Ponzi Schemes and Social Security

In light of the recent Bernard Madoff investment scandal, I wanted to investigate the definition and structure of a Ponzi scheme. Ponzi schemes and pyramid schemes are similar in that new investments of money are used to pay other investors. However, Ponzi schemes are generally positioned as investments in a central fund where pyramid schemes pay investors who recruit new investors.

Here's a simple example. Let's say there is a fund which touts the high yield return of 5% per month by some sophisticated and complex investment techniques. This initially attracts 10 investors with $100 each. At the end of one month, the fund shows growth for each account to $105. Realizing that this type of return yields almost 80% annually, it attracts more investors. So, 10 more investors each invest $100. Let's say this continues for one year without any sign of problems.

At the end of the first year, the fund would have collected $12,000 (12 months * 10 investors per month * $100 per investor). Each investor would have an account balance which reflects the 5% monthly yield. The total sum of all investors' account balances would show as $16,712.98. But, since this is a fraudulent scheme, none of the extra $4,712.98 actually exists. However, as long as the investors don't "cash out", the scheme continues. Meanwhile, typically, the fund manager has probably "cashed in" some of the original $12,000 for personal purposes. This game can be played as long as new investment capital exceeds the demands for cashing out (or until the fund manager gets caught).

So, this brings me to Social Security. I have a new article this morning on United Liberty discussing this topic. I contend that Social Security is nothing more than a structured Ponzi scheme. Workers "invest" into Social Security (via forced taxation). The money from those investments are used to pay off previous investors (current retirees and beneficiaries). Today, the amount of money coming in exceeds the money going out. This excess cash is then used by the government to fund other spending, so there is no money in the investment fund. Technically, the Social Security program takes this excess cash an purchases government bonds. Today, the value of bonds held equates to over $2 trillion. This will all get interesting in the next 10-20 years when the amount of new investment is not enough to cover the money required to be paid out.

This scheme will collapse.