What’s a Ponzi Scheme?

03Oct10

Also known as a pyramid scheme.   This is what happens when a group of people give money to the person at the top of the pyramid and each get six more people involved and move the names up a row.  It continues on and on, money given to the name at the top of the list and incorporating more people at the bottom.  It works great and the people at the top get paid, except eventually and quite quickly (in only about 13 iterations) we run out of people to include.  So the people not at the top of the pyramid have paid in, but never get paid.  It’s all because there aren’t enough people remaining to pay into the system to support those at the top of the pyramid.

Does this sound at all familiar?  Well, this sort of a program would work great if you live in a country where the population is always growing at a consistent rate, and people are retiring and dying at a consistent rate.  But what happens when one generation is larger than those behind it?  What happens when generations live longer than others?  Answer, you run out of money.  When you have more people receiving money from the system than you have paying in, you have reached the end of the scheme, and the payers are left with nothing to show for their contributions.

Sound familiar yet?  Does this sound anything like the US Social Security system?  The “baby boomer” generation has begun to retire, and this generation is bigger than the next “Generation X“.  In addition, the life expectancy for Americans keeps increasing, now into the 80s.   So we’ll be paying these baby boomers for the next 20-30 years with fewer payers into the system than ever.  And making matters worse, our politicians have seen the Social Security fund as their own “rainy day piggy bank”.  They use it to fund other programs, with promises to pay it back.  Similar to the pension funds in RI.  The payback never happens and the fund ends up with massive liabilities.

Recently, candidate for Congress, John Loughlin referred to the Social Security program as a Ponzi scheme.  His opponent, David Cicilline disagrees and doesn’t see the comparison.  Apparently Cicilline thinks the program is fine and is being managed properly.  I guess that’s understandable, seeing as badly as Social Security is being run, it’s still better off than the city of Providence under the Cicilline administration.  So I guess it’s just a matter of perspective.

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