket it and use it to buy cars, jewelry, houses, clothing, vacations, expensive meals and so on. In short, it's used for consumption.

What does the U.S. government do with all its borrowed money? Stuff that looks suspiciously like consumption. Most government operations aren't meant to generate profits. Law enforcement and regulation protect lives and property. The courts are there to resolve disputes. The President is supposed to manage the Executive branch departments and provide leadership. The legislative process is supposed to do something useful, although what that might be seems to have been lost in the mists of time. These operations are not intended to yield dividends or create wealth. They are forms of consumption. So, too, is most of the federal stimulus spending. And the federal bailouts and accommodations that are never repaid (which could total to a large amount) will end up as consumption.

Granted, not personal consumption. But that simply means that the federal government isn't operating an illegal Ponzi scheme. Since the government survives mainly by wheedling money out of Peter to pay Paul, its finances sure look like some kind of Ponzi scheme. To make things worse, nowadays when Peter doesn't have enough cash to cover all the government's spending, the Federal Reserve simply prints money. Indeed, trillions of dollars worth. Paul gets . . . paper spun out of thin air.

Recent comments by Chairman Bernanke and other governors indicate that the Fed isn't about to pull back those printed dollars. The Fed's balance sheet will apparently stay its Brobdingnagian size as far into the future as one can foresee. The latest thinking at the Fed about "withdrawing" liquidity seems to be that it would pay higher interest rates on member bank deposits at Federal Reserve banks. That would put a floor under fed fund rates, and arguably reduce interbank lending (and thereby constrain overall lending). But the target for fed fund rates these days is zero to 0.25%, so even if the Fed pays 0.2% and effectively prevents fed fund rates from going below 0.2%, how much will lending be constrained? The hot, new thing in the financial markets is the carry trade, where speculators borrow dollars, convert them into foreign currencies, and invest overseas for returns expected to be a shipload larger than 0.25%. A 0.2% interest rate on member bank deposits won't constrain an unemployed novice day trader let alone a multi-billion dollar hedge fund. We hesitate to delve into anathema, but the Fed needs to raise its fed funds target rate before it will constrain much of anything.

So we have a government ponzi scheme, which gives itself a boost by printing money whenever it can't find new lenders. What a racket. No wonder the Chinese and other foreign creditors of America are nervous.

There is a way out of the federal Ponzi scheme--a marked increase in federal tax revenues, which is devoted to debt repayment. That could come from a brisk resumption of economic growth or by increasing taxes. The former seems as likely as Godot's arrival. The latter may happen, although the additional tax dollars don't seem destined for debt reduction.

Nevertheless, let's accentuate the positive. With all these freshly minted dollars floating around, it's understandable why the bids at the Madoff auction were higher than expected. Bernie's victims, at least, can be grateful for federal profligacy.