|PONZI SCHEMES: A GENERAL ANATOMY
Continued from Cover
|In both variants of the Ponzi Scheme or Bubble Game, the mechanics are entirely identical. The
only income a Ponzi Scheme has comes from money paid into the investment. There is no business
operating to generate an income. Returns are manufactured by refunding part of the investor’s
money. In order to secure a constant flow of manufactured returns, the operator continually brings
in new investors.
Key to all Ponzi Schemes is the promotion of a fictional
business whose mechanisms are beyond rational
comprehension. In Charles Ponzi’s case, he claimed to be
playing off the disparity in international postage rates. (It
actually made no sense on the face of it.) Bernie Madoff was
simply claiming to be able to beat the standard investment
return by 2% regardless of market conditions. Typical schemes
will say they invest in flipping distressed properties, have a
formula for market timing the buying or selling of stocks or
claim to provide overnight dollar matching for banks which hold
dubious currencies. The stories, being fiction, are all fairly
disposable. You are being offered limited access to a secret
gold mine. An improbably consistent above average return
is the lure of every Ponzi Scheme.
|I have Secret Knowledge
From My Magic Helmet!
Charles Ponzi’s particular scheme was marketed entirely at the masses. Ponzi was offering a 25% return
within 90 days on investments of nearly any size. This enabled the average person to get in at one dollar,
five dollars, twenty dollars or similar manageable amounts. Most people who invested let their return roll
over. Your average Joe who bought a $10 coupon which at the end of 90 days was redeemable for $12.50
let it go another term, confident that it would be worth $15.62 in another 90 days. People not cashing out
bought Ponzi time to sell more investments. Ponzi was so successful in keeping money rolling into his
scheme that he was able to survive two rather large runs of people cashing out.
Most Ponzi schemes are not as dynamic.
More typical is the mechanism Madoff used--
that of creating a Straw Champion. A Straw
Champion is a person who your scheme has
made wealthy. You then trot this person out to
greet potential investors. He’s an actor with
fancy props. He doesn’t necessarily have to
be a confederate, but he does act as a
salesman. The Straw Champion meets people
at society functions, at golf courses, at any
place where potential targets might hang out.
There, he talks up the operator and arranges
meetings. The core target market for schemes
of this type are what we used to call Strivers—
the near well to do. They are either business
owners or people living off a considerable
income stream. The scheme is typically
pitched as a way of diversifying your
holdings—as a capital growth portfolio portion.
It’s yet another permutation of a secret gold mine only special people get to know about. Although all
Ponzi Schemes are essentially alike, they are custom tailored for specific audiences. The Ponzi
operator will always put the ‘special-ness’ of his target audience out front. Because you are this type of
person, you are uniquely qualified for this particular opportunity. This approach is highly scalable, as we
can see from the examples of Ponzi and Madoff.
Not all Ponzi Schemes are perpetual motion machines. Many Ponzi Scheme operators know that their
racket has to have a programmed beginning, middle and end. In order to win, the Ponzi operator has to
vanish with a sizable amount of money before his investors flock to cash out. Charles Ponzi himself is
particularly notable for having stayed put long after the threads were showing on his disreputable
enterprise. Effectively, he never ran for it. Few Ponzi operators are this cool.
Since doomsday is always approaching in a Ponzi Scheme, most operators will stick to a strict Pure
Bubble Game. Here the operator claims to have purchased a high demand commodity at a well below
market price. He needs cash in order to sell the commodity and is willing to cut investors into his
guaranteed profit. The hairiest of these scams is the oil futures racket.*1 Here our boy has locked in a
ton of oil futures at way below market price. In order to cover the interest on the loan he took out from
the bank to buy these futures, he needs to bring in a little cash. His gross return is a guaranteed 20%.
He owes 8% to the bank. Your return for participation is a split of his 12% profit. Since he only has so
many futures, you have to act quickly. This offer will not be repeated. 6% isn’t bad for an immediate and
certain return. It all sounds reasonable, except for the fact that our boy doesn’t have any oil futures to
begin with. He and his business evaporate at about the time he has sold 40% of his inventory.
The Faked Solvency approach is a fake it until you make it scheme which can be liquidated at any time.
Here the target isn’t so much investors as it is the buyers of insurance products or discount marketers.
The operator has set himself up as a specialty insurance company or as a warranty guarantee firm.
In the real warranty or insurance businesses, fees are collected from policy holders and then pooled into
an investment trust. The income from this trust is then used to pay out claims and cover the firm’s
liabilities. In the Faked Solvency version, there is no investment trust. The investment trust portion of the
firm’s expenses goes up the operator’s nose. This means that the insurer is paying out claims with
money sent in as premiums. It also means that the insurer probably cannot cover a major liability event.
Both of these are bozo no nos and much more common than the public suspects.
Since it’s not illegal to start an insurance company from a standing start, the government will allow a firm
to make claim payments out of cash received for a time. Failure to allow this would mean that there
would never be any new insurance companies. The hope is that the firm will eventually create an
investment pool with real income and liquid assets. At some point it becomes a mandate. Unfortunately,
this grey area allows a lot of room for scams to operate.
The good news is that a capital starved firm can usually turn around and sell its paying policies to a
better established entity. In fact, many make a living doing just that. In the minds of the purchasing
entity, a paying policy is usually worth more than the liability it represents. The bad news is that some of
these small operators are likely to split into the ethers if they encounter a badly timed liability event. That
means your policy is worth nothing.*2
This racket is even worse at the warranty end of the spectrum. Most products have to have some kind of
warranty in order to be sold in the average big box retailer—which is where most products are sold. For
your standard manufacturer, this hurdle is no problem whatsoever. They either buy the warranty from an
established firm or have a department internally to handle such. It is to your discount, no name, knock
off, fly by night manufacturer (or, more likely, importer) for whomthis warranty issue becomes a problem.
He has to convince Wal-Mart that someone larger than him is willing to stand behind his slip shod
As opposed to someone larger than the manufacturer, many retailers will settle simply for someone
other than the manufacturer. For discount retailers, the whole warranty guarantee process is a cover
your ass type of affair, done in as half-hearted a manner as they can get away with. This leaves the
door open for our scam artist. Our scam guy collects the money and offers up his official looking
documentation to the manufacturer, who in turn shows it to the retailer.*3 The retailer checks on the
trust and approves the purchase of the manufacturer’s goods. And the moment anyone’s back is turned,
our scammer liquidates the trust, takes the money down to Tijuana and bets on chickens.
Faked Solvency is something of a back door crime. We all pay for it in increased insurance rates and
extra mark ups at stores. In the case of the warranty firm, eventually the retailer winds up eating the
cost. This indirect function makes the crime very attractive.
It’s very hard to spot Faked Solvency since it acts like a real business until it pops. After all, most
businesses pay their expenses out of their income. What makes this Faked Solvency is that the type of
business that the firm pretends to be in requires more assets than simply an ability to pay bills. You
cannot claim to be in the insurance business unless you can actually insure people. It would be like
claiming to be in the cola bottling business without a bottling plant.
|The Pure Bubble Game is a little easier to spot. First off, it’s largely run by serial offenders. Charles
Ponzi bankrupted a bank in Canada before he started his little scheme in the United States. Bernie
Madoff’s parents were convicted of running a Ponzi Scheme. Beware of any operator recycling a claim
from another venture. Second, beware of any flashy displays of wealth on the part of previous investors.
Keep in mind that any audience for an investment seminar is likely to be seeded with plants. If you wind
up being ‘love bombed’ by the crowd, walk out the door.*4 Finally, you have to ask yourself the same
question with investment peddlers that you do with psychics and other persons out to do you good for a
If this secret is so outstanding, why are you willing to share it?
The answer is always the same: Because I am lying.
|For more information on Frauds, check out:
*1 An ‘oil future’ is a guarantee to buy crude oil at a set price. The idea is that the guy has the
ability to buy oil for a lot less than it is selling under current market conditions. All types of ‘futures’
can be used as a pretext in a Ponzi Scheme.
*2. The less specialized your insurance is, the better the chance it is backed by an entity other
than the issuing party. Most consumer insurance is re-insured against company default. Insurance
specifically against property damage to an item you purchased, such as an ATV or a home
theater system, is the most likely to go into straight default without recourse. In that case, you are
*3 All Ponzi Schemes inevitably hinge on maintaining appearances. In the warranty scam, all you
need is good stationary, a business bank account and a pleasant phone manner. There is also an
art to creating a domino bond—a bond that’s backed by another bond that’s backed by a bond you
can make liquid and convert to cash. Once you have cashed out the first bond, all of the others
become valueless. That makes your guarantee trust an empty shell.
*4. What the hell are you doing at this seminar in the first place? No legitimate investment scheme
or business opportunity is ever mass marketed. People who have business secrets, keep them.
They do not sell them to the public. Ever.