Ponzi Schemes

A Ponzi scheme (/ˈpɒnzi/; also a Ponzi game) is a form of fraud which lures investors and pays profits to earlier investors by using funds obtained from more recent investors. Investors may be led to believe that the profits are coming from product sales, or other means, and remain unaware that other investors are the source of profits. A Ponzi scheme is able to maintain the illusion of a sustainable business as long as there continues to be new investors willing to contribute new funds and most of the investors do not demand full repayment and are willing to believe in the non-existent assets that they are purported to own.1 Although the scheme has been around a long time2, it was finally named after Charles Ponzi, a Boston businessman who pleaded guilty in November 1920 and served 5 years in prison.

There are numerous variations on the Ponzi scheme, but all have the same basic characteristics:

    • an initial investment
    • promise of above average returns
    • vague descriptions of how funds are to be used
    • payoff to earlier investors with funds from later investors
    • requires an ever increasing investment of money

So why the sudden interest in Ponzi schemes that we all know are illegal. Well, let’s consider another, slightly different scheme used to induce investors to invest more and more money, much of which is used to payoff earlier investors and which is entirely legal. That scheme is the one of the two means of financing our federal budget, the first being the collection of taxes.

Clearly, the collection of taxes provides the lion’s share of our federal budget but, unfortunately, it’s never (well, almost never) enough. So the treasury has to borrow money to make ends meet. This year alone, the treasury will have borrowed approximately one trillion dollars. Now this has been going on for a long time, so the accumulated debt is approximately 21 trillion dollars3. To finance this debt, the treasury lures investors to purchase various investment instruments, namely 4 week, 8 week, 13 week, 26 week and 52 week treasury bills, 3 year and 10 year treasury notes and 30 year treasury bonds which are auctioned off aperiodically (but frequently) as needed to pay it’s obligation. (There are 6 scheduled auctions remaining this year.) When the bills, notes and bonds mature, investors cash them in and that becomes part of the overall federal budget outlay. With $21 trillion outstanding and most of it in short term notes (1 year or less) that probably amounts to about $40 billion every week that needs to be refinanced. So every week they need to sell at least $40 billion in treasury bills, notes and bonds to pay off those that have matured and another $2 billion to make up this year’s borrowing. Now, does this ring any bells?

Except for the promise of huge return on investment, this federal debt refinancing has all the earmarks of a Ponzi scheme.

  • The treasury gives only vague information about the nature of the investments
  • It gives no description of how the money is to be used
  • Funds from new investments is used to pay dividends on earlier investments.
  • It requires an ever increasing amount of investment.

But then, if one makes the vague claim “it’s for our nation’s security” is the big payoff, it fits the description of a Ponzi scheme exactly.

1 Wikipedia

2 The same scheme was described by Charles Dickens in one of his novels in 1844. The scheme had no name at that time.

3 Most people have no concept of what is a trillion dollars. To put it in perspective, have you ever handled a $1000. bill? Just imagine you had enough $1000 bills to amount to $1 trillion (that would be 1 billion bills) and you stacked them in a single pile one atop the other. How high do you think the pile would reach? The thickness of a single bill is .0043 inches and 1 billion of those would amount to a stack 358,333 feet, or approximately 68 miles, high.