Ponzi, Madoff, and Franklin Roosevelt

In the past year, as the fog of unstoppable economic success lifted and some semblance of market clarity entered investors’ minds, a sobering phenomenon began to occur. It appears as though nobody had bothered to notice, during our extended surge of prosperity, that more than a few freeloaders had been discreetly riding the tidal wave at investors’ expense. After the discovery of Bernard Madoff’s $50 billion Ponzi scheme, many more suddenly surfaced, and suddenly the Securities and Exchange Commission was paying attention. In fact, 74 such schemes have been uncovered in the last two years, targeting an expansive range of people, from charitable institutions to deaf investors to retirement home residents. Throughout economic history, there have always been people who had the audacity to swindle money, but it is the ever-growing magnitude of recent endeavors that proves the most frightening. Such schemes are carefully formulated and conducted, in order to run below the surface of the roiling economic waters by which investors are captivated.

Charles Ponzi, caught in 1910, was certainly not the inventor of the ploy, but was the first person to accomplish the feat on a relatively large scale in the United States. Boiled down into its basic constituents, a Ponzi scheme requires a good salesman and a lot of suckers to take the bait. The operator takes money from people with promises of high returns, and pays them bits of their own money back as “returns” to satisfy them. As more people give money, the pool grows larger, and can keep paying these “returns” without ever physically investing a dime. In reality though, if everyone wanted their money returned at this point, nobody could retrieve the full amount of their investment, because part of it has already been paid to others, not to mention the often hefty salary Ponzi operators bestow upon themselves as a reward. The money pool can grow large enough that it can pay back in full those who back out, so as not to arouse suspicion from authorities, but the scheme as a whole resembles to a fire—it can only maintain its expansion as long as there is a supply of oxygen to feed it. Ponzi schemes can be massive, but they are fundamentally self-contained by the number of willing investors, and are therefore destined to die out after reaching critical mass.

But wait, why does this scenario sound hauntingly familiar? Perhaps it is because one such condition has been in operation since 1935, when it was signed into law by President Franklin Roosevelt. America has long been nervous about the fate of Social Security, and rightfully so. It is, essentially, one enormous nation-wide pyramid scheme, in which the first round of investors are paid by the second round of investors, for generations and generations. Having just discussed the inevitable outcome of such a process, the moment of truth has already arrived; there aren’t enough new donators to pay off baby-boomer receivers, and the timer on the bomb is ticking. Privatization of the system has been proposed, but running a business requires profitability, a trait Social Security structure clearly lacks. Are there other options? Short of pure government expenditure, no, not without sacrificing the whole program and starting over. Nobody would think to associate Madoff with Roosevelt, but unfortunately both designs have been fated to failure from the moment of inception.