Ponzi Schemes and Social Security

The latest scandal on Wall Street involves an investment pyramid scheme that evidently has bilked investors out of billions of dollars. The bad guy, so far as we can tell, is a fellow named Bernard Madoff, who may well go down as the greatest financial swindler in history. His phony investment fund, which peaked in value at about $50 billion, has now (as was inevitable) gone bankrupt.

So what exactly is a “Ponzi Scheme?” Every twenty years or so, Ponzi Schemes seem to crop up out of nowhere. The usual scenario is someone at work coming up to you and telling you that, if you invest a hundred bucks today, you’ll “earn” two hundred bucks back in (let’s say) a month. How, an honest person might ask, can you expect to double your money in just thirty days?

Don’t worry, the fellow at work tells you. The money goes into an “investment fund.” You are curious.

“What gets invested in?” you ask.

“Nothing,” he answers. “We just grow the fund by getting new investors. You get paid out of the new funds. Then the next fellow gets paid by the next new investor. And so on and so on.”

Being an honest person, you decline the offer, of course. You realize, as a reasonably intelligent person, that eventually the fund has got to run out of “investors.” Then, the whole pyramid will come crashing down.

Those who were first in on the pyramid scheme make lots of free money. Those who get in last, lose everything.

Such schemes are, of course illegal. There is one exception, though: it’s not illegal when the government does it.

When the government does Ponzi Schemes, it calls it “Social Security.” In this racket, people are forced to pay into a supposed “investment” in which their retirement funds are paid out of funds collected from new, incoming taxpayers.

The geniuses who invented this Ponzi Scheme figured it would never have to collapse, because the government could use force to get new “investors,” while private Ponzi Schemes had to use guile and persuasion.

And, just as in all pyramid schemes, the first ones in make out like bandits. The last ones lose their shirts. The well-documented first recipient of Social Security, one Ida M. Fuller, contributed a grand total of $24.75 into the scheme. She lived a hundred years, collecting $23,000 for her “investment” of $24.75.

“You see?” the government bandits said. “The system works! Ida M. Fuller’s return on investment was astronomical!”

And so it was. See http://en.wikipedia.org/wiki/Ida_May_Fuller

But, Ponzi schemes eventually run out of suckers. With government force behind its particular scheme, though, new suckers are created all the time. The problem is, the pool of those collecting funds will continue to grow against the pool of those paying in. Ah, but the government can solve this problem by raising Social Security taxes. So today, we have a system in which the government simply extracts money from working folks, then turns a portion of it over to retirees, minus overhead expenses. If the Ponzi scheme runs out of money, government can arbitrarily change the rules, by raising the retirement age and hoping more people die before they ever collect a penny.

If you tried to set up such a system, in the marketplace, you would properly be hauled off to jail, just like Bernard Madoff. But when government does the same thing, it’s all fine and dandy.

The suckers, today, are the ones who work their entire lives, and die just after retirement. They pay untold thousands into the pyramid scheme, and collect almost nothing. A few live long enough to break even. And a few even manage to make money on the Ponzi scheme, if they live long enough.

Amazingly, there is no popular uprising against this fantastic swindle. Quite the contrary; the Social Security Ponzi scheme remains an “untouchable”, popular program. The propaganda behind it has been stunningly effective.

Imagine if you could invest the same amount that is stolen from you every month via the Social Security Ponzi scheme, in some form of actual, legitimate retirement fund. Even if you died the day after you retired, you would at least leave a nice nest egg to your children to help them get a good start in life. With Social Security, there is no “nest egg.” You lose every penny.

As always, private swindles are morally far superior to government swindles, because nature itself limits the damage. Bernard Madoff managed to swindle fifty billion bucks–about the budget of a moderate-sized government agency. Then, the inevitable happened, and the scheme collapsed. Social Security, by contrast, swindled over ten times as much–$550 billion–just in the single year 2006 ( http://en.wikipedia.org/wiki/Social_Security_debate_(United_States) ) But, by using force, the US government can keep the swindle alive until we all go bankrupt together.

(See also an excellent recent column by Lew Rockwell at http://www.lewrockwell.com/rockwell/madoff-metaphor.html ) As Rockwell explains, the Madoff phenomenon is simply an expected result of our inflated, phony money, bubble-based economy.

Update 12/22/2004. It strikes me that the old saying, “you can’t cheat an honest man” applies to the sorry tale of Mr. Madoff. If the guy telling you to invest in a Ponzi Scheme at work faces an honest man, he has to say how those fantastic profits actually happen. But the honest man realizes instantly that you can’t go on forever recruiting suckers to prop up your scheme. So he refuses.

The problem with Social Security is–you have no right to refuse! So the phony bubble of a phony “investment” can go on and on and on, until it eventually threatens to bankrupt the entire country.