Understanding Ponzi Schemes

Understanding Ponzi Schemes

Can Better Financial Regulation Prevent Investors from Being Defrauded?

New Horizons in Money and Finance series

Mervyn K. Lewis

A Ponzi scheme is one of the simplest, albeit effective, financial frauds to engineer, and new schemes keep coming forward. Despite this, however, people continue to invest in them. How are we to account for the seemingly never-ending lure of such schemes? In providing answers to this central question, this concise and well-researched book examines how Ponzi schemes operate, how they differ from pyramid schemes, Ponzi finance and other financial arrangements.

Chapter 1: An outline of the book

Mervyn K. Lewis

Subjects: economics and finance, behavioural and experimental economics, economic crime and corruption, economic psychology, financial economics and regulation

Extract

A dictionary might well contain the following entry: Ma-doff n. 1: a selfish and excessive desire for more of something (such as money) than is needed; 2: a person who commits unconscionable financial fraud – see GREED. The name Bernard Madoff is now synonymous with greed and he has a special place in the annals of infamy as the man who conducted if not the longest running, most certainly the largest, Ponzi scheme and investment fraud in history, amounting to paper losses of $64.8 billion if promised returns are included. However, Ponzi frauds and the schemes built around them come in all shapes and sizes, as will be made clear by the 11 case studies examined in later chapters and, as well, in the profiles of the ‘rogues’ gallery of con men’3 set out in the next chapter. Stripped to its essentials, and with the huff-and-puff and ‘spin’ that invariably surrounds them removed, a Ponzi scheme is one of the simplest, yet effective, financial frauds to engineer, and is named after Charles Ponzi who ran such a scheme in Boston in 1920. The promoter of the scheme promises investors an attractive return on investment and declares it to be secure, but in reality no real ‘investment’ takes place. People are encouraged to invest in the scheme, and the money deposited by those early investors is used to pay the first ‘dividend’ until investors feel comfortable and decide to invest more.