The "Yertle the Turtle" Ponzi Game

With special thanks to Dr. Seuss

and

 Tara Simeonidis

On the far-away Island of Sala-ma-Sond, Yertle the Turtle was king of

 the pond. It was clean.  It was neat.  The water was warm.  There was plenty

to eat. The turtles had everything turtles might need.  And they were

all happy.  Quite Happy indeed.  They were … until Yertle,

 the king of them all, decided the kingdom he ruled was too small

May 16, 2008

 The climb to the top of paper mache throne of Yertle and his friends has set the stage for a true shock and awe surge of asset write downs through most of 2008.  Widespread collateral defaults, particularly at the credit hedge funds, will trigger forced selling from margin accounts.  Rolling downgrades will require divestitures by pension funds and insurance companies that find themselves in violation of rules on holding investment grade paper.  Add in even mildly bad outcomes for the credit insurance markets and the global financial system could become a catastrophe without a floor.

Instability and crises are inherent features of financial markets.  Have we reached the Ponzi stage in the credit cycle?  Factor in that all financial claims against assets, which have become multiples larger than annual GDP and you could make the case that the tower is indeed shaky. As they climb, they continue to increase the notional value derivatives along the way. What’s disturbing is that notional value refers not to the derivative but to the size of the portfolio it is referencing.  The enormous scale of outstanding financial claims and derivatives is a useful index of leverage in the world economy and especially in the United States and, leverage is the flip side of volatility.  An option may be valued at say 5% of the portfolio it is referencing, but a small change in portfolio value will cause very large changes in option values.  With notional derivative values now in the $500 trillion range, rapid swings of $5 trillion to $10 trillion in derivative values are altogether plausible and could inflict enormous damage.

How could leverage get so high?  There are relatively few names or underlying companies that are deeply traded, several hundred at most.  And a relatively small number of institutions, basically the global banks, investment banks and credit hedge funds, do most of the trading.  In effect, they’ve built a huge Yertle the Turtle like unstable tower of debt by selling it back and forth among themselves, booking profits all along the way.  That is the definition of a Ponzi game.  So long as a free money regime forestalled defaults, Yertle’s tower might wobble, but it has stayed erect.  However, small disturbances in any part of the structure can bring the whole tower down, and the seismic rumblings already in evidence portend disturbances that are very large.  The response to the looming crisis has been overwhelmingly to downplay and to conceal.  That is a path to turning a painful debacle into a decade’s long tragedy.

In the not too distant future

“And today the great Yertle, that Marvelous he, is King of the Mud.

That is all he can see.  And the turtles, of course … all the turtles

are free as turtles and, maybe, all creatures should be.”

Thank you … Dr. Seuss

Thank you Tara