The Ultimate Guide to Ponzi Schemes: Oldest and Biggest Scams, Madoff and More

Ponzi. Such a fun word to say, isn’t it? It’s not however fun to be a Ponzi victim: Madoff’s 1,000+ victims have lost over $60 billion. Certainly it’s not a subject of humor, if your pension invested with Madoff, or if you donated to a charity that invested with him, or if you personally invested in what turned out to be a scam. Still, we can all get a tiny bit of consolation that countless people have been swindled in similar schemes since the invention of currency. Let’s take a look at the Madoff scheme, then dig into the definition and history of Ponzi schemes, so we can figure out how to better protect ourselves in the future.

The Madoff Ponzi Scheme

By now everyone has heard of Bernie Madoff and his massive financial scam. What usually isn’t explained however is how he was able to keep investors and regulators in the dark over so much money, over such a long period of time.

If you’re looking for a hundred word, concise summary, you’re probably out of luck. The Madoff scheme came about because of a confluence of many factors, some of which are pretty complex. Still, Lew Rockwell does a pretty good job of pulling it all together in his article, Madoff Explained. He cites the following factors (summarized in my words):

• Bernie Madoff was very smart. Especially with money and finance.
• Bernie Madoff does not appear to have a sufficiently developed moral conscience.
• An extended boom period–in turn caused by many other factors, like artificially cheap money from the Fed (more in the next point)–allowed him to pay off earlier investors, with sufficient return, to keep current and future investors “believing.”
• The Federal Reserve, American people, and US executive branch were unwilling to weather even a slight recession, thereby causing the Fed to keep interest rates low, thereby causing many financial bubbles to continue to inflate.

I might also add two other contributing factors:

• The theme of “deregulation,” which was highly prevalent in the 1990s and 2000s, decreased the authority, manpower, and budget of Federal regulators and investigators to uncover this kind of scheme.
• Federal regulators appear to be, on the whole, extremely incompetent. Choosing to work for the government may in fact be a negative selection bias.

But of course, each of the above bullet points could be expanded to a 900-page thesis. So if you’re interested in reading more about the Bernie Madoff scheme, I’d recommending the following Web pages:

• The US Dept. of Justice: United States vs. Bernard L. Madoff: Official Web site on the court case brought by the DOJ Southern District of New York.
• The New York Times: The Talented Mr. Madoff: An in-depth profile with a lot of information on the man himself, and “why” he did what he did.
• The Wall Street Journal: Bernie Madoff News: A portal with all the latest Wall Street Journal content and news on Madoff, his victims, the trial, etc.
• The Wall Street Journal: Madoff’s Victim List: A helpful visual (geographic and tabular) representation of the victims (including the amount by which each victim was swindled).

Definition of a Ponzi Scheme: What Is It, Exactly?

Alright, so we’ve discussed the Bernie Madoff Ponzi scheme, but still haven’t defined precisely what a “Ponzi scheme” is. A lot of people use the phrase Ponzi scheme incorrectly, when referring to MLM organizations, etc. But according to Webster, the term is actually defined as an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks.

But how does this work in practice? Here are some good resources on how Ponzi schemes actually work:

• SEC.gov: Ponzi Schemes: The federal government is probably a good source of information about scams, since they’re often the ones left cleaning up the mess once the scams are uncovered.
• Wikipedia: Ponzi Scheme: I like this page because it has a section on what isn’t considered a Ponzi scheme, including a “bubble,” a “pension fund,” “robbing Peter to pay Paul,” and “Multi-level marketing.”
• TIME Magazine: A Brief History of Ponzi Schemes: The History of Ponzi schemes, from their namesake (Charles Ponzi) to the present day.

The Largest Top Ponzi Schemes: Scams that Echo in History

Ponzi schemes have existed throughout modern history, and we’ll probably never uncover all of them that succeeded. Still, it’s interesting to take a look at the ones that did succeed (and then subsequently collapsed). Business Pundit has a great article on the top Ponzi schemes in history. Here is their top ten:

1. The Namesake: Charles Ponzi
2. Madman Madoff: Bernie Madoff
3. The Retiree Plunderer: Michael Eugene Kelly
4. The Boy Band Bandit: Lou Pearlman
5. The Biblical Bilker: Gerald Payne
6. The Costa Rica Crooks: Enrique, Osvaldo and Freddy Villalobos
7. The Lottery Uprising: The Albanian Government
8. The Scientologist Snake: Reed Slatkin
9. The Haiti Haters: various Haitians?
10. The Fraudulent Feminist: Sarah Howe

Read the entire BusinessPundit article here. HowStuffWorks also has a page on notable Ponzi schemes, though it’s not as in-depth as the BusinessPundit post. Finally, TIME Magazine’s A Brief History of Ponzi Schemes is a nice write-up that features a few more recent scams.

How to Avoid a Ponzi Scheme

Of course, if there’s one thing you should take away from all this, is that it’s probably not a good idea to get involved with, or invest in, a Ponzi scheme. I’d encourage you to remember two investing maxims:

• If it sounds to good to be true, it probably is.
• Be fearful when others are greedy, and greedy when others are fearful. (Warren Buffett)

But if you’d like to educate yourself further, here are the resources I’d recommend:

• LectLaw: How to Avoid Ponzi and Pyramid Schemes
• CBS: Tips to Avoid Ponzi Schemes (video)
• FBI: Common Fraud Schemes

All that reading is enough to make me nervous. I’m glad to be sticking with my portolio of Vanguard ETFs, TIPS, and high-yield savings… I’ll leave the “300% returns” to the suckers!

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