Parrallels with pyramid selling or MLM

Pyramid selling or multi-level marketing has some interesting aspects to it and some firms have applied these aspects to their distribution models very effectively. Others have applied them less effectively and even dangerously. One sector that has applied some of the principles of pyramid selling is the financial services sector. Here’s how.

Mortgage or loan agent lends huge amount to individual who can only repay if the value of the property goes up. The agent doesn’t mind because the lender will pay a commission and take on the debt. The individual thinks this is normal as typically individuals have been encouraged to trust the financial sector. The lender pays a fee to an investment bank who packages up the loan and sells it in various risk tranches to investors looking for a higher return. Crap loans become high-quality debt  – hey presto!

This all works very well as long as there are enough suckers out there to continue taking on the loans. House prices reached such a high that even these suckers begain to doubt the wisdom of 120% mortgages. Oh dear. Demand for loans dries up, demand for property dries up, prices fall and all loans based on property values are hit.

Pyramid selling schemes often suffer from exactly this phenomenon. Think of one of the most basic such schemes, the Chain Letter. I write a letter to 100 people who each send me £10. They in turn send a letter to 100 people and receive £10 from each. The scheme continues until the last people to pay £10 cannot find anyone else to pay them £10. It then falls apart.

Of course one solution to today’s problem is that banks continue to lend recklessly or even more recklessly. This assumes that Governments and regulators continue to pump money into the system, reduce interest rates and encourage borrowers to borrow. Surely this wouldn’t happen! Oh but yes, this is exactly what is happening.

Today’s policies will create a bigger recession than the problems that they are intended to cure. FTSE at under 3000 by Spring.

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