The "Ponzi"
A Ponzi scheme is a fraudulent investment operation that pays returns to investors out of the money paid by subsequent investors rather than from profit. The term "Ponzi scheme" is used primarily in the United States, while other English-speaking countries do not distinguish colloquially between this scheme and other pyramid schemes.
The Ponzi scheme usually offers abnormally high short-term returns in order to entice new investors. The perpetuation of the high returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors in order to keep the scheme going.
The system is destined to collapse because the earnings, if any, are less than the payments. Usually, the scheme is interrupted by legal authorities before it collapses because a Ponzi scheme is suspected or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases.
The scheme is named after Charles Ponzi, who became notorious for using the technique after emigrating from Italy to the United States in 1903. Ponzi did not invent the scheme, but his operation took in so much money that it was the first to become known throughout the United States. His original scheme was in theory based on arbitraging international reply coupons for postage stamps, but soon diverted investors' money to support payments to earlier investors and Ponzi's personal wealth.
Knowingly entering a Ponzi scheme can be rational, in the economic sense, even at the last round of the scheme if a government will likely bail out those participating in the Ponzi scheme.
Bernard Madoff Scandal:
On December 11, 2008, former chairman of the NASDAQ Stock Market Bernard Madoff was arrested and charged with a single count of securities fraud, but one which, if proved, may rank among the biggest frauds ever - totaling $50 billion of fraudulent losses. If these figures are accurate, this would be the biggest Ponzi scheme in history.[4] It is alleged that one of Madoff's biggest investors, René-Thierry Magon de la Villehuchet, of Access International Advisors, committed suicide around December 23, 2008, following the disclosure of the scheme.[5] At the time of this writing, it is unclear to what extent Access International's funds were involved in the scheme. Villehuchet is alleged to have lost as much as $1.4 billion in Madoff's scheme.[6]
While the scheme was typical of a Ponzi in its structure, it differed in its pace and its marketing. Rather than offer (suspiciously) high returns to all comers, Madoff instead offered modest, but steady returns to an exclusive clientele, returns produced in both up and down markets. The investment method was stated to be through a combination of stock purchases tracking some index and related puts and calls (contrary "bets" on the index's direction), but with the exact details a proprietary secret. Madoff exploited social networks to promote it among a largely upper class Jewish clientele, with significant funds invested from educational and social charity funds directed by the clients. The slow pace and "insider" marketing enabled the scheme to survive for an unusually long time and also to grow far larger than would be expected of a common Ponzi. All worked well for Madoff until the general market downturn of 2008 motivated a larger than usual number of investors to cash out their positions. With little actual liquidity, the scheme collapsed. In fact, the stated methodology was not possible, since the existing markets in puts and calls were not large enough to support the claimed activities, an observation noted by several critics prior to the collapse.[7] The scheme also differed in that even some hedge funds invested in Madoff's funds, with some investors unknowingly exposed through multiple fund investments that they believed to be diversified.
Source: http://en.wikipedia.org/wiki/Ponzi_scheme
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