Barry Baxter, Contributor
Warren Buffet is the most successful money manager in recorded history. In January 1990, one share of his Berkshire Hathaway fund cost US $8,350. Today, it is worth about US $137,000. This works out to an average return rate of about 17 per cent per year. No one else has ever produced such large returns for so long.
A return of 10 per cent per month works out to 314 per cent a year. This is over 18 times Warren Buffet’s historical average. A sporting equivalent to this would be scoring 18 times as many goals as Pele.
Ponzi Pyramid Schemes
Here are word-for-word excerpts from two Wikipedia articles. Nothing has been changed or added. (http://en.wikipedia.org/wiki/Pyramid_scheme) (http://en. wikipedia. org/wiki/Ponzi_scheme # What_is_and _is_ not_ a_ Ponzi_scheme)
“A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, usually without any product or service being delivered.
Pyramid schemes are illegal in many countries, including the United States, Great Britain, Malaysia, Norway, Australia and New Zealand.”
“A Ponzi scheme usually offers abnormally high short-term returns in order to entice new investors. The high returns that a Ponzi scheme advertises (and pays) require an ever-increasing flow of money from investors in order to keep the scheme going.
“The system is doomed to collapse because there are little or no underlying earnings from the money received by the promoter. However, the scheme is often interrupted by legal authorities before it collapses because a Ponzi scheme is suspected and/or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases.
“The scheme is named after Charles Ponzi, who became notorious for using the technique [in 1920]. Today’s schemes are often considerably more sophisticated than Ponzi’s the underlying formula is quite similar and the principle behind every Ponzi scheme is to exploit lapses in judgement arising from investor naivety.
“An advertisement is placed promising extraordinary returns on an investment – for example 20 per cent for a 30-day contract. The precise mechanism for this incredible return can be attributed to anything that sounds good but is not specific: ‘global currency arbitrage’, ‘hedge futures trading’, ‘high-yield investment pro-grammes’, ‘offshore investment’, or something similar.
“With no proven track record for the investors, only a few investors are tempted, usually for smaller sums. Sure enough, 30 days later, the investor receives the original capital plus the 20 per cent return. At this point, the investor will have more incentive to put in additional money, and, as word begins to spread, other investors grab the ‘opportunity’ to participate. More and more people invest, and see their investments return the promised large returns.
“The reality of the scheme is that the ‘return’ to the initial investors is being paid out of the new, incoming investment money, not out of profits. There is no ‘global currency arbitrage’, ‘hedge futures trading’, or ‘high-yield investment programme’ actually taking place. Instead, when investor D puts in money, that money becomes available to pay out ‘profits’ to investors A, B, and C. When investors X, Y, and Z put in money, that money is available to pay ‘profits’ to investors A through W.
“One reason that the scheme initially works so well is that early investors – those who actually got paid the large returns – quite commonly reinvest (keep) their money in the scheme (it does, after all, pay out much better than an investment). Thus, those running the scheme do not actually have to pay out very much (net) – they simply have to send statements to investors that show how much the investors have earned by keeping the money in what looks like a great place to get a high return. They also try to minimise withdrawals by offering new plans to investors, often where money is frozen for a longer period of time, for example 50 per cent return per month for one year. They then get new cash flows as investors are told they could not transfer money from the first plan to the second.
“The catch is that at some point one of three things will happen: 1) the promoters will vanish, taking all the investment money (less payouts) with them; 2) the scheme will collapse of its own weight, as investment slows and the promoters start having problems paying out the promised returns (and when they start having problems, the word spreads, and more people start asking for their money, similar to a bank run); 3) the scheme is exposed because when legal authorities begin examining accounting records of the so-called enterprise, they find that much of the ‘assets’ that should exist, do not.”
ALBANIA
Here are word-for-word excerpts from The Rise and Fall of Albania’s Pyramid Schemes by the IMF’s Christopher Jarvis. Nothing has been changed or added. (http://www.imf.org/external/pubs/ft/fandd/2000/03/jarvis.htm)
“During 1996-97, Albania was convulsed by the dramatic rise and collapse of several huge financial pyramid schemes. At their peak, the nominal value of the pyramid schemes’ liabilities amounted to almost half of the country’s GDP, about two-thirds of the population-invested in them. When the schemes collapsed, there was uncontained rioting, the Government fell, and the country descended into anarchy and a near civil war in which some 2,000 people were killed.
“[Other countries] can learn from the way the Albanian authorities handled – and mishandled – the crisis. When pyramid schemes emerge, they should be dealt with swiftly and firmly. Companies believed to be operating pyramid schemes should be investigated. By definition, the liabilities of pyramid schemes exceed their assets, and the schemes fund payments to investors out of new investment inflows. To determine whether a company is operating a pyramid scheme, it is necessary to find out if it has real investments and if these investments are likely to be sufficient to cover its liabilities. The investigation can be conducted by the police, a government ministry, or the central bank.
“The key point is that the investigators should be able to recognise financial fraud and also to assess the value of company assets. If such expertise does not exist in the country, then the investigation can be conducted by outsiders; the IMF and the World Bank should be prepared to help governments find qualified outsiders, if necessary, either from other governments or from large international accounting firms with expertise in this area.
greater losses
“The investigation should be swift. If a company is found to be operating a pyramid scheme, it should be closed immediately. Allowing schemes to continue will result only in more inflows of deposits and greater losses. Governments can close these companies for a variety of legal reasons: the companies may be taking unlicensed deposits or operating businesses without licences; they may be evading taxes; or they may be liable for prosecution for straightforward fraud.
Once an investigation of a pyramid scheme has begun, the operators will try to steal as much of the assets as possible before the truth comes out. This cannot be entirely prevented, but freezing any assets held in the formal financial sector and seizing other assets that can be easily disposed of may save depositors a great deal of money.
“Once a scheme is closed, all assets should be seized and turned over to administrators. Legislation may be needed to void contracts made by the companies in the last several months (to prevent theft by transfer to associated parties) to give administrators full control over the assets of the companies and protect them from legal challenges.
The Government should make it clear from the outset that it will not compensate depositors for their losses. If this is not done, the fiscal costs are likely to be ruinous, and the moral hazard considerable.”
