Tag Archives: Inception

Ponzi inception

In the movie "Inception," Leonardo di Caprio led a gang of mind-soldiers who, with the help of explosions, torture, and snowmobiles, planted ideas in people's heads.  IRL, in real life for the uninitiated, those people are pundits, who repeat stuff that's nuts, in hopes it will catch people unawares and find fertile ground in the public consciousness. 

Among the many examples of this sort of dishonest activity is the claim that Social Security is a "Ponzi scheme."  For those who haven't paid attention, the argument goes something like this.  Way back, a guy named Ponzi claimed to have an investment fund that paid rich dividends.  It sort of did, but it wasn't an investment fund.  He took money from new investors to pay off the old one, all the while not actually investing anyone's money. 

By contrast, Social Security is a "pay as you go" plan.  People working now pay for the people retired now.  This has led people to claim that it is a "Ponzi scheme."  Such a claim is obviously ludicrous.  Two obvious reasons.  First, the Ponzi scheme was a swindle perpetrated on investors by Ponzi, not a transparent system of social insurance and retirement; second, the Ponzi scheme was illegal, and not the purposefully-designed plan of a duly-elected representative body. 

These two key differences (explained here with lots of references) escape the subtle mind of Charles Krauthammer, who redefines, or tries to redefine, the illegality and fraud out of the phrase "Ponzi Scheme." 

The Great Social Security Debate, Proposition 1: Of course it's a Ponzi scheme.

In a Ponzi scheme, the people who invest early get their money out with dividends. But these dividends don't come from any profitable or productive activity — they consist entirely of money paid in by later participants.

This cannot go on forever because at some point there just aren't enough new investors to support the earlier entrants. Word gets around that there are no profits, just money transferred from new to old. The merry-go-round stops, the scheme collapses and the remaining investors lose everything.

Now Social Security is a pay-as-you-go program. A current beneficiary isn't receiving the money she paid in years ago. That money is gone. It went to her parents' Social Security check. The money in her check is coming from her son's FICA tax today — i.e., her "investment" was paid out years ago to earlier entrants in the system and her current benefits are coming from the "investment" of the new entrants into the system. "Pay-as-you-go" is the definition of a Ponzi scheme.

So what's the difference? Ponzi schemes are illegal, suggested one of my colleagues on "Inside Washington."

But this is perfectly irrelevant. Imagine that Charles Ponzi had lived not in Boston but in the lesser parts of Papua New Guinea, where the securities and fraud laws were, shall we say, less developed. He runs his same scheme among the locals — give me ("invest") one goat today, I'll give ("return") you two after six full moons — but escapes any legal sanction. Is his legal enterprise any less a Ponzi scheme? Of course not.

So what is the difference?

It's the fraud, of which illegality is a consequence, that makes something a "Ponzi scheme."  A Ponzi scheme and Social Security may involve some of the same methods, but so does check fraud–they both involve writing checks.