Ponzi schemes are common: people want to make money and wolves wearing wool are everywhere.
By his own estimate, Bernie Madoff lost $50 billion of investor funds while the Securities & Exchange Commission (SEC) regulated his fund. A December 19, 2008 New York Times article, "Madoff Scheme Kept Rippling Outward, Across Borders" by Diana B. Henriques described Madoff's fraudulent investment scheme:
"The first worldwide Ponzi scheme — a fraud that lasted longer, reached wider and cut deeper than any similar scheme in history, entirely eclipsing the puny regional ambitions of Charles Ponzi, the Boston swindler who gave his name to the scheme nearly a century ago."
On paper, Bernard Madoff generated 15% returns year after year. Once financial markets started plunging, all the money pouring in wasn't enough. People wanted cash and, typical of Ponzi schemes once people start a run, the enterprise collapsed.
Many wealthy and powerful people were defrauded and Madoff will be prosecuted.
Federal prosecutors in Manhattan are currently prosecuting Bryant Rodriguez for a smaller scale Ponzi scheme: bilking churchgoers at the upper Manhattan El Camino Church of about $600,000 in 2007. Prosecutors called it a classic financial grift as Rodriguez promised investors 30% on their investment every two weeks. The scheme fell apart when investors started to withdraw their money.
Ponzi's Scheme
Charles Ponzi, an Italian immigrant in Boston, devised his fraudulent investment scheme in 1920. He made millions of dollars in a short time by paying 50% returns to investors after 45 days out of money paid by subsequent investors rather than from any actual profit from investment. His scheme relied entirely on current investors meeting the obligations due those who had invested earlier, while Ponzi pocketed the difference.
Ponzi schemes are typically very successful until they collapse. Everyone makes money and is happy while new "investors" can be found and until regulators shut down the operation or there's a run on the funds used to pay off "investors." Once confidence is lost in the person or persons running the scam, because there is no real investment supplying value, everything collapses.
Social Security and Medicare
On August 14, 1935, FDR signed the Social Security Act into law. Social Security, which shares many of the characteristics of a Ponzi scheme, is funded with Federal Insurance Contribution Act (FICA) payroll taxes. Individual social security and medicare taxes are calculated as a percentage tax on up to $106.8K of salary for 2009--with 7.65% paid by you and 7.65% paid by your employer to the government instead of to you--for a net 15.3% reduction in your paycheck. The "contributions" are to be considered an "investment" by workers into a government-mandated retirement account. As in the early stages of a Ponzi scheme, Social Security had lots of new "investors" when FDR and Congress started it.
The 1935 Social Security Act created an "Old-Age Reserve Account" in the Treasury which was to pay benefits and invest the reserve in federal debt, including unmarketable debt issued for this purpose, originally earning 3 percent. Social Security’s tax rate was to rise gradually, to create a reserve big enough so its interest would cover future costs. The Social Security Act started tax collections in 1937 and was to start benefit pay outs in 1942.
On August 10, 1939, FDR signed the Social Security Amendments of 1939 which renamed the Social Security Old-Age Reserve Account to the "Federal Old-Age and Survivors Insurance Trust Fund" managed by the Secretary of the Treasury, added family coverage, started pay outs in 1940, and funded the Trust Fund directly from FICA taxes. Similar to a Ponzi scheme, Social Security was marketed to the public as an insurance fund which invested investor contributions.
And just as investor contributions are not invested in a Ponzi scam, it's a myth that current FICA payments are invested in a "trust fund" earning interest. FICA taxes paid by today's workers are, as in a Ponzi scheme, transferred to pay today's retirees. When FICA taxes exceed Trust Fund outlays, the remaining surplus funds don't go into money-making investments, but instead get spent by the Treasury on federal outlays. In return, the "Federal Old-Age and Survivors Insurance Trust Fund" receives IOUs--unmarketable Treasury bonds carried as intra-governmental holdings on federal budget spreadsheets. There is no money put aside; there is no investment--only claims on taxpayers of the future.
When the most recent budget surplus occurred in 1999, the national debt still increased. Why? Because as required by law, FICA tax surpluses were borrowed to fund federal outlays. Social Security’s Trust Fund is a bookkeeping device at the Treasury and nothing more. The "trust fund" label was for public indoctrination only to reassure the public that Social Security was trustworthy. As with a Ponzi scheme, there is no actual investment, just the appearance of one:
- In a 1937 brief to the Supreme Court, the Roosevelt administration conceded that Social Security “cannot be said to constitute a plan for compulsory insurance within the accepted meaning of the term insurance” and characterized Social Security as a “public charity” program under the “general welfare” clause of the Constitution. The Supreme Court declared Social Security constitutional in two separate decisions because it was a welfare system and not an insurance system.
- The Social Security commissioner, Stanford Ross, after he announced his resignation, conceded in 1979 that: "...the mythology of Social Security contributed greatly to its success... Strictly speaking, the system was never intended to return to individuals what they paid."
- On February 9, 2005, President Bush acknowledged Social Security is not a trust fund:
"Some in our country think that Social Security is a trust fund -- in other words, there's a pile of money being accumulated. That's just simply not true. The money -- payroll taxes going into the Social Security are spent. They're spent on benefits and they're spent on government programs. There is no trust. We're on the ultimate pay-as-you-go system -- what goes in comes out. And so, starting in 2018, what's going in -- what's coming out is greater than what's going in. It says we've got a problem. And we'd better start dealing with it now."
As with "non-sanctioned (i.e. illegal) Ponzi schemes," Social Security also depends on enough people paying in to be able to fund others receiving the benefits. The system works only as long as new "investors" are recruited to pay in more money. By General Accounting Office (pdf) and other estimates , Social Security and Medicare will be in increasing financial trouble over the next two decades as the number of people receiving payments becomes greater than the number paying into the system. This is what collapses Ponzi schemes. As Thomas Sowell says in Basic Economics, Basic Books, New York, N.Y., 2000, p. 206:
"In a genuine insurance, the premiums paid by the current generation are invested and the returns used to pay either annuities to that very same generation or to pay death benefits to their survivors. That is why insurance companies do not have to worry about how big the next generation is going to be, but politicians do. Politicians do not invest the Social Security premiums, but spend the money as fast as they get their hands on it."
According to Gary North:
"The entire Western world is trapped in a Ponzi scheme sold by politicians: free lunches in our golden years of retirement."
While Madoff is prosecuted for operating a Ponzi scheme that lost $50 billion, the government has lost nearly $4 trillion in its own Ponzi scheme. The current national debt is over $10 trillion, of which over $4 trillion is unfunded liabilities, the majority of which are for the Social Security Trust Fund.
Other than the difference between private criminals competing with those of the state, is there any difference between Ponzi, Madoff, and Social Security?
The state's answer:
"Social Security is and always has been either a 'pay-as-you-go' system or one that was partially advance-funded. Its structure, logic, and mode of operation have nothing in common with Ponzi schemes or chain letters or pyramid schemes." - an archive of a Social Security website.
What's yours?
The lady protests too much, methinks.
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