Wednesday, February 11, 2009

Ponzi Primer

Okay class, today's lesson is about the Ponzi.

A Ponzi scheme is a scam. The person who starts it offers a hopeful investor a ‘better than market’ rate of return and then more importantly delivers, at least at first. By using his own money he reels in a naturally greedy investor by giving him back the original investment plus more after a short period of time. He says he will continue doing this and if the original ‘mark’ takes the bait the scam is off and running. Others find out and invest hoping for similar profits. A straight face by the scammer and a good economy allows the fraud to continue. The Ponzi can thus grow to ridiculous levels as in the Madoff fraud.
However if too many people demand their money back at the same time the scheme falls apart because the money does not exist anymore. The scammer must find and trick enough new investors to join so he can to pay the old investors. But the longer the scam exists the harder that is to do.

The stock market also asks you to invest your money in the hopes of higher returns but you only get those higher returns if others invest after you and send the price of the stock higher. That price is arbitrary and is determined by many factors including a perceived value of future worth known as a ‘Mark.’ The ‘Mark to Market’ method of valuing a stock is used to determine the future price of an investment. Mark to Market is, anthropomorphically speaking the “Man behind the Curtain” to whom you should not pay attention.

Hmmm, this sounds vaguely familiar, doesn't it?

A bank asks you to deposit money in return for more money back later. The more money part is known as interest. Banks are able to give you interest by loaning your money out to others and charging them higher rates in return. In other words the banks are ‘middle men’ between your money and a needy borrower. Bookies call the difference between what they get vs. what they give you the 'vig' but banks just call it business. You are not upset as long as you end up with more than you started.
So in simple terms the banks need new money in order to pay back older investors.

Wait a second, this sound familiar also, right?
Right! That's because they are all Ponzi schemes.

The difference between these three Ponzi schemes is that the Government does not regulate the first one and therefore they do not get a 'vig.' But as we have learned the hard way we can lose money no matter which scheme we invest in. So before investing in anything class do your own research and be diligent.

For crying out loud remember the phrase “Caveat Emptor” (“Let the buyer beware.")
And live by the rule, "If it looks to good to be true…"

Class dismissed.

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