Day #351: What is a Ponzi Scheme?

I just read an interesting article that addressed the question of whether or not the U.S. Social Security system is simply an elaborate Ponzi scheme.  It’s an interesting proposition if you think about it.  You see, a Ponzi scheme (named after Charles Ponzi, a notorious scam artist in the early 1920s) is a fraudulent investment operation that pays off early investors using the investments from subsequent investors as opposed to true profits.  Because of this payoff mechanism, the schemes are only viable as long as new investors can be brought into the operation and the fraud is undetected.

What about Social Security?

The suggestion in the article was that the cash flow makeup of a Ponzi scheme is frighteningly similar to that of Social Security.  Retirees’ benefit payments are made based on the contributions of younger workers.  In fact, one of the main reasons why the Social Security system is in so much turmoil today is because of its top-heaviness.  That is, due to the ‘baby boom’ of the late 50s and early 60s, new workers are not replacing retirees in the Social Security system at a rate that will keep the system viable in the long run.  It is quite possible that new workers entering the system will never receive a payout.  While that reality is not unlike the situation when a new ‘investor’ gets in on a Ponzi scheme too late, this does not mean that Social Security is a scam.  The key difference is that the intent of Social Security was never to defraud its stakeholders.  Some, like Dean z at Forbes.com would argue otherwise.  Zarras says just because the original intent was good and honorable, that doesn’t mean that the current iteration of Social Security isn’t fraught with problems on the scale of a giant Ponzi scheme.  The Social Security Administration refutes this notion and argues that the Social Security system has always been a pay-as-you-go or partially advance-funded system.  They argue that what leads the naysayers to make comparisons to Ponzi schemes is the start-up process.  In any retirement plan, the SSA argues, it is not uncommon for initial beneficiaries to receive more than what they put into the system.  They argue that to avoid this, you would have to either exclude certain workers or provide inadequate pension funds to early beneficiaries.  In the case of the SSA, their first beneficiary, Ms. Ida received more than $22,000 over 30+ years after only contributing $24.75 in payroll taxes.  That’s one heck of a return on her investment!

Is It or Isn’t It?

On the one hand, such arguments grab attention and force conversation.  We all know that Social Security needs some fixing in order for folks my age to be able to draw benefits at retirement.  Whether or not the system is a Ponzi scheme depends upon that fix.  If the system is repaired — either through benefit cuts, tax increases or some combination of the two — then it doesn’t feel so icky and Ponzi-like.  If it is allowed to dry up and folks like me retire with nothing after paying into the system for years, then that’s another story.  This all points out to the need for budgetary reform and this doesn’t happen over night.  I love it when the pundits jump up and down and get us talking and thinking about how to make things better.  I hate it when the jumping up and down only leads to more anger and frustration.  Here’s hoping for a fix in short order!

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