Monday, December 15, 2008

St. Ponzi and The Parable of The Cellphones

A sudden weather change has dumped four inches of fresh global warming on us and dropped the air temperature to -7° F this morning, with a wind-chill of -25° F, so given that Mr. Ponzi's name has been much in the news lately — and that in any case I've got to cut things short and go dig out the driveway — this seemed like an opportune time to re-run this column from a few years ago. Enjoy.

The senior executive called everyone into an all-employee meeting. "We appreciate the long hours you've been putting in," the executive said, "and we realize how long it's been since most of you have had a real raise. But the projected cashflow for 2004 is still pretty tight, so we've had to come up with an alternate plan. Effective immediately, we're giving each of you a new grant of stock options, and free and unlimited company cellphones!"

This was exciting news. Nobody in the room really believed their stock options would ever be worth anything — that was about on par with telling them, "Effective immediately, we're buying each of you 3 quick-picks for this weekend's PowerBall" — but a free cell phone: now that was a tangible! That was something the employees could literally hold in their hands; that was something they could actually use. This was a way in which the company's largess could actually have a direct and positive impact on each employee's personal monthly budget.

So by and large, the employees took the free cellphones. Those who already had their own cellphones dropped their plans, with some grumbling about being unable to transfer their existing phone numbers or caller lists to the new company accounts. Those who'd never before had a cellphone suddenly felt an urgent need to get one. And a few employees even went so far as to cancel their home land lines, in expectation that the free company cellphones would handle all their telephone needs.

A year and a restructuring later, the company called everyone into yet another all-employee meeting. "We hate to do this to you," the senior executive who'd replaced the previous senior executive said, "but 2004 turned out to be even tougher than projected. So we've been looking at ways in which to tighten our belts and cut unnecessary expenses, and we've come to the conclusion that the company simply cannot afford to provide free cellphones for everyone any longer. Effective immediately, those of you who can prove that you absolutely need a company phone will be allowed to keep yours, but as for the rest of you, you have a choice: either give up your company cellphone, or start paying for it yourself."

Oh, the wailing and gnashing of teeth! The anger! The protests! Those who'd had their own cellphones a year before just grumbled a little more and changed accounts again, and those who couldn't afford it and couldn't prove a need simply went without and grumbled later, in private. But strangely enough, it was the employees who'd never before had a cellphone, and who'd since become completely dependent on their "free" phones, who complained the longest and loudest before finally, grudgingly, agreeing to start paying for it themselves.

Or maybe it wasn't so strange after all...

After sex, the two most powerful human motivators are the fear of loss and the desire for gain. (Before sex, it's the desire for sex.) Of the two, fear of loss is usually the stronger, which is why more people have life insurance policies than investment management plans.

Now, the secret of being really successful in sales — especially if you're selling something people don't actually want or need — is to find some way to tie your pitch into one of the Seven Deadly Sins, and especially into that peculiar combination of greed, envy, and pride that manifests itself as the fear of loss, or more precisely, the fear of missing out on an opportunity to be greedy. In its crudest form, this is why so many ads blare:
A slightly more sophisticated approach is to find a way to twist the customer's desire for gain until it becomes the fear of loss. A good example of this is what is called "The Puppy Dog Close." In it's archetypal form, the salesman in the pet shop tells the reluctant customer:
"Yes, I understand that a puppy is a lot of responsibility, and you're not quite sure that you're ready to make the commitment required to own an AKC-registered Bishon-Poupon. So tell you what: why don't you take advantage of our free in-home trial offer? Take little Fluffy here home for just 24 hours, if it doesn't work out, you can bring her right back and we'll refund your money, no questions asked."
The secret to this technique, of course, is that very few people ever bring the puppy back, because by the time 24 hours have passed a sense of pride of ownership has emerged and the idea of "we're getting a puppy" has been replaced by, "we're losing our puppy if we take her back." The fear of loss replaces the desire for gain, the little mutt stays, and goodbye, carpets.

By the way, this technique also works very well if you want to move a lot of cellphones.

At higher levels of sophistication, expert salespeople begin finding ways to combine greed, envy, pride, lust, and sloth into new and powerful synergisms. For example, a true master of the technique was Charles K. Ponzi, who in December of 1919 claimed to have found a way to play the international postal exchange rates in order to generate enormous cash returns in very short amounts of time. Investors in Ponzi's business, The Securities Exchange Company, purchased, for $1,000 apiece, coupons that were redeemable for $1,500 in 90 days time.

According to Ponzi, the invested money was used to fund his postal exchange activities, and whatever he was doing, it certainly seemed to be working. All of his original investors were paid off in full in 45 days, and the resulting good press and word-of-mouth brought first hundreds, then thousands of people flocking to put their money into Ponzi's company, even as many financial experts declared that the business made absolutely no sense and couldn't possibly be profitable in the long run. In this case, pride, greed, envy, and sloth were combined with incredible potency to produce the fear of looking like a schmuck for missing out on the deal of the century, and normal investor caution was thrown to the wind. In a matter of six months Charles Ponzi went from having to borrow $200 to buy office furniture to having reported assets in excess of 12 million (1920) dollars.

What a pity, then, that it was all a fraud. There was no postal exchange business; no money being held in individual investor accounts; capital was being redistributed and called income. The early investors were simply being paid off with the cash put in by later investors, and the money left over after that was dumped directly into Mr. Ponzi's personal bank account, to support his lavish and flamboyant spending habits. The Securities Exchange Company was just one monumental pyramid of borrowings from Peters to pay off Pauls, and in July of 1920, Ponzi began running out of Peters.

By the end of July the company had imploded like a 1999 dot-com, and by the middle of August Ponzi was sitting in a jail cell, "for his own protection," while 10,000 irate investors were trying to find out what had happened to their money and federal and state authorities were racing to see who could prosecute him first. Ponzi wound up serving a lengthy federal prison term, after which he spent several years bouncing around state courts and prison systems before finally being deported. He died in poverty in Brazil in 1949, but his name lives on, in what has since become the proper name for a particular type of pyramid investment fraud that is aggressively prosecuted wherever it is found: The Ponzi Scheme.

Now by this point you're no doubt wondering what all this has to do with cellphones. Actually my real topic is Social Security, and my points are three-fold:

  1. The Social Security system operates exactly like a classic Ponzi scheme. The money being put in by those "investing" in Social Security today is being used to pay off those who "invested" in earlier years, in amounts out of all proportion to what the earlier investors actually paid in and any reasonable rate of return. There are no individual investor accounts; capital is being redistributed and called income; and whatever cash is left over from daily operations is dumped directly into the general fund, to support the federal government's lavish and flamboyant spending habits.
  2. Unlike Charles Ponzi, the Social Security Administration has one great advantage: it can force people to join the scheme, literally at gun-point if need be. When Social Security was first created in 1935 it was sold to the taxpayers as being just a final safety net for those who really needed it and had nowhere else to turn. The system was expanded in 1939, and again several more times in the 1950s and 1960s, each time promising more and better returns to its "investors" while forcing ever-larger numbers of workers to give up their existing private pension plans and join the system, thus expanding the base of the pyramid and preserving the illusion of stability for a little while longer.
  3. As the idea of privatization — or more accurately, of allowing people the option of not investing a small percentage of their income in the pyramid scheme — becomes a topic of public discussion, those who protest the loudest against it seem to be those who would never have thought they needed a retirement plan in the first place, if the government hadn't presented them with this wonderful "free" offer. But having taken the cellphone home and become dependent on it, they cannot imagine living without it, and any suggestion that the system is fundamentally unsustainable is met with a response straight out of the limbic system:
    "The government has made a commitment! It must honor that commitment! If that means they have to raise taxes, then so be it! Raise the taxes!"

In short, the creation of a "free" benefit has created a dependency; anything that threatens to disturb this dependency engenders the fear of loss in its most potent form; and it is at this point that a rational discussion of the problems inherent in the system becomes very, very, difficult.

Still, a rational discussion is vitally necessary. The Social Security system is at heart a Ponzi scheme, which can only remain solvent by either bringing more investors into the system, reducing the payout to those cashing out, or demanding more money from each individual currently paying in. The Baby Boomer generation is fast approaching retirement age, meaning the system has enormous liabilities that it must shortly begin paying out — or to maintain the metaphor, enormous numbers of investors who will shortly begin trying to redeem their Ponzi coupons.

Unfortunately, we seem to have reached a natural limit on the further expansion of the base of the pyramid. Our country simply is not adding new taxpayers to the population as rapidly as it did back in the 1960s and 1970s, when the first wave of Baby Boomers graduated and went to work. Short of annexing Mexico and Canada, it seems unlikely we will ever see those sorts of growth rates in the taxpayer population again.

So what is the solution? Honestly, I don't know. But do I know that we must find one, and I do know that before anyone starts thundering on again about sacred commitments and raising taxes and all that rot, they'd better consider this: America is in the midst of a profound demographic change. Those new taxpayers that we are adding to the rolls are far more likely than in decades past to be black, brown, Hispanic, or Asian. As the incomes and populations of the former minority groups grow, so will their political clout, and it is highly debatable whether the politicians of America in the year 2025 will feel any obligation to honor the commitments made by Euro-Americans, to Euro-Americans, some 50 years before their own grandparents even entered this country.

That's the choice we face. Either we fix Social Security now, or we wait and have it fixed for us, by the children of the same people who staff our nursing homes, mow our lawns, and serve our fast food. And personally, I can't imagine that latter choice turning out in any way that any but the most self-loathing of Baby Boomer Euro-Americans might consider to be "good."