I’ve received a lot of feedback—maybe “blowback” is a better term—from comments I made on the Dec. 17, 2008 edition of Mad Money. On the show I compared the Bernie Madoff scam to another Ponzi scheme taking place on a much larger stage—Social Security.
It was a pretty controversial statement and it deserves some context. Before I get into all of that, let’s define a Ponzi scheme. According to the Securities and Exchange Commission, it goes something like this:
'Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. Ponzi thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons.
' Ponzi told investors that he could provide a 40% return in just 90 days compared with 5% for bank savings accounts. Ponzi was deluged with funds from investors, taking in $1 million during one three—hour period—and this was 1921! Though a few early investors were paid off to make the scheme look legitimate, an investigation found that Ponzi had only purchased about $30 worth of the international mail coupons.
'Decades later, the Ponzi scheme continues to work on the "rob-Peter-to-pay-Paul" principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses.'
Remind you of anyone? Like Madoff’s investors, Social Security’s balance sheet is basically off the books, and Congress, playing the Madoff role, is using the Social Security fund as an ATM to fund pet projects, pay for earmarks, and cash in on boondoggles. And like Madoff, the last in will be among the first out of luck with Social Security. With more recipients and fewer contributors, Social Security is a Ponzi scheme that is headed for the same fate that has leveled Madoff investors. The Social Security’s own 2007 trustee’s report says that the fund could run out of money by 2042, and maybe sooner.
Here’s what I said in the show: “We know the truth about Ponzi schemes. We all know the name of the biggest Ponzi scheme in history and it’s not even illegal. In fact, it is run by the U.S. government. And the name of it – well, they call it Social Security.
“In a Ponzi scheme, investors get the returns from the money paid in by subsequent investors and eventually the whole thing falls apart. The last people to invest get hosed. In Social Security, a program I love, workers pay for the benefits of current retirees and hope someday future workers will pay for their benefits – it’s all a Ponzi scheme.”
These were not hasty comments. I’ve been doing a lot of reading up on Social Security lately, especially after the Madoff scandal hit the street, and I’m more convinced than ever that the two funds have more in common than not.
Particularly useful is Cliff Mason’s Millennial blog on CNBC.com. Full disclosure, Cliff is my nephew, but we disagree on a lot of things, just not this one. Like Cliff, I am not in favor of privatizing Social Security, nor do I think that Social Security will “go bust,” as he puts it.
But the similarities between what Madoff and Social Security have done are substantial. As pointed out by Cliff Mason, like Madoff, Social Security:
- Depends on new investors to pay the investment returns of older investors.
- Led investors to believe the system was working perfectly, when the opposite was true.
- Installed a system where investment returns are, by and large, off the books.
- Saw its foundation begin to crumble when the amount of old investors vastly exceeded the number of new investors.
I don’t think that the government intentionally set out to exploit Americans through Social Security. A lot has changed since it was enacted under Franklin Delano Roosevelt back in 1935 as part of his “New Deal”. Back then, the average life span was only 67 years-old, so when contributors reached 65-years-old, the age when they could begin receiving benefits, most only cashed government checks for a few years.
That’s not so today, as Americans are living longer and are cashing Social Security checks more often and in greater numbers than FDR might have imagined. We could fix Social Security by implementing a “means-testing” policy where people, mostly rich people, who didn’t need the money would leave it in the Social Security fund for the less affluent. And we could delay the age at which Americans can collect Social Security – perhaps to age 70 or so. Sure, these moves wouldn’t eliminate the Ponzi aspect to Social Security, but they’d do a world of good.
Even so, an investment “fund” like Social Security that cannot survive if investors want their money back is a foreign and dangerous concept to a traditional Wall Street guy like me. In my experience, if an investor wanted out of my fund, he could sell and get out.
Ponzi schemes aren’t built to accommodate people who want their money back – they’re built to take advantage of people who want their money back.
Way back when, Ponzi’s investors learned that lesson. Only time will tell what kind of lesson Social Security contributors will learn.
At the rate we’re going, it could be a painful one.