What is a Ponzi scheme and is NM a similar scam? 

 

Ponzi Scheme

The word Ponzi comes from Charles Ponzi who made this type of scheme well-known.

A Ponzi scheme is an illegal investment scheme that involves paying returns to investors out of the money paid in by later investors, rather than from net revenues generated by any real business. According to the FTC (Federal Trade Commission), “…there is an expression that nicely summarizes this scheme: It’s called “stealing from Peter to pay Paul.”

Charles Ponzi’s basic idea was that he would take money from person #1 and tell him that he would give him a high interest on his money. When person #2 gave Ponzi money, Ponzi would take part of that money and give it to person #1 - thereby fulfilling his obligation to give him a high interest. When person #3 came in, Ponzi would take some of that money and pay off person #2 - thereby fulfilling his obligation. If there were no #4, then Ponzi could not fulfill his obligations to #3.

The government claims that these schemes run out of people and collapse.

Charles Ponzi learned this scheme while working at a bank in Canada. He noticed that the bank “knew” that at no time would everyone walk into the bank and withdraw all their money simultaneously. Therefore, the bank could loan out other people’s money to potential borrowers. Banks still operate on this fundamental principle today.

Personally I believe that banks operate an “organized” Ponzi scheme:

 

When a bank pays you interest on the money you have deposited with them, where do they get that interest? Perhaps from money they’ve earned in the stock market or business investments, as well as from other people’s money. Isn’t that “borrowing” from Peter to pay Paul?” 

 

What would happen if people stopped putting money into banks? Would they collapse?

 

A Ponzi scheme is different from a Pyramid scheme in that in a Ponzi scheme the money goes back to one person (such as Charles Ponzi), hence the person at the top is making all the money. By contrast, in a pyramid scheme, each “level” makes money.

 

The Federal Trade Commission states that what’s wrong with a Ponzi Scheme is that there’s no “real” business attached to it and, “When the scheme collapses, most investors find themselves at the bottom, unable to recoup their losses.” (Debra Valentine, General Counsel for the U.S. FEDERAL TRADE COMMISSION)

 

MLM is not a Ponzi scheme because it has a real product and it is a real business. Make sure you review: How to evaluate an MLM company.

 

Additional thoughts on the subject…

Based on the way the FTC defines a Ponzi scheme, the US Social Security system is just such a scheme. The Social Security Administration calls it “Pay-As-You-Go.”

 

Here is the Social Security Administration’s response to this claim:

There is a superficial analogy between pyramid or Ponzi schemes and pay-as-you-go insurance programs in that in both money from later participants goes to pay the benefits of earlier participants. But that is where the similarity ends. A pay-as-you-go system can be visualized as a simple pipeline, with money from current contributors coming in the front end and money to current beneficiaries paid out the back end. So we could imagine that at any given time there might be, say, 40 million people receiving benefits at the back end of the pipeline; and as long as we had 40 million people paying taxes in the front end of the pipe, the program could be sustained forever. It does not require a doubling of participants every time a payment is made to a current beneficiary. (There does not have to be precisely the same number of workers and beneficiaries at a given time - there just needs to be a stable relationship between the two.) As long as the amount of money coming in the front end of the pipe maintains a rough balance with the money paid out, the system can continue forever. There is no unsustainable progression driving the mechanism of a pay-as-you-go pension system and so it is not a pyramid or Ponzi scheme.
 

If the demographics of the population were stable, then a pay-as-you-go system would not have demographically-driven financing ups and downs and no thoughtful person would be tempted to compare it to a Ponzi arrangement. However, since population demographics tend to rise and fall, the balance in pay-as-you-go systems tends to rise and fall as well. During periods when more new participants are entering the system than are receiving benefits there tends to be a surplus in funding (as in the early years of Social Security). During periods when beneficiaries are growing faster than new entrants (as will happen when the baby boomers retire), there tends to be a deficit. This vulnerability to demographic ups and downs is one of the problems with pay-as-you-go financing. But this problem has nothing to do with Ponzi schemes, or any other fraudulent form of financing, it is simply the nature of pay-as-you-go systems.

 

Obviously Social Security is “legal” because the government makes the laws. If you have a hard time believing that the government could run a scheme, read this. But it certainly seems like they are borrowing from Peter to pay Paul. Their analogy of a pipeline seems a whole lot like what Charles Ponzi was doing. …”visualized as a simple pipeline, with money from current contributors coming in the front end and money to current beneficiaries paid out the back end… Perhaps I’m just missing something.

 

Now, looking at it historically, I think Social Security did a great job at helping to break the Great Depression. But it appears to me (and this is just my opinion) that the government used the concept that Charles Ponzi was arrested for.

 

The largest proof that it operates similar to a Ponzi scheme is that it appears to have “not worked!” The current talk coming out of the government is that they are going to drop Social Security because it will be bankrupt in a few years. Meaning, it’s going to collapse. The reason for this, they claim, is because there are not enough new people paying into the scheme to pay those who’ve been contributing all their working lives. So evidently there are not enough Peters to pay Pauls.

 

Allow me to restate the comment from the FTC: “Every pyramid or Ponzi scheme collapses…. When the scheme collapses, most investors find themselves at the bottom, unable to recoup their losses.” (Debra Valentine, General Counsel for the U.S. FEDERAL TRADE COMMISSION)

 

No matter how one twists the details, the facts are that at a minimum some people in the government have used Social Security to run a fraud. In 1983 the government predicted this “demographic change” of the Baby Boomers would occur and bankrupt social security. To prevent it from happening, Congress raised payroll taxes and reduced the benefits given to retirees (Peter pays more, Paul gets less). As a result, the government collected more money, $667 billion in excess was brought in between 1983 and 2001, and the government spent it! The definition of fraud it to trick someone. So is Social Security collapsing because there are not enough people paying into the scheme, or is it because of mismanagement of funds?

 

Personally, I’ve been paying into the Social Security scheme for 27 years. I don’t think I will be able to recoup my losses. Hopefully you “got in at the beginning” and will get more out of it than me.