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The outrage currently buzzing about Bernard Madoff's outsized version of the classic Ponzi scheme brings home a sobering fact: instead of wondering why so many investors bought into his scheme, we should be asking why wouldn't they?

After all, our whole economic boom was based not on fraud, but on lending that amounted to the same fiction of wealth creation that is at the core of a Ponzi scheme. Let me use a middle class family to illustrate.

Bill is 52 and makes $72,000 per year. He purchased his home in Ohio in 1983 for $88,900 (the average price at the time) with a 30-year fixed mortgage 80/20 loan @13% interest (it was high then). His actual amount financed was $71,120. His 2006 PTI (payment, taxes and insurance) $896.00/month. Assuming he did not refinance until 2006 (unlikely but theoretically possible) his home was valued at $95,900 by an appraiser, versus the $64,559 principle balance. At the time of the loan, Bill took a little over $21,000 in equity out of his house.

He used that money to pay off some credit cards, pay the first year of his son's college tuition, and took a vacation.

But where did the $21,000 come from? That money was given to him by the bank under the presumption that if Bill (or the bank) were to put that house on the market, he would be able to sell the house for at least 80% of the $95,900 that the appraiser stated the house was worth.

Two years later, with foreclosed homes selling for $70,000 in his neighborhood, he is now upside down in a home he has been paying the mortgage on religiously for over 15 years.

Where did the $21,000 come from and where did it go?

The answer is that the $21,000 was like the payout from Madoff's fund to the early investors. The bank gave him that money based on having approximately $2,100 in cash reserves and presuming that in the event he were default, they could recoup the difference between the debit still showing for his original mortgage and his new one with the sale of his property. Then Bill's mortgage, like millions of others, were bundled up into securities sold on the open market under the presumption that the face value of his mortgage and the others were based on real value and not presumed value.

But that value did not more than Bernard Madoff's magical assets returning 12% existed anywhere but in the mind of his investors. In the end, the real estate assets that provided our economic expansion, were a daisy chain of empty promises and presumed future value. Both were based in a fragile fiction that has since shattered.

Learn more about this author, Beth Coughlin.
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