Wharton MBA for Executives

Bernard Madoff is making headlines because he is the most recent NY investor to get caught pulling a ponzi scheme.  Some estimates say that his losses are estimated at $50 billion.  That’s right, 50 BILLION dollars, not million.  That’s a lot of money.  Eventually, he ran out of investors and got caught when people tried to get their money back.

For the uninitated, a ponzi scheme is basically a scheme where you take money from investors, and pay the early investors with money that you get from the later investor.  So who pays the later investors?  Well, even more later investor.  Who pays those guys?  Well, you get the point…nobody.  The guys at the end get screwed.

But really, ponzi schemes are not really anything new.  In fact, ponzi schemes are everywhere.

In one of our last macroeconomics classes, for the current policy topic we talked about Social Security.  I was going to talk to Professor Abel over lunch or something but just didn’t really get around to it.  We (the people who work now) pay into social security and that money is invested and used to pay the retired people who are no longer working.  In theory, when I retire there will be people working and paying social security and that money will be used to pay me.  Of course this requires that the population always stays constant or grows but never has significant decreases because if the population goes down, there simply won’t be enough people paying social security to pay the retired folks.  You also need a relatively stable remaining life expectacty after 65.  If we all started living for 200 years, a guy would get social security for the next 140 years and that wouldn’t work either.

Social security is one of the biggest ponzi schemes around.  We had the baby boomers so the population increased significantly and afterwards, the population growth slowed down.  When the baby boomers retire over the upcoming years, it will put a lot of strain on the social security system because not enough of us will be working to support all those retired folks.  In addition, when social security was first started in 1936 (during FDR’s presidency), the remaining life expectancy of a person who lives to age 65 was shorter than it is today.

In fact, if you look at average remaining life expectancy for those surviving to age 65 in 1940 it was 12.7 years (male) and 14.7 years (female).  in 1990 this is 15.3 (male) and 19.6 (female).  But the more alarming number is in the number of Americans age 65 or older.  In 1880 it was only 1.7 million.  in 1930 it was 6.7 million.  In 1940 it was 9.0 million.  In 2000 it is a whopping 34.9 million.  That’s a lot of people to support.

So it is clear that Social Security is not much different from a plain old ponzi scheme where you take money from one group to pay the former group.  The winners in social security are those who were retired back in 1936 because they got paid social security benefits but never put money into the system.  The losers are going to be whenever the system is cancelled or modified in a major way.  For example, if we were to stop it today, those who are retired are the big losers (they paid SS their whole lives but don’t see any of it now) and those who have been working are also losers (I will never see what I’ve paid into the system for the past 12 years).

But if you read 3 paragraphs above, I wrote that social security is “one of” the biggest ponzi schemes around.  What’s the biggest?  The US treasury.  Our national debt is around $10 trillion.  I barely even know what “trillion” means because it’s like a joke…like the word “kazillion” or something like that.  We just keep borrowing more and more money from China, Japan, etc.  The government takes their money, pays back returns on treasury bonds using that money that they borrowed, etc.  Does anyone actually think that we are ever planning to pay back $10 trillion?  Professor Abel mentioned that it’s really not that much money in terms of percentages and as usual, he’s right.  Many people own homes that cost $1 million and put 20% down and borrowed $800k.  These people probably don’t make $800k/year…in fact many of them probably make around $100k/year so they have debt of 8X their annual wage.  The $10 trillion is nothing like that.  The US government probably got around $2.66 trillion from taxes, etc. in 2008.  The budget is around $2.9 trillion.  And our debt is $10 trillion.  So compared to the guy who owns the $1m house, it’s nothing near that.  In fact, the national debt can go up a lot more before we really hit crisis territory.

Regardless, the US treasury debt is huge and will stay huge.  Sure there might be a few years where we have a budget surplus.  The only way to really do that is someone comes into office, raises everyone’s taxes, and lowers spending…but that sounds like a recipe to become unpopular really quick.  Let’s see…I’m going to raise your taxes and then I’m going to cut spending so people will be out of jobs (government employees, people who are indirectly supported by the government (e.g. defense industry), etc.).  Doesn’t sound like the makings of a popular guysi.

Anyway, ponzi schemes are everywhere.