The age of the 5 percent Ponzi scheme

November 20, 2013

Nov 20 (Reuters) – Things have come to a pretty pass when
Ponzi schemes are luring in the chumps with promises of only a 5
percent return.

A Federal judge on Monday ruled that Anthony J. Lupas, a
Pennsylvania Alzheimer’s sufferer and accused Ponzi king, does
not have the mental capacity to stand trial for 31 counts of
fraud and conspiracy. (here)

Prosecutors say the 78-year-old’s alleged scam fell apart in
2011 after he fell, injured his head and could not keep up with
the payouts. The reported details of the scheme, whereby Lupas
is alleged to have relieved investors of $6 million, are
unremarkable, save one: he was only promising a 5 percent annual
return.

That 5 percent figure is either, in a perverse way, the
triumph of monetary policy or it is, even more disturbingly, a
sign that we live in a very low-return world.

You see in order to run a successful (and long-running)
Ponzi scheme you are looking for a sweet spot in terms of the
fantasy gains you promise: not so high as to raise eyebrows but
juicy enough to cause the salivary glands to kick in.

After all a Ponzi scheme, which makes payments to existing
investors out of the funds it attracts from new ones, needs to
keep attracting investors or it will collapse.

Think about Bernie Madoff, who perpetrated the largest Ponzi
scheme in U.S. history by offering investors a metronome-like 12
percent a year.

That, however, was back in the go-go 1990s and 2000s, when
everyone with a 401k and a dream thought they could make 10
percent a year with their eyes closed. Their eyes were closed
all right, but mostly to the risks.

Now, to be fair, Lupas was offering a 5 percent tax-free
return (after all, if the investment is an illusion so must be
the tax liability), so for higher-rate investors it was a bit
more of a lure. And I suppose if you are only paying out a 5
percent dividend it would take a bit longer before you’d paid
out all of your capital in ‘returns’.

It is possible too that the 5 percent figure was calibrated
to attract sober-sided investors, and that the low returns in
turn made them less likely to ask questions.

Still, 5 percent is not much of a dream to be offering. It
is a bit like setting out to run a love fraud by posing on the
Internet as an overweight middle-aged man.

A NEW AGE?

So I think this particular case is telling us something new.
It is not just the old story of greed, but something a bit
closer to desperation. After the past decade of booms, busts and
bubbles, investors are facing a world in which it is ever more
apparent that it is hard to make even a modest return.

That someone might meet this unmet need with a fraud is only
a delicious irony.

In part, we might be able to explain, not blame, this by
looking at monetary policy. Keeping interest rates pinned so low
for so long has put many savers, especially the elderly, in an
increasingly uncomfortable position. Particularly if they don’t
see themselves as risk-takers, there are really precious few
alternatives out there (by which I mean none) offering what
they’ve become accustomed to getting.

So while the intention of monetary policy is to push
investors to take on more risk, it is here having the effect of
pushing them into the hands of someone offering what appears to
be a fraudulent (but safe!) 5 percent.

The other possibility is that monetary policy isn’t creating
this world of low returns, only reacting to it.

William Bernstein, of Efficient Frontier Advisors, published
a piece recently describing what he called the “Paradox of
Wealth,” a tendency for economic growth to give rise to low
returns. (here)

This happens, Bernstein argues, because richer people defer
consumption more willingly, leading to a surfeit of capital,
because these low returns bring on speculative dupes (see Ponzi
schemes) and because technological innovation speeds up. New
technology is great, but requires a lot of capital and tends to
make a bit of a mess of existing business models.

If we are living in a happy, rich and peaceful world, low
returns on investment may prove a bit of a fly in the ointment.
Ben Inker, of fund manager GMO, speculates about the damage of
100 years of 3.5 percent real returns.

“Every endowment and foundation will nd itself wasting away
instead of maintaining itself for future generations. And the
plight of public pension funds is probably not even worth
calculating, as we would simply nd ourselves in a world where
retirement as we now know it is fundamentally unaffordable,
however we pretend we may have funded it so far.”

That world, if it is arriving, may feature quite a few 5
percent Ponzi schemes.
(At the time of publication, Reuters columnist James Saft did
not own any direct investments in securities mentioned in this
article. He may be an owner indirectly as an investor in a fund.
For previous columns by James Saft, click on )

(Editing by James Dalgleish)

One comment

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Wow. 5% was the rate that I got as a kid in the sixties on my little “day of deposit to day of withdrawl” account.

The tragic aspect of this story is that the investors couldn’t really be described as greedy. These folks are just trying to find a way to get by.

It’s fascinating how we have become a culture of extremes. Look at the federal funds rate and how fast it went to zero. Perhaps a 5% return on a bank deposit is too much in a weak economy but the federal reserve dictates these rates for everyone. Instead of an effective rate of 0% why not manipulate the rate to, say, 3%?

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