5 ms·

The Problem with Ponzis

79 points by SQL2219 5y ago

stickfigure 5y ago
It's tiresome hearing the word "Ponzi" misapplied to speculative asset bubbles. If Peloton paid a dividend out of investor money, then it would be a Ponzi scheme. Right now it's just a (probably) bad investment. The difference is material.
- acjohnson55 5y ago
  I mostly agree, but I do believe the author is trying to paint a picture of a Ponzi-like dynamic of early investors cashing out as gullible later investors buy in (many hoping to cash out to still later investors). The fact that there are real cashflows is incidental, as they apparently aren't enough to cover the costs of doing business as usual.
  - anonporridge 5y ago
    That's still not a Ponzi. That's a pump and dump. And when the pump and dump never ends, generation after generation, that's money.
    - anonporridge 5y ago
      responding to myself Kind of like the difference between a cult and a religion. In a cult, there's one person who knows it's all bullshit. In a religion, that person is dead. The difference is time and self sustainability.
    - fnord77 5y ago
      I don't think 'pump and dump' is the right term for this phenomena. It's something a bit different. With a p&d, founders/early investors know it is a sham and are trying to hype up the price and get out before the hammer comes down. This is more like the dotcom days or trying to be like Amazon - the founders really think they can grow the business into something profitable, but for whatever reason wildly miscalculate the trajectory. The founders are going to ride it right into the ground (or until they get the boot)
    - acjohnson55 5y ago
      From https://en.wikipedia.org/wiki/Ponzi_scheme https://en.wikipedia.org/wiki/Ponzi_scheme: > A Ponzi scheme is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors. The scheme leads victims to believe that profits are coming from legitimate business activity (e.g., product sales or successful investments), and they remain unaware that other investors are the source of funds. Sounds pretty Ponzi-like to me, even if that's not the intended mechanism of the company. I would agree that a literal, correct Ponzi scheme would involve no plausible way to make operational profits. I think pump-and-dump is actually further from the dynamic the author is describing. Although pump-and-dumps don't absolutely have to be short-term, they tend to be. From https://en.wikipedia.org/wiki/Pump_and_dump#Comparison_with_other_types_of_schemes https://en.wikipedia.org/wiki/Pump_and_dump#Comparison_with_...: > - Ponzi schemes typically come with the expectation of profit over a relatively-extended period of time and typically last for months, years or even decades before their inevitable collapse. By comparison, pump and dump scams are designed to make profits extremely quickly and are executed over a period of weeks, days or even hours. > - Ponzi schemes are occasionally the result of investment vehicles that are originally intended to be legitimate but ultimately fail to perform as expected. By comparison, pump and dump schemes are invariably intended to be scams from their conception, although a fairly common tactic employed by pump and dump schemers is to take over a once-legitimate business (one that is either failing or defunct), or even just its name, in order to pump and dump its stock.
      - stickfigure 5y ago
        The key difference is the word profit. Peloton et al do not claim to make a profit, there is no dividend. The reason the difference is important is because if you we understand what a Ponzi scheme really is, we won't be able to identify them and prosecute them. Claiming that "everything is a ponzi scheme" is actively harmful.
        panarky 5y ago
        Peloton doesn't claim to make a profit, but expectations of "profits" are the expectations of "investors", where early "investors" extract gains on their investment from new money coming in from later "investors". Just because a scheme is legal under current laws does not mean it is not a Ponzi or Ponzi-adjacent.
  - stickfigure 5y ago
    > early investors cashing out as gullible later investors buy in This isn't the Ponzi dynamic. Full stop. In a Ponzi scheme, early investors suffer just as much as later investors if they never cash out. "Buy low sell high" (and the reverse) is not the Ponzi dynamic. Speculative asset bubbles do not require continual new investment. They are essentially zero sum games, and if they are traded thinly enough, can be propped up by a tiny band of holders (or even a single trader doing wash trades!). Ponzi schemes are frauds, but not all frauds are Ponzi schemes.
- est31 5y ago
  Yeah, a ponzi scheme bases on exponential growth and if you know the fake dividend size as well as the size of your economy, you can create upper limits for its lifetime, while speculative asset bubbles are different. They don't give guarantees about paying the dividend at some fixed date, so can remain overvalued for way longer times. That's the same problem that the crypto currencies have. No lie to keep up that you get dividends in terms of dollars, means less solvency issues to be solved by the person charged with keeping up the bubble (if it's even an individual doing it, usually ponzis have one person or individual at the center while bubbles can have many actors). Just spreading HODL mentality as well as optimism is enough.
echelon 5y ago
"Ponzi" isn't an apt name for stocks that can't turn a profit. They're just inherently bad ideas with hype. That said, this is a good article and definitely presages bad times ahead for growth stocks. Not just the unprofitable ones. (I've been modestly cycling out of growth and into value and cyclicals.) Any advice on stocks to short?
- edoceo 5y ago
  Don't short.
  - jkhdigital 5y ago
    Hedge funds and market makers are the only shorts nowadays, for retail punters the options market is always a better play. Anyone can buy put options with a fixed upfront cash price, a “safe” way to bet against a ticker.
- jtbayly 5y ago
  If I’m mostly in a big ETF, how can I also protect myself from these companies?
  - acjohnson55 5y ago
    Hypothetically, you could short overvalued companies. But you might be better off finding a value-oriented ETF that simply excludes high-multiple growth stocks. Blue chips and dividend stocks, perhaps. But this is very simplified advice. You may want to buy a couple hours of a fiduciary advisor's time if you want to seriously pursue that strategy. Most folks will simply ride the top x-hundred companies, let their returns get padded in the good times and take the drag in the bad times as growth stocks rise and fall. Over decades, this strategy backtests pretty well.
  - anonporridge 5y ago
    Use ETFs with strict rules of entry designed to keep out the imposters. I believe the S&P 500 index actually broke their own rules by not adding TSLA in the quarter it should have been added. I imagine the people in charge of the index were incredulous about it's insane value rise and questionable profitability. Then again, the risk you take by using an index that excludes these kinds of companies, is that you miss out on the next AMZN until it's fully valued. Just VTI and chill.
the__alchemist 5y ago
This article seems built on a foundation of 20/20 hindsight. It would be more credible if it pointed out examples that haven't (yet?) dropped dramatically.
- hn_throwaway_99 5y ago
  For the life of me, though, I recall looking at Peloton's valuation before it crashed and thought "Does Peloton think every household in the US is going to own 2 bikes and a family subscription?" More than "Ponzi stocks", though, in the present day and age I really feel these are just basically just a type of meme stock. I define a meme stock as one where investors are chasing momentum where they know it will eventually crash, but they're really just betting they'll be able to get out before everyone else. Hertz was perhaps the most famous example, where the stock was bid up even though it was already in bankruptcy proceedings and was inevitably going to $0. This is the thing that I feel has pretty fundamentally changed in stock investing in the last ~5 or so years. During the original .com boom, many investors really did believe all those worthless .coms would eventually make a profit (and, indeed, many of those .coms were just too early - Pets.com famously crashed and burned, but Chewie is a multi-billion dollar business). But these days I feel like there is a new type of speculation, more like video gaming, where hardly anyone believes a particular company has good long term potential at a sky-high valuation, but that if there is a chance a stock can be pumped on wallstreetbets et al long enough that there is a valid short term play.
  - shukantpal 5y ago
    > Hertz was perhaps the most famous example, where the stock was bid up even though it was already in bankruptcy proceedings and was inevitably going to $0. Hertz shareholders did receive a material payout after Apollo's debtor-in-possession takeover of the company. https://www.wsj.com/articles/hertzs-complex-shareholder-payout-explained-11623358891 https://www.wsj.com/articles/hertzs-complex-shareholder-payo...
    - panarky 5y ago
      >> inevitably going to $0 Hertz common stock is currently worth more than $11 billion, virtually unchanged from a year ago. Clearly, there's nothing "inevitable" about bankruptcy proceedings.
bern4444 5y ago
Not much unique information here. TLDR: Ponzi schemes are bad and unwind quickly. They can take the form of "normal companies". Peloton being one example (according to the author). What's more interesting to me is just because a company may be a Ponzi scheme - which is bad for investors - doesn't mean the products are bad for consumers. It's almost like a wealth transfer instead. Investors support a business that consumers buy into, the investors get wiped out once the company unravels and lose, but the consumers who bought use and continue to use the products get to keep the product - assuming in this concrete case that Peloton doesn't lock everyone out remotely. This doesn't mean the company is bad, just that it's a bad investment. The product can still be extremely successful and useful. Does this mean the company failed to deliver value? Depends on who you ask. The consumers who bought the products will say no. Only the investors will say yes. Companies exist for reasons beyond returns to investors. They should aim to be sustainable, but if they're not, it doesn't necessarily mean they're a "bad" company.
- pintxo 5y ago
  Bad companies can sell good products and vice-versa.
fnord77 5y ago
> There is even an “anti-ARK” ETF––the Tuttle Capital Short Innovation ETF (SARK) launched two weeks ago––that tracks the inverse performance of the ARK Innovation ETF through swaps contracts. From https://www.barrons.com/articles/cathie-wood-ark-invest-short-selling-51637788917 https://www.barrons.com/articles/cathie-wood-ark-invest-shor...
kthejoker2 5y ago
Really hate imprecise language, a Ponzi scheme is literally a fraud predicated on bringing jn a constant supply of new investment dollars to pay the earlier investors (fraud because there either is no underlying asset at all (Madoff's returns) or its value is fraudulently misrepresented to investors (the original scheme by Mr. Ponzi himself)) It is not * speculation or "asset bubbles" (I don't believe in bubbles, but they are definitely not Ponzi schemes) * MLM / pyramid schemes (although these can also be Ponzi schemes, usually when the promised levels of operational support, marketing, product dev, etc. aren't honored) * pump and dump / option manipulation ( these can be fraudulent, but they're not Ponzi schemes - they don't require a steady flow of investors to sustain themselves - in fact, one large institutional investor can be sufficient)

79 points by SQL2219 5y ago

It's tiresome hearing the word "Ponzi" misapplied to speculative asset bubbles. If Peloton paid a dividend out of investor money, then it would be a Ponzi scheme. Right now it's just a (probably) bad investment. The difference is material.

acjohnson55 5y ago
I mostly agree, but I do believe the author is trying to paint a picture of a Ponzi-like dynamic of early investors cashing out as gullible later investors buy in (many hoping to cash out to still later investors). The fact that there are real cashflows is incidental, as they apparently aren't enough to cover the costs of doing business as usual.
- anonporridge 5y ago
  That's still not a Ponzi. That's a pump and dump. And when the pump and dump never ends, generation after generation, that's money.
  - anonporridge 5y ago
    responding to myself Kind of like the difference between a cult and a religion. In a cult, there's one person who knows it's all bullshit. In a religion, that person is dead. The difference is time and self sustainability.
  - fnord77 5y ago
    I don't think 'pump and dump' is the right term for this phenomena. It's something a bit different. With a p&d, founders/early investors know it is a sham and are trying to hype up the price and get out before the hammer comes down. This is more like the dotcom days or trying to be like Amazon - the founders really think they can grow the business into something profitable, but for whatever reason wildly miscalculate the trajectory. The founders are going to ride it right into the ground (or until they get the boot)
  - acjohnson55 5y ago
    From https://en.wikipedia.org/wiki/Ponzi_scheme https://en.wikipedia.org/wiki/Ponzi_scheme: > A Ponzi scheme is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors. The scheme leads victims to believe that profits are coming from legitimate business activity (e.g., product sales or successful investments), and they remain unaware that other investors are the source of funds. Sounds pretty Ponzi-like to me, even if that's not the intended mechanism of the company. I would agree that a literal, correct Ponzi scheme would involve no plausible way to make operational profits. I think pump-and-dump is actually further from the dynamic the author is describing. Although pump-and-dumps don't absolutely have to be short-term, they tend to be. From https://en.wikipedia.org/wiki/Pump_and_dump#Comparison_with_other_types_of_schemes https://en.wikipedia.org/wiki/Pump_and_dump#Comparison_with_...: > - Ponzi schemes typically come with the expectation of profit over a relatively-extended period of time and typically last for months, years or even decades before their inevitable collapse. By comparison, pump and dump scams are designed to make profits extremely quickly and are executed over a period of weeks, days or even hours. > - Ponzi schemes are occasionally the result of investment vehicles that are originally intended to be legitimate but ultimately fail to perform as expected. By comparison, pump and dump schemes are invariably intended to be scams from their conception, although a fairly common tactic employed by pump and dump schemers is to take over a once-legitimate business (one that is either failing or defunct), or even just its name, in order to pump and dump its stock.
    - stickfigure 5y ago
      The key difference is the word profit. Peloton et al do not claim to make a profit, there is no dividend. The reason the difference is important is because if you we understand what a Ponzi scheme really is, we won't be able to identify them and prosecute them. Claiming that "everything is a ponzi scheme" is actively harmful.
      - panarky 5y ago
        Peloton doesn't claim to make a profit, but expectations of "profits" are the expectations of "investors", where early "investors" extract gains on their investment from new money coming in from later "investors". Just because a scheme is legal under current laws does not mean it is not a Ponzi or Ponzi-adjacent.
- stickfigure 5y ago
  > early investors cashing out as gullible later investors buy in This isn't the Ponzi dynamic. Full stop. In a Ponzi scheme, early investors suffer just as much as later investors if they never cash out. "Buy low sell high" (and the reverse) is not the Ponzi dynamic. Speculative asset bubbles do not require continual new investment. They are essentially zero sum games, and if they are traded thinly enough, can be propped up by a tiny band of holders (or even a single trader doing wash trades!). Ponzi schemes are frauds, but not all frauds are Ponzi schemes.
est31 5y ago
Yeah, a ponzi scheme bases on exponential growth and if you know the fake dividend size as well as the size of your economy, you can create upper limits for its lifetime, while speculative asset bubbles are different. They don't give guarantees about paying the dividend at some fixed date, so can remain overvalued for way longer times. That's the same problem that the crypto currencies have. No lie to keep up that you get dividends in terms of dollars, means less solvency issues to be solved by the person charged with keeping up the bubble (if it's even an individual doing it, usually ponzis have one person or individual at the center while bubbles can have many actors). Just spreading HODL mentality as well as optimism is enough.

echelon 5y ago

"Ponzi" isn't an apt name for stocks that can't turn a profit. They're just inherently bad ideas with hype. That said, this is a good article and definitely presages bad times ahead for growth stocks. Not just the unprofitable ones. (I've been modestly cycling out of growth and into value and cyclicals.) Any advice on stocks to short?

edoceo 5y ago
Don't short.
- jkhdigital 5y ago
  Hedge funds and market makers are the only shorts nowadays, for retail punters the options market is always a better play. Anyone can buy put options with a fixed upfront cash price, a “safe” way to bet against a ticker.
jtbayly 5y ago
If I’m mostly in a big ETF, how can I also protect myself from these companies?
- acjohnson55 5y ago
  Hypothetically, you could short overvalued companies. But you might be better off finding a value-oriented ETF that simply excludes high-multiple growth stocks. Blue chips and dividend stocks, perhaps. But this is very simplified advice. You may want to buy a couple hours of a fiduciary advisor's time if you want to seriously pursue that strategy. Most folks will simply ride the top x-hundred companies, let their returns get padded in the good times and take the drag in the bad times as growth stocks rise and fall. Over decades, this strategy backtests pretty well.
- anonporridge 5y ago
  Use ETFs with strict rules of entry designed to keep out the imposters. I believe the S&P 500 index actually broke their own rules by not adding TSLA in the quarter it should have been added. I imagine the people in charge of the index were incredulous about it's insane value rise and questionable profitability. Then again, the risk you take by using an index that excludes these kinds of companies, is that you miss out on the next AMZN until it's fully valued. Just VTI and chill.

the__alchemist 5y ago

This article seems built on a foundation of 20/20 hindsight. It would be more credible if it pointed out examples that haven't (yet?) dropped dramatically.

hn_throwaway_99 5y ago
For the life of me, though, I recall looking at Peloton's valuation before it crashed and thought "Does Peloton think every household in the US is going to own 2 bikes and a family subscription?" More than "Ponzi stocks", though, in the present day and age I really feel these are just basically just a type of meme stock. I define a meme stock as one where investors are chasing momentum where they know it will eventually crash, but they're really just betting they'll be able to get out before everyone else. Hertz was perhaps the most famous example, where the stock was bid up even though it was already in bankruptcy proceedings and was inevitably going to $0. This is the thing that I feel has pretty fundamentally changed in stock investing in the last ~5 or so years. During the original .com boom, many investors really did believe all those worthless .coms would eventually make a profit (and, indeed, many of those .coms were just too early - Pets.com famously crashed and burned, but Chewie is a multi-billion dollar business). But these days I feel like there is a new type of speculation, more like video gaming, where hardly anyone believes a particular company has good long term potential at a sky-high valuation, but that if there is a chance a stock can be pumped on wallstreetbets et al long enough that there is a valid short term play.
- shukantpal 5y ago
  > Hertz was perhaps the most famous example, where the stock was bid up even though it was already in bankruptcy proceedings and was inevitably going to $0. Hertz shareholders did receive a material payout after Apollo's debtor-in-possession takeover of the company. https://www.wsj.com/articles/hertzs-complex-shareholder-payout-explained-11623358891 https://www.wsj.com/articles/hertzs-complex-shareholder-payo...
  - panarky 5y ago
    >> inevitably going to $0 Hertz common stock is currently worth more than $11 billion, virtually unchanged from a year ago. Clearly, there's nothing "inevitable" about bankruptcy proceedings.

bern4444 5y ago

Not much unique information here. TLDR: Ponzi schemes are bad and unwind quickly. They can take the form of "normal companies". Peloton being one example (according to the author). What's more interesting to me is just because a company may be a Ponzi scheme - which is bad for investors - doesn't mean the products are bad for consumers. It's almost like a wealth transfer instead. Investors support a business that consumers buy into, the investors get wiped out once the company unravels and lose, but the consumers who bought use and continue to use the products get to keep the product - assuming in this concrete case that Peloton doesn't lock everyone out remotely. This doesn't mean the company is bad, just that it's a bad investment. The product can still be extremely successful and useful. Does this mean the company failed to deliver value? Depends on who you ask. The consumers who bought the products will say no. Only the investors will say yes. Companies exist for reasons beyond returns to investors. They should aim to be sustainable, but if they're not, it doesn't necessarily mean they're a "bad" company.

pintxo 5y ago
Bad companies can sell good products and vice-versa.

fnord77 5y ago

> There is even an “anti-ARK” ETF––the Tuttle Capital Short Innovation ETF (SARK) launched two weeks ago––that tracks the inverse performance of the ARK Innovation ETF through swaps contracts. From https://www.barrons.com/articles/cathie-wood-ark-invest-short-selling-51637788917 https://www.barrons.com/articles/cathie-wood-ark-invest-shor...

kthejoker2 5y ago

Really hate imprecise language, a Ponzi scheme is literally a fraud predicated on bringing jn a constant supply of new investment dollars to pay the earlier investors (fraud because there either is no underlying asset at all (Madoff's returns) or its value is fraudulently misrepresented to investors (the original scheme by Mr. Ponzi himself)) It is not * speculation or "asset bubbles" (I don't believe in bubbles, but they are definitely not Ponzi schemes) * MLM / pyramid schemes (although these can also be Ponzi schemes, usually when the promised levels of operational support, marketing, product dev, etc. aren't honored) * pump and dump / option manipulation ( these can be fraudulent, but they're not Ponzi schemes - they don't require a steady flow of investors to sustain themselves - in fact, one large institutional investor can be sufficient)