The World's Largest Ponzi Scheme

There has been a lot in the news lately about the Bernard Madoff (pronounced made off?) Ponzi scheme. Now a lot of you might not know what a Ponzi scheme is, so I’ll explain it briefly. Ponzi schemes have been around a while, but they got their name from Charles Ponzi, the first guy to make it famous because his grew to be so large during the 1920’s. Put simply, a Ponzi scheme is a fraudulent investment operation that involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profit from any real business.

Suppose an advertisement is placed promising extraordinary returns on an investment—for example 20% for a 30 day contract. The golden key is to bamboozle ordinary people who have no in-depth knowledge of finance or financial terms. High flown terms that sound impressive but are essentially meaningless will be used to dazzle investors. Terms such as "global currency arbitrage", "hedge futures trading", "high-yield investment programs", "offshore investment". Taking advantage of the lack of investor financial sophistication, the promoter will then proceed to sell them a stake in his pot of gold.

With no proven track record for the investors, only a few investors are tempted, usually for smaller sums. Sure enough, 30 days later the investor receives the original capital plus the 20% return. At this point, the investor will have more incentive to put in additional money and, as word begins to spread, other investors grab the "opportunity" to participate. More and more people invest, and see their investments return the promised large returns.

The reality of the scheme is that the "return" to the initial investors is being paid out of the new, incoming investment money, not out of profits. No "global currency arbitrage", "hedge futures trading" or "high yield investment program" is actually taking place. Instead, when investor D puts in money, that money becomes available to pay out "profits" to investors A, B, and C. When investors X, Y, and Z put in money, that money is available to pay “profits” to investors A through W.

The catch is that at some point one of three things will happen:
1. the promoters will vanish, taking all the investment money (less payouts) with them;
2. the scheme will collapse under its own weight, as investment slows and the promoters start having problems paying out the promised returns. When the promoters start having problems, the word spreads and more people start asking for their money, similar to a bank run;
3. the scheme is exposed, because when legal authorities begin examining accounting records of the so-called enterprise they find that many of the "assets" that should exist do not.

Hmmm… sounds eerily like Social Security… Our parents and grandparents are being paid by the money we put in, but eventually it will collapse under its own wait, and some unfortunate generation will not get paid.

Oh. I forgot. The government can just print the money. I guess that’s the only thing Mr. Madoff didn’t take into account. If he could have simply printed the money he would have been all set when his investors cashed in.

The ironic thing is that Mr. Madoff is made out to be a bad guy, while politicians on Capitol Hill are heroes for doing the very same thing only on a much larger scale. Mr. Madoff’s little $50 billion Ponzi scheme is chump change compared the trillions we have dumped into the bottomless pit of Social Security, the world’s largest Ponzi scheme.