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December 16th, 2008
11:32 AM ET

Ponzi schemes: the good and the bad

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Justin Fox
Time

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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soundoff (8 Responses)
  1. rod

    He's not in jail? Why doesn't this surprise me. The rich and influential have the deck stacked. Their worst day, quite possibly might be my best. American justice? I'll bet if he grovels and promises the judge he'll never do it again, he walks with probation.

    December 17, 2008 at 9:14 am |
  2. Sharon Wilberding

    Where did Bernard Madoff get the $10,000,00.00 bail money? Is this not the money he stole from investors? I think it is an outrage that he is not in jail. If he has this kind of money, why hasn't it been confiscated?

    Louisville, Ky

    December 16, 2008 at 5:57 pm |
  3. Michael

    This guy is a crook and shoud'nt be treated any different becouse of his wealth not for long I hope

    December 16, 2008 at 5:09 pm |
  4. Sharon Kitchen

    As I read this it occured to me that Mr. Madoff,being 70 years old,has been at this a long time........................................how long will the list be of those he will bring down?
    How many and in what fields?
    How does he explain his actions?
    To whom is he accountable too?
    Will he ever see jail time?
    What will his cost be?
    Does he know by face all those people he will have ruined?
    Does he even care?
    Where will it all stop?

    December 16, 2008 at 4:17 pm |
  5. Annie Kate

    Its amazing how one man's greed can negatively affect so many people who are seemingly unconnected with what that man did. I hope Madoff goes to prison for a very long time. @Sheri – I hope your husband finds another job quickly. I know its hard when you are so specialized but I will be thinking of you and your family and hoping for the best. I've been where you are now several times and I understand how very hard it is.

    Annie Kate
    Birmingham AL

    December 16, 2008 at 3:57 pm |
  6. JC- Los Angeles

    Yet another morally bankrupt executive behaving like a modern day robber baron; and we have problems with the pirates off the Somali coast?

    December 16, 2008 at 1:24 pm |
  7. Sheri Carle

    The ramifications of Madoffs scheme reaches far beyond Wall Street , or investing.

    My husband Jeff is a former thoroughbred jockey, who is exercising race horses at Stone Bridge Farm.
    Stone Bridge's owner is Jeff Tucker of Fairfield Greenwich .
    Mr Tucker has been hard hit , personally as well in his company. and investors.
    My heart goes out to Mr. Tucker..he truly is a compassionate and caring man...and must feel a huge burden because of the people this has affected , through his business's.

    Because of the financial hit that Mr Tucker took due to this scam ,My husband Jeff Carle was told today that he has 3 weeks left on the payroll at Stone Bridge Farm, here in the Saratoga NY area.

    We will loose our health insurance , and the income that he brings in to pay our mortgage.

    Stone Bridge Farm is a large facility here in the upstate area, and there are many people employed here who are going to be scrambling , and out of a job, just like we will be.

    What my husband does for work is so specialized , and in this area especially in the winter , there isn't a whole lot of opportunity available!

    Madoff's GREED is unimaginable..there are going to be many more stories of countless numbers of families affected by this scam.

    December 16, 2008 at 1:22 pm |
  8. Mary V., Salt Lake City, UT

    BERNARD MADOFF SHOULD BE INCARCERATED FOR LIFE!

    December 16, 2008 at 12:52 pm |