How to spot a Ponzi scheme and not get suckered in

It was Ambar, my ex, on the line again.

“I have an excellent proposition for you,” he said.

“If you are the proposition, then for the record, I stopped being interested in you a long time back,” I replied.

“Why do you have to be so bitchy, early in the morning?”

“That’s my style!”

“So when do we meet?” he asked, not giving up.

“You don’t give up. Do you? Let’s see, I have sometime free in the evening, after I get out of office and before I meet him for dinner.”
“Oh. So now I have become a time filler. And who’s he?”

“That my dear is none of your concern. I’ll see you at around seven,” I said, disconnecting the call.

“So tell me what is your proposition?” I asked, getting to the point straight away when we met over coffee.

“I have an excellent investment proposition for you,” he explained.

“You will double my money in 90 days?”

“Well something like that.”

“So what’s the plan?”

“I have become a member of this company that runs surveys. By paying a fee of Rs10,000 per year, you will get two surveys to fill per week and for each survey the company will pay you Rs600. So that’s 1,200 per week or Rs62,400 per year, a return of 524% over a period of one year.”

“And how will the company pay me so much money for filling up basic surveys?”

“Arre they have got into alliances with big companies in order to carry out surveys for them,” was his explanation.

“And these companies will pay them for their surveys?”

“Yes, that’s what I have been told.”

“Hmmm. The business model doesn’t sound convincing enough. It looks like a Ponzi scheme to me,” I said.

“A Pozni scheme?

“Not Pozni baba, Ponzi!”

“Now what’s that?”

“Charles Ponzi, an Italian immigrant to the US, launched an investment scheme in August 1919, in the city of Boston, promising to double money in 90 days. At its peak, the scheme had 40,000 investors who had invested around $15 million in the scheme. The scheme collapsed a year later on August 10, 1920, and it was revealed that Ponzi was using money being invested by the new investors to pay off his older investors,” I answered.

“So he did not have a business model?”

“He did. In the process of starting an export magazine, Ponzi realised that a huge opportunity to make a riskless profit existed. Ponzi had made an offer to person in Spain asking him to subscribe to his magazine. That person sent him an international postal reply coupon. This coupon could be exchanged at the local post office for American stamps, which had to be used to on the parcel through which the export magazine would be sent to the subscriber. Ponzi realised that the coupon in Spain cost the equivalent of one cent in American currency. But when he exchanged it at his local post office, he got stamps which were worth six cents. So there was an opportunity to make a riskless profit of 500%, Ponzi thought. Ponzi also realised that this idea worked in the context of other countries as well. He planned an investment scheme around this idea. He would raise money. Convert that money into foreign currency, buy the international postal reply coupons, get them back to America, convert them into American stamps and sell them for a huge profit.”

“Wow. That was some arbitrage opportunity. How did he exploit it?” interrupted Ambar.

“Well a lot of things sound good on paper. But they don’t work in real life. Ponzi had not taken into account the complexity of the whole operation. The problems of dealing with postal organisations all over the world and the problems of converting and transferring currencies to various countries and then getting it back from there.”

“Oh. And I thought it was a brilliant idea!”

“Also, with all the money coming in, Ponzi had started to live extravagantly. After some time the media got involved and on July 26, 1920; the Boston Post ran a story questioning the legitimacy of the scheme. Finally the scheme collapsed on August 10, 1920 and it was revealed that only two stamps were actually purchased and money brought in by the new investors was being used to pay off old investors. The moral of the story is that any Ponzi scheme can keep running only till the money entering the scheme is more than the money leaving the scheme.”

“Now I did not know that.”

“Well darling, you never knew a lot of things. Did you?”

“Hah. You never really forgive me!”

“Okay, let’s not deviate from the topic at hand. Any successful Ponzi scheme seems to have some sort of business model. Ponzi had a business model and so does your so called “survey” company. This ensures that there is some selling point when it comes to getting investors to invest in the scheme. Also, most Ponzi schemes start with a legitimate purpose. Like in your case the company hopes to earn money by doing surveys. The only trouble is no one pays the kind of money that is being promised for carrying out surveys,” I said trying to get back to the point.

“That seems to be true.”

“Most Ponzi schemes start with an apparently legitimate purpose, like carrying out surveys, which is not illegal. But nothing helps a Ponzi scheme more than assuring an investor that his money is safe. And how does a company do that?”

“Well, by returning the investor the money he has invested.”

“It is a little more complicated than that. The company needs to pay off the first lot of investors who have invested the money. These investors in turn become the word of mouth advertisers for the company, like you.”

“Can you explain that in a little more detail?” he asked.

“Let’s take the example of your company. You have invested Rs10,000 and been assured Rs62,400 in return. Now for the ease of calculation let’s assume you have been assured Rs60,000. From the way I look at it your scheme seems totally like a Ponzi scheme. In order to pay you Rs60,000 the company will have to get in at least six investors who invest Rs10,000. This money will then be handed over to you. This does two things. One you have been converted and you are now going around trying to get others to invest in the scheme. And two, the company now has to get at least 36 new investors to pay off the six investors whose money was used to pay your Rs60,000. To pay off the 36 new investors, the company now needs 216 investors. And so the cycle continues. If this scheme continues by the 12th round the company would need around 36.3 crore new investors to pay off the old investors.”

“36 crore...that’s one big number” exclaimed Ambar.

“Yeah, it is. That’s why most Ponzi schemes collapse under their own weight after sometime. All Ponzi schemes are zero sum games, where the money gained by the early investors is equal to the money lost by the latter investors. And the most vulnerable investors are those who come at the end,” I explained, finishing my cup of coffee and getting up to leave.

“Actually, to tell you the truth, I knew all this,” said a rather sheepish Ambar.

“Oh. And you still invested in the scheme?”

“Yes. I did.”

“Why?”

“Ever heard of the greater fool theory?”

“No,” I replied.

“What happens is that at times, investors might understand that what they are getting into is a Ponzi scheme, but they would still be willing to enter the scheme, because they feel that some greater fools could be depended on to enter the scheme after they have and this would give them handsome returns on their investments,” he explained.

“And I was supposed to be one of your greater fools?”

“Hmmm. Yes.”

“Why?” I asked.

“Oh. That would be my revenge of your badla,” he said trying to have the last laugh.

It made me wonder, what happens to boys when they grow up into trying to be “men?”

The writer can be reached at chandniburman@yahoo.com.
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