Bernard Madoff's $50 billion Ponzi scheme caught the attention of people all over the country. People know that he did something wrong with a lot of money, but what exactly did he do? What exactly are "Ponzi schemes"? And what are their origins?
At its core, a Ponzi scheme is a fraudulent method of investment, whereby someone takes money from one group of investors and uses it to pay another group of investors; investors are not paid from the profit of the "investment." Initially, however, the mastermind behind the Ponzi scheme has to pay investors out of her or his own pocket to get the scheme running. Ponzi schemes are problematic because they eventually go bust. Ponzi schemes work by luring in investors with large short-term returns on their "investments." So, to keep a Ponzi scheme going, the mastermind needs a constantly increasing revenue stream, and to get such a constantly increasing revenue stream usually involves getting more people into the scheme. As the scheme keeps expanding, involving more and more people, someone is likely to catch on and report the Ponzi scheme to the authorities. As a result, Ponzi schemes usually are caught by the authorities before they explode.
In general, however, Ponzi schemes can usually end in one of three ways:
1. the Ponzi scheme gets to big for its own good; as some investors ask for their money and it becomes difficult to pay them, other investors worry and also attempt to get their money. But there is not enough money, and the Ponzi scheme is exposed.
2. the authorities catch on to the Ponzi scheme, possibly because someone reports suspicious activity or because the authorities themselves see something suspicious
3. the mastermind behind the Ponzi scheme runs away and vanishes with the money
When exactly Ponzi schemes originated is unclear. They became famous, though, in the United States at least, in the 1920s because of an Italian immigrant named Charles Ponzi. He lured over 40,000 people to "invest" over $15 million with him. He promised them that if they kept their money with him for 45 days, then they would get a 50% return. If they kept their money with him for 90 days, they would get a 100% return. Eventually, within two years, when Ponzi was caught, investors received a little over $5 million back--37 cents for every dollar, to be exact.
Ponzi schemes are very alluring to investors who take part in them, but they can have serious consequences. For more information on Ponzi schemes, contact the Milwaukee fraud defense attorneys of Kohler & Hart, LLP. Visit their website at www.kohlerandhart.com.
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