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Ponzi Scheme Defined
December 12, 2008 1:58 PM
ABC News' Stu Schutzman reports:
"Giant Ponzi Scheme" was splashed across headlines today, referring to the arrest of a New York Banker accused of bilking investors to the tune of $50 billion dollars. That's serious bilking, which would no doubt make Carlo Ponzi proud (more on him in a moment).
A "Ponzi Scheme," says the Securities and Exchange Commission, operates on the "rob-Peter-to-pay-Paul principle." Usually the scam is generated by a less than scrupulous individual who offers investors enormous return, in very little time and with very little risk. Too good to pass up, huh?
Those who do invest early actually can make gobs of money; think of them as the skinny, pointy top of a pyramid. The money paid to them comes from the next rung of investors, a slightly fatter part of the pyramid. They generally come in after the word is out that big bucks are being made. As more investors come in and the pyramid gets fatter, there is more cash for pay offs. But towards the bottom, as the pyramid gets really fat, with no product to be sold or service to be rendered, there are simply too many people to pay off and eventually the entire pyramid collapses. By then, the progenitor of all this often is long gone to some tropical paradise having skimmed his fortune off the top.
Carlo Ponzi, namesake of these schemes, was by all accounts a born liar and swindler. He came to America from Italy in the early 1900s with $2.50 in his pocket having gambled away his life savings crossing the Atlantic. Now "Charles" Ponzi, he was short in stature but long on money-making ideas. After a series of low paying odd jobs, Ponzi began seeking more lucrative employment; like writing bad checks or illegally smuggling immigrants into the country. After his release from prison, Ponzi actually started a legitimate advertising business. The venture failed but his idea eventually became the "Yellow Pages." Even that would have been small potatoes for Ponzi who was looking to make millions -- enter the original Ponzi Scheme.
By 1920, Ponzi had it figured out. Convince wealthy people to invest in his idea to buy and sell postage stamps on the international market. Careful exploitation of exchange rates would result in enormous profits. Investors could make 50 percent profit in less than 2 months. They came running. The money was coming in faster than he could count it.
In February 1920, Ponzi made $5,000; By July he was making $250,000 a day. Overnight he became one of the richest men in America. Mansions, fancy cars, he even brought his family over from Italy. But alas, his hubris and a very dogged investigative reporter for the Boston Post ultimately brought Ponzi down. Stories that Ponzi's investment scheme was a fraud created a run on his company. Angry investors stormed the front door. Ponzi paid many of them off from out of pocket. Eventually he was convicted of mail fraud and sent to prison. His dream, he once said, was to make enough money to buy a Navy Warship and create the world's first floating international shopping mall. Such is the stuff of dreamers…and schemers.
December 12, 2008 | Permalink | Share | User Comments (33)
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Hang on a second. EVERY SINGLE BANK IN THE WORLD runs a Ponzi scheme. HELLO?!?! Banks take your deposits, invest them in other areas, and give you interest that is made from their investments while they keep the rest. *IF* there is a run on a bank, the bank will NOT have enough cash to satisfy the run because they have Ponzi'd the money out. Why do we make these schemes illegal when banks do it themselves?
Posted by: Eric | Dec 12, 2008 2:22:28 PM
WallStreetMarketNews reports on even more massive fraud just like Madoff's occuring in the financial markets.
Posted by: julie | Dec 12, 2008 3:55:14 PM
Eric, it's because banks lend based on the viability of the business they lend to to produce a product that meets a demand. If the business can prove viability the bank won't lend. Pyramid schemes solicit investors that go well beyond their ability to remain viable. They simply grow beyond their ability to provide a product or service and exhaust the market demand for what they're selling. Any normal business that a bank lends to would stop borrowing until they can increase demand in their product or reduce their operating expenses.
Posted by: Ly | Dec 12, 2008 3:55:51 PM
Fantastic insight Eric! If only he would have purchased a bank charter along the way.....
Posted by: Jim | Dec 12, 2008 3:57:13 PM
*Sorry "if the business CAN'T prove viability then the bank won't lend"
Posted by: Ly | Dec 12, 2008 3:57:53 PM
You mean it's kinda like Social Security??
Posted by: Darryl | Dec 12, 2008 3:59:38 PM
Eric, The article implied that in a Ponzi scheme, there is no actual goods or services at the core - it's just drawing cash based on a pitch that will never be executed. At least that's what I read into it.
Banks have actual goods and services - the availability of immediate cash in exchange for payback with interest. That's a definite value add for the consumer - a product that clearly exists. Just because there is risk involved doesn't make it a scam - every business incurs risk when they invest in production or sales without guaranteed revenue.
Posted by: erickson55345 | Dec 12, 2008 4:05:47 PM
So there you are fools aplenty and their money have parted
There is an old Indian saying in a village where there are greedy and miserly people, there will be no shortage of conmen
The Club members of Boca Raton Golf Club and their ilk have the same mentality as the villagers and have been conned because of their greed. Sympathy - I have none
Madoff and his chimpanzee Auditors -Friehling & Horowitz should spend a very long time in a harsh corrections facilities
The Chimpanzees certainly did not get peanuts for cooking the books
Posted by: Anil | Dec 12, 2008 4:12:14 PM
What bigger ponzi scheme or pyramid scheme than the stockmarket. All started many years ago by a group of schemers. Even today you buy stock and almost immediately the stock is artificially inflated and some one is just waiting for a slight rise so that he can sell and make a fortune. Every stockmarket loss is someone's gain. There are clubs just for the purpose of inflating and selling to make their daily wages. talk about junk bonds, How about Junk stocks? here are a million boiler makers out to rip somebody off. And with unemployment like this people have to have some way to nourish their family and all the while, the Government is nourishing the banks. There are thousands of people here in the States who wouldn't think of getting a job and work for a living, when they can make a living scheming.
Posted by: Ragan | Dec 12, 2008 4:24:06 PM
I almost forgot... The Federal reserve (aw hell lets call it like it is) The Money Cartel known as the Federal Reserve, Prints money with absolutely no colateral or anything to back it up. Now it releases this money to the Banks and the banks loan it out for interest and the bank gets to keep some of the interest and the Feds must get to keep some of the interest money. These guys at the Federal reserve do absolutely for their share. I would call this loan sharking and usury. But these are the people who will soon force America to join the Global financial world. All of you should watch the Video "The Capitalist Conspiracy" Its all coming true.
Posted by: Ragan | Dec 12, 2008 4:31:58 PM
Ragan - define the term 'Money Cartel'
what does that mean?
Posted by: Greg | Dec 12, 2008 4:34:39 PM
my favorite part is that Anil went back to amend his post and did not even notice what a mess it was.
Posted by: Greg | Dec 12, 2008 4:40:58 PM
Eric, read the aticle or at least go to Wikipedia. You have no idea what a Ponzi scheme is.
Posted by: Greg | Dec 12, 2008 4:42:13 PM
Want to learn more about the Federal Reserve? Go to You Tune and put n teh search, Inflation adn the dollar's crash. BTW ABC would not let me paste in the address, saying I was "spamming". Whatever.
Posted by: Silent scream | Dec 12, 2008 4:48:49 PM
The wealthy have now lost $50 Billion
So lets thank
Madoff and his chimpanzee Auditors -Friehling & Horowitz who will pay themselves, friends & relatives huge bonuses from the $300 Million or so left in the kitty
They only stole money from the wealthy
Just like Lehman Brothers
Posted by: Anil | Dec 12, 2008 4:52:04 PM
Madoff's chimpanzee "Auditors" - Friehling & Horowitz operated out of a 13-by-18 foot mud hut in an office park in New York City’s northern suburbs
Wow does that not surprise us
Noboby questioned the qualifications of messrs Friehling & Horowitz let alone the mud hut
They are not even qualified as Certified Public Accountant (CPA)
Only CPAs who are licensed can audit a corporation
How did they get away with fraud for so long
Posted by: Anil | Dec 12, 2008 5:02:10 PM
ericson said, "Banks have actual goods and services - the availability of immediate cash in exchange for payback with interest."
Oh, I see. That must be why Washington Mutual and Indy Mac both failed and went bankrupt this year, and Citigroup needed several hundred billion dollars to stay afloat.
You're right, banks aren't ponzi schemes. And neither are any of the failed banks on this list, right?
Posted by: Eric | Dec 12, 2008 6:15:42 PM
Greg said, "Eric, read the aticle or at least go to Wikipedia. You have no idea what a Ponzi scheme is."
Yes I do. And most banks runs Ponzi schemes. They 'invest' money they don't have. PERIOD. That is why all of the banks on the following list have failed since Oct. 2000. Banks like these, and Citigroup, the largest bank/ponzi scheme in the world, hide their schemes on secret 'level 3 balance sheets' and inflate their worth by adding useless 'Goodwill' to their public balance sheet.
Posted by: Eric | Dec 12, 2008 6:19:29 PM
The Federal Reserve creation of money out of thin air IS a Ponzi scheme. How did they do it? Easy! First they con congress and the public into using their federal reserve notes back in 1913 and then later on (1971) Nixon drops the gold standard. Tada! Now your federal reserve notes are backed by NOTHING and the FED can print as much "money" as it wants whenever it wants making your paper money, in the limit, worthless. FED = Fraud.
Posted by: Darrin | Dec 12, 2008 7:21:02 PM
sounds like how the treasury works.
Posted by: the_turk | Dec 13, 2008 2:39:52 AM
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