In a Ponzi scheme, like the one Bernard Madoff is reported to have orchestrated, new investors are brought in to pay back the old investors. There’s never any actual investment; the debt just rolls over.
This means that the scheme requires an endless supply of new investors. The schemer’s debt gets exponentially bigger as time goes on, and there’s no way to end the ploy. Unlike other crimes — murder, rape, jaywalking — this one requires a lifetime commitment, not just an afterlifetime commitment. You can’t just say you’re done, bury the evidence and move on. Ponzi schemes are self-perpetuating, and by their very nature, there is no such thing as “done.” Unless, of course, you go to jail. Or die.
[B]ig Ponzi schemes are almost always based on exploiting the trust of a tightly knit social network. The victims are usually members of ethnic communities, elite country clubs, churches or other social hubs where people are unlikely to do their due diligence because they trust their friend, family member, clubmate or neighbor, and have seen others in the same social circle get rich through the proposed “investment opportunity.” In Mr. Madoff’s case, for example, the victims appear to be primarily rich Jewish investors, whom he met through elite groups like the Palm Beach Country Club. The Foundation for New Era Philanthropy, a notorious Philadelphia-area Ponzi scheme, preyed on Christian religious organizations and charities.
2) Turn (or return) the business into something legitimate. Unlike the schemers in #1, these Ponzi architects likely started out with some hope for legitimacy. They wanted seed money to kick off some brilliant investment idea. But then the “brilliant” idea falls through. They are then in the position of having to pay off initial investors. Rather than declare failure, they recruit new investors to pay off the old ones.
They may be stuck in a rut, but they have confidence (or perhaps, self-delusion) that they’re so clever that they’ll come up with another, better idea and strike it rich that way.
This was more or less Charles Ponzi’s strategy.
“He truly thought he could eventually turn around and go legitimate,” Mr. Zuckoff said.
As in Ponzi’s case, this exit strategy pretty much always fails because the schemers are looking for the big scalp — and there’s never an investment profitable enough to fill that deepening pocket of debt.
There is more overlap than the simple categories I’ve laid out here would imply; Mr. Ponzi, for example, had other run-ins with the law involving financial dishonesty, so it’s not as if he was exactly hell-bent on legitimacy.
It’s also hard to say, based on the limited information available, where within this array of strategies Mr. Madoff fell. He probably was banking on exit strategy #2, the turn (or return) to legitimacy.
Most Ponzi schemes last a year at most, experts say. (Charles Ponzi’s lasted just nine months.) This indicates that Mr. Madoff, who had been investing clients’ funds since at least 1960, probably started out legitimate or semi-legitimate.
“I don’t know the ins and outs of what happened here,” said Stephen P. Zeldes, a professor of finance and economics at Columbia Business School. “He may have initially had a few bad years, or a few bad quarters, and not wanted to tell that to investors,” Mr. Zeldes said. “Maybe he then pretended that returns were better than they were, thinking he could make it up some future years. Maybe he was thinking he could gamble a bit, get a good return, and no one would ever know.”
In other words, Ponzi schemers don’t necessarily start out as such, and as sophisticated as they are, they may not consciously accept the fact that they’re engaging in a Ponzi scheme. They fool themselves into thinking that the Ponzi scheme is merely a stop-gap measure to hide their losses until they (theoretically) come up with something brilliant.
“I don’t think he originally started thinking he was going to scam his investors,” says Utpal Bhattacharya, a finance professor at the Kelley School of Business at Indiana University who studies financial crime. “His original motive was probably to hide his losses.”
I agree with the professor – Madoff just couldn’t bear to give up those front-of-the-restaurant tables reserved especially for him, the hushed whispers when he strolled into the golf club locker room, the genuinely successful people begging him to take their money and rip them off. So he never confessed until everything came down around his ears. And the ears of everyone he must once have loved, perhaps.
For What It's Worth 