Bernard Madoff appears to have operated a Ponzi scheme, in which money from new investors was used to pay off those who got in earlier. But there are other, perfectly legitimate financial endeavors that share this same basic model.
The most obvious is Social Security (and James Pethokoukis has already nominated Madoff for Social Security Commissioner). Today's taxpayers contribute money that is funneled to today's Social Security recipients, and hope that tomorrow's taxpayers will put in enough money to fund their retirements. Something similar is true of government finance in general: Those who buy Treasury securities and municipal bonds do so on the assumption that future taxpayers (and bond investors) will keep pouring in enough money to allow governments to make good on their commitments.
This applies not just to government finance. Wall Street too depends on a continual stream of new investors appearing on the scene to take securities off the hands of today's investors. And when everybody tries to take their money back at once, the system stops functioning—as we've seen over the past few months.
So what's the difference between these widely accepted arrangements and the reviled Ponzi scheme? Well, one is that the government can compel future taxpayers to contribute more if things aren't working out so well—which has happened repeatedly with Social Security. But there are limits to this approach. Raise taxes high enough and either the economy suffers or taxpayers find ways to avoid paying—or both.
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