Tuesday, December 13, 2011

Ponzi Scam is illegal but all Financial Institutions run with the same Model

The recent media reports stated that the Ponzi scam hit the 12 districts, the majority of which are the eastern Dzongkhags. The online internet scam has swindled 539 people of their hard earned Nu. 7.1 million. The scam was able to find victims even in the farmers who hardly understood the mechanism of internet. Scam was able to victimized huge numbers of people in the world, banking on unlimited human desire.  
The Ponzi scam was first started as Ponzi scheme by an Italian-American Carlo ‘Charlie’ Ponzi in 1920s. During that time, the world postal offices used to issue the International Reply Coupon that could be exchanged for postal stamps throughout the postal members of the world.
Ponzi who didn’t really have clean criminal record had an idea that could change the business of the world forever. He probably thought, ‘what if I buy the coupon at the lower prices from one country and sell it at higher prices in some other countries?’  Ponzi bought little over US$ 100 worth of the International Reply Coupon.  With these he started the Securities Exchange Company with the promissory note that the money would be return in full with 50% interests within 90 days. Unbelievable.

Sue to initial returns, the erstwhile cautious customers threw caution to the wind. The investors grew by millions. He was even able to own the bank, The Hanover Trust Company. Many started hailing him as financial genius or the Great Ponzi.
How did it work?
The scheme mechanism could be called as robbing Dorji to pay Ugyen. He took the money from Dorji. With this money, he paid yesterday’s investor Ugyen. Tomorrow, he would pay Dorji with Tenzin’s money.
Let’s say yesterday, Ugyen was the first investor. With lucrative and unbelievable return, he would persuade others to invest. With the increasing numbers of current investors, there was no dearth of return for preceding investors.
How came the returns stopped dead? Everything has to reach the saturation point. At the beginning, the numbers of preceding investors became more and more while the current investors and future investors became less and less which meant Ponzi had to pay the investors but there were no future investors from which he could pay the senior investor. His scheme crashed and became scam.  In 1941, he died broke and alone.
Legacy of Ponzi Scam
The legacy of  Ponzi is visible everywhere throughout the world both as legal and illegal business.   In Bhutan, there are many legalized ponzi schemes in banking, Insurance, lotteries and the bonds. You put your money in the bank at 6% interest. The same money is loaned at around 12% interests to some other people. The bank made profit of 6% from your deposited money. Imagine a situation, where there are fewer clients who take the loans. The money you have deposited will already be used for paying CEOs and Employees. There will be no money in the bank treasury as some of us might be expecting. Thus, the money will stop flowing to you when there is no money flowing to the bank.
The insurance company also used the same tactics. Have you ever wonder how they paid you for your damaged car?  Your money paid as the insurance would be already used for salaries and CEO’s fat cheque. You are paid from the money paid by the clients who came to invest after you. These types of businesses run on the assumption that there will be larger number of people who are insuring than those who are claiming the insurance.
These are two examples of legalized Ponzi Scam. As long as there is no burst, it will be known as business scheme.

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