Pyramid Schemes: The Parlous State of the World Economy

The humble beginnings of the ‘building society’ can be traced back to a tavern in Birmingham.

In 1775, Richard Ketley, the landlord of the Golden Cross Inn, established ‘Ketley’s Building Society’.

Ketley’s newly formed entity was true to label.

The monthly membership fees were pooled and used for the purpose of building homes for the society’s members.

The original building societies were created as fully terminating cooperatives.

When all society members had their own home, it was mission accomplished…the society was terminated.

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Ketley’s Building Society model was soon adopted by other communities.

In the 1830s, the building society structure changed from being ‘fully terminated’ to ‘permanent’…hence they became known as the Permanent Building Society.

As older members completed their home purchases, newer members were welcomed into the society’s fold…perpetuating the life of the building society.

Our English ancestors introduced the permanent building society into Australia.

In 1867, the good folk of Geelong began the (appropriately named) Geelong Building Society.

By all accounts, the Geelong Building Society operated on a prudent basis.

In 1959, another building society opened its doors for business in Geelong…it too (as fate would have it) was appropriately named…the Pyramid Building Society.

The founders of Pyramid Building Society were Vautin Andrews (a solicitor and mayor of Geelong) and Bob Farrow (an accountant).

When Pyramid started its operations, building societies were not permitted to receive deposits from the public. Capital was raised by borrowing from banks and/or insurance companies.

That all changed in the mid-1960s. Legislation was passed that enabled building societies to accept deposits from the public.

The fledgling Pyramid Building Society recognised the commercial value in broadening its depositor base.

Unlike its more conservative, long established Geelong competitor, Pyramid capitalised on the legislative change.

In 1971, Pyramid, the new kid on the block, took over the longstanding Geelong Building Society.

This was the first in a series of mergers/takeovers undertaken by the acquisitive Pyramid Building Society.

In the late 1970s, Bob Farrow retired due to ill health.

The reins of Pyramid’s operation were handed to his son, Bill Farrow (aged in his late twenties).

The timing could not have been better for an ambitious young man…the regulatory shackles that bound the financial sector were soon to be removed.

According to the Treasury Department’s review into the operations of Pyramid Building Society…

The problems of the Pyramid Group stem from the freedom afforded by the deregulation of the 1980s. The Group went into commercial lending soon after deregulation and grew rapidly from that point. Between 1981 and 1989 assets grew from $260 million to $2,900 million.

Financial deregulation was also a boon for banks. The banks aggressively competed for customer deposits.

During the 1980s, the fight for funds resulted in more than 100 building societies ceasing operations.

In this highly competitive environment, how did Pyramid succeed where others failed?

This is from the Treasury Department’s report (emphasis is mine)…

Particular actions by the [Pyramid] Group further contributed to its problems. These actions included: borrowing at higher rates than the major banks (between 2 to 4 per cent higher)…

Wooing depositors with higher rates is how you increase your asset base 10-fold in less than a decade.

The perceived strength of Pyramid — an institution with $2,900 million in assets — lulled investors into the complacency trap.

They ignored the golden rule…higher returns tend to come with higher risks.

Did any of the depositors ponder this basic question?

For me to receive the higher deposit rate, who’s borrowing at even higher rates?

Probably not. In the good times, people tend to smell the sizzle and ignore the flame.

But, as they say in the classics, all good things come to an end.

In 1990, Australia was on the cusp of entering the ‘recession we had to have’.

Again from the Treasury report (emphasis is mine)…

The [Pyramid] Group began experiencing liquidity problems in late 1989 and early 1990 with a run on deposits throughout February/March 1990 with more than $200 million being withdrawn. A second run in May/June 1990 led to its ultimate close on 22 June 1990.

Lack of liquidity is never a problem when no one perceives there’s a problem.

People don’t want their money back while they’re earning an above average return and there’s no real hint of risk to capital.

All it takes is a minority (only $200 million from an asset base of $2,900 million) to obtain first mover advantage and it’s all over for the majority. Doors are closed and receivers appointed.

The Pyramid depositors who panicked in February/March 1990 must surely have thanked their luck stars.

According to Wikipedia:

The [Pyramid] group collapsed in 1990 with debts in excess of $2 billion.

The building society model was originally designed to build member wealth, not destroy it.

Richard Ketley would have been turning in his grave at the collapse of Pyramid Building Society.

The cartoon published in The Age 4 June 1990, illustrated the plight of depositors who (literally) gambled on Pyramid’s higher returns growth strategy…

Pyramid Building Society 1990 Cartoon

Source: The Age

[Click to open in a new window]

The Lessons Learned

The lessons in the collapse of Pyramid Building Society are as relevant today as they were 30 years ago.

  1. The solid foundations of a business, industry, asset class or nation can take centuries to build (stability) and only a short space of time to be exploited and destroyed (instability).

Bernanke fell into the ‘stability leads to instability’ trap when he said in July 2005, We’ve never had a decline in [US] house prices on a nationwide basis.

The US share market’s artificially enhanced performance is another classic case of an asset class with a serious case of stability leading to instability. The lure of higher returns – especially in a low interest rate environment — is too tempting to ignore.

The more stable the market appears to be, the more unstable it becomes.

  1. Higher rates invariably come with a risk to capital.

The promised extra return is never a free lunch. There’s always a reason why the rate is higher. With the RBA dropping rates to 1%, the investment industry is falling over itself to bring ‘higher yielding’ products to market.

The industry — like Pyramid Building Society — knows the easiest way to woo investors is with the promise of higher returns.

Based on my experience, the absolute WORST time to invest in any industry product is when everyone is thinking the same.

In the late 1980s/early 1990s unlisted property funds boomed precisely when the commercial property market was about to tank.

In 1999, the industry rolled out an abundance of ‘dotcom’ products…12 months later we had the tech wreck.

In 2007, margin lending (borrowing to invest in shares) was all the rage…right before the GFC hit.

In each case it was the promise of participating in higher returns (from the latest hot sector) that attracted dollars into products.

Investors lured by the promise of ‘higher yields’ are destined to meet the same fate.

That extra few per cent of income return will come with a serious level of risk to capital…far more than you ever thought possible in the good times.

  1. Liquidity doesn’t matter until it does. The investment industry tells you that cash is idle money…it needs to be employed to earn higher returns.

And that’s true while things are going well. But when the cycle rotates from up to down, then cash is crowned the king.

The time to cash up is before the mob panics not after…the Pyramid depositors who headed for the exit in February/March 1990 were the smart ones.

  1. All periods of extended and exceptional growth come to an end. History is replete with examples of empires, dynasties, markets, industries, businesses, political parties that have gone through periods of ascendancy and decline.

The State of The World Economy

Everything is cyclical. The US share market has enjoyed a spectacular run (thanks to the unqualified support of the Fed) since the dark days of 2008/09.

This too will end and when it does, the dramatic collapse is likely to send shockwaves around the world. The time to exit with your capital intact is well before this happens.

Over the past few decades, central banks have also been building a society. One that’s become totally dependent upon an increasing base of debt to achieve growth.

The lessons of crises past have been knowingly and wilfully ignored.

Investors all over the world have been forced to chase promises of higher returns from sources with dubious credit ratings.

History tells us how this will end.

Whether we want to be or not, we’re all members of the central bank building society.

The charter of the central bank building society is slightly different to the one started by Richard Ketley.

Instead of a scheme to build homes for its members, the central bank building society’s primary objective is to build one giant pyramid scheme.

Judging by the parlous state of the world economy, it’s a case of mission accomplished for the central bank building society .

My sincere hope is the central bank building society was established on a fully terminating basis and not a permanent one.

But I somehow I don’t think so.


Vern Gowdie

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Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

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