Ponzi Scheme
Think about those old movies. The ones with the scam artists, the con men working their mark, the grift, the con, the flim flam, the hustle, the bamboozle. Well, we're here to let you in on a little inside dope: We've got two scams you’ll need to, uh, wise up to...the Ponzi scheme and the pyramid scheme.
First, let's talk Ponzi schemes: To start, there was actually a guy named Ponzi...Charles Ponzi. He was a conman during the 1920s. You know, the time of flappers and speakeasies and folks doing the lindy hop on top of flagpoles. People were making money on Wall Street and in Florida land deals.
And, for a while, with Mr. Charles Ponzi, who had a very particular investment structure. But he didn’t actually invent the hustle...different con artists had used it and authors (including Charles Dickens) had described the scheme for at least 70 years before Ponzi gave his name to the set up.
A Ponzi scheme works like this: the fraudster attracts investors by offering a big guaranteed return on their investment. For instance, the actual Ponzi promised 50% profit in 45 days and 100% return in 90 days. He claimed that he was using some kind of postage arbitrage to reap these returns.
In actuality, he just used new money to pay off older investors. Ponzi got initial investors to give him some money. He used that money to help find new investors...and those new investors then gave the fraudster their money. Then he used the new influx of cash to pay off the initial investors.
It all went well for a while. But eventually, it became impossible to find new investors quickly enough to pay the old ones. The money coming in wasn’t enough to pay off recent investors. Eventually, the whole thing blew up.
The most famous Ponzi Scheme in history isn’t actually the one perpetuated by Charles Ponzi. It was run by a guy named Bernie Madoff. He ran a multi-billion dollar Ponzi scheme disguised as a successful money management business. He was a respected figure on Wall Street for decades. And he used this high-profile respectability to rope in nearly 5,000 clients.
Victims of Madoff included actor Kevin Bacon, pitching great Sandy Koufax, and others. The scam would work like any Ponzi Scheme: Kevin Bacon deposits $1 million. Madoff takes a cut for himself, then uses that money to pay off other investors. It only works as long as there are new investors to get involved.
Eventually, though, Ponzi schemes run out of new blood. Madoff’s scam eventually blew up in 2008, when the financial crisis spooked investors and Madoff ran out of money to pay off clients. Ultimately, $65 billion went up in smoke. Okay, on to a pyramid scheme...which involves your three-bedroom, two-and-a-half bath Victorian style pyramid being listed on Zillow.
All right, you called our bluff. It’s actually named after the shape of a pyramid. The Egyptians are in no way involved. And yes, to you geometry nerds out there, we realize this image is a triangle and not a pyramid. 3-D rendering is expensive. Bear with us: The idea’s the same. You start at the top with one person.
He gets money from each of the people he recruits. So he finds two people. They pay him money for the right to recruit other people into the scheme. They also get money for recruiting people. So each of them finds two people. Same deal. These new recruits pay money upward.
And so on. Just like the Ponzi scheme, the pyramid keeps going as long as there are new people to come on board. But eventually, the number of people available for recruiting runs out. The people on the bottom can’t find anyone new. The people on the high levels make money, but the people on the bottom, the largest group, are out of luck. And out of money.
The problem with pyramid schemes? Some legitimate companies have very similar structures. These are called multi-layered marketing companies, or MLMs. You know your friends who sell candles, or makeup, or nutritional shakes? Yeah, those are MLMs. One level recruits people on other levels, with money moving upward to the top.
The difference? Theoretically, real products are eventually getting sold to real consumers. A classic illegal pyramid scheme just has money moving up. And not much of value moving down. But just as in some of those old movies, it’s not always easy to tell the good guys from the bad.
The Bernie Madoffs of the world can look like legitimate Wall Street players, but turn out to be Ponzi scammers. And the new invisible lipstick product you’re so excited about selling can turn out to be a pyramid scheme. You have to be careful, because it can all um...blow up in your face.