Magic Carpet Ride

| November 18, 2022

How do you explain the impossibility of a thing? This question brings to mind an inconsequential conversation I had with a childhood friend many years ago. Upon his return from a trip to Iran shortly before the abdication of Mohammad Reza Shah Pahlavi, he told me that flying carpets existed. When I explained to him that Persian carpets existed, but that none of them can fly, he asked me when I had traveled to Iran. My friend had an excuse. He was hit by lightning several hours after we returned from a Taj Mahal concert in Greenwich Village and never fully recovered.

My only direct experience with Bernie Madoff followed the same pattern. A pension administrator tried to convince a friend and client to invest in what I later realized was a Madoff feeder fund. Like a flying carpet, he explained to me how using an options strategy called a “split strike conversion” allowed his mother to earn double-digit returns without ever having a down month. I had no greater success with this gentleman than I had with my old friend. The monthly statement seemed to be indisputable proof that an unexceptional options strategy could magically provide exceptional returns with no downside risk.

We recently saw the spectacular failure of a crypto exchange. Like Persian rugs, blockchain technology exists and is useful. As an investment though, it has not proven to be a hedge against inflation or a replacement for gold. Of course, anything will increase in value as long as enough people throw enough money at it. If a large number of people decided to make handmade oriental rugs a means of exchange, then the prices would take off, if not the rugs themselves. At least the investors would have some nice floor coverings when the bubble burst.

Special purpose acquisition companies (SPAC) are a different form of magical thinking. Allow me to give you Guy’s definition of a SPAC. It is an investment that begins with sponsors who have knowledge and investors who have money. It ends with sponsors who have money and investors who have knowledge. According to Eliot Brown of The Wall Street Journal, “as the air has come out of the SPAC boom of recent years, a clear winner has emerged: the money managers who oversaw the blank-check companies and who kept making profits in the face of significant losses to stock investors.” The appellation “blank-check company” should be a tipoff and Brown tells us that some SPAC managers earned “average annualized returns of 110% on their initial investment.” That is levitation, but of the type that pickpockets perform. *

This brings me back to the problem of explaining the impossibility of a thing. Bubbles and scams can go on for a very long time, often for years. This seeming defiance of gravity provides confirmation. We feel regret for not “getting in.” Most of us do not have the knowledge and experience to make sound judgments about “investment opportunities” being celebrated on television and by respectable news outlets. When I say “this is impossible,” people naturally respond that they have seen it with their own eyes.

I have never met anyone who could explain to me how to calculate the intrinsic value of crypto money. My advice is that when there is no way to calculate the value of a thing, prudent people should pass, no matter how much our friends appear to be making. When asked for a blank check, we should ask why wealthy sponsors need our money and not that of cash-flush institutions. I have seen the machine from the inside and in my experience, if a new issue is being offered to the public, then institutions have already passed. To think otherwise is to believe in flying carpets.

* Brown, E. "SPAC Sponsors Were Winners Even on Losers" The Wall Street Journal, Online, Markets | Finance, Oct. 15, 2022. Accessed on Nov. 15, 2022.