Paul Chou

“How is Wall Street, Papa?”
— Bernie Madoff’s Granddaughter, The Wizard of Lies

Recently, I watched the “The Wizard of Lies” movie depicting Bernie Madoff’s $65 billion “hedge fund” fraud. I’ve interacted with folks who lost so much in that debacle. It is gut-wrenching to see a replay of any disaster, this one included.

However, it did give me an idea for a discussion about one of the most common questions about Wall Street. And of course, I’ll tie in some physics ideas to this as well.

Bernie Madoff’s fraud evaporated generations of families’ paper wealth in an instant, when, in fact, that illegitimate wealth never existed. But the truth is there are plenty of legitimate enterprises with legitimate wealth that legitimately loses money as well. It happens in private markets and public stock markets all the time.

So to the main question that gets asked — where did all that money go?

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Three cynical answers are that it just evaporated, was wasted on lawyers, that someone stole it, or likely some combination of the three. (Sorry, that is actually 4 answers). I want to discuss another lens to look at these events when money/stuff goes missing.

Enter Einstein

What you see here is the first observed collision of two black holes by LIGO, which saw for the first time something Einstein predicted a long time ago (and now, in time, won the project leaders the Nobel Prize).

These are two enormous things colliding and producing a bunch of waves in a galaxy far, far away. The amazing point here is that after collision, the final object is smaller than the size of the two original objects. It’s like if you threw two baseballs together, and they became one, and the result was a baseball that was the size of one baseball.

The natural question is, what the heck happened to the other baseball? Is it just gone?

The graphic above shows you…the actual “stuff” in the things colliding ends up being converted into those waves being emanated. It’s not (easily) visible, but it’s a real amount of energy. The stuff that is “lost” is embedded in the fabric of space itself.

Enough physics — what does this have to do with the evaporation of wealth? Whether you’re a victim of a Ponzi scheme, or when your stock investments lose 30% in a week, or when your VC investment goes from $10 million to zero, it also goes somewhere.

In the case of neutron stars or black holes “losing mass,” they are embedding that loss into the fabric of space itself. It’s never lost. For money being lost, it’s embedded not in the fabric of space, but the fabric of society.

As monstrous an idea of $65 billion disappearing in a second is, what that event produced is a society that is now more cautious of “sure thing, 10% per year” investments. Regulations are revised, tightened, and more sophisticated. People are generally more risk-aware.

The lessons of a failed enterprise linger with the displaced workers who then go elsewhere to other companies. Those folks teach their colleagues, maybe their children, about what to do next time. Lessons of failed unicorn companies ripple throughout entrepreneurship circles like a wave. Those are real and valuable effects. The loss has been converted into lesson.

So next time an investment goes south and you think…

…it’s not.

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