What is a Ponzi Scheme?

The most famous Ponzi scheme was created by Bernie Madoff. For approximately 40 years he was able to convince investors that their deposits were generating income from legitimate investments. In fact he was paying investors what they expected to receive by using money deposited from new investors. There was no trading or investing taking place. This is a scheme that can continue as long as there is enough money coming in from new investors to pay what is owed to those who have been in the scheme for longer. When this finally came to an end the losses from investors went into billions of dollars. The main features of a ponzi scheme are;

• The scheme can continue indefinitely with the owners continuing to draw profit as long as there is more money coming in than going out.
• Regular payments to investors is a feature of a Ponzi scheme. If people are not paid the returns they are expected then the scheme will quickly collapse. By paying investors what they expect this can perpetuate the scheme for many years and greatly increase the profit of the owners of the scheme.
• A Ponzi scheme will normally end in one of 2 ways. If the owners are caught and prosecuted then any funds in the scheme will most likely be lost at that point. The owners may choose to end the scheme themselves when there are not enough people joining to make it viable to continue. With modern Ponzi schemes it is normal that the owners will continue to make excuses, give plausible reasons and so on regarding the delayed payments for as long as possible. Eventually people will realise what is going on and it will all come to an end. More often than not the perpetrators get away with it because they are living in countries where sophisticated financial crime is not prosecuted. However there have been prosecutions and jail terms for people who have been actively promoting the Ponzi schemes.
• The creation of a fictional financial product is required in order to convince people of the legitimacy of the company.