"Ponzi Scheme" (Wikipedia article)
A Ponzi scheme is a fraudulent investment operation that involves paying returns to investors out of the money raised from subsequent investors, rather than from profits from any real business. The scheme is named after the discoverer of the technique, Charles Ponzi, an Italian immigrant in 1903 to the United States. The manner of Ponzi's initial scheme was actually fairly crude, among other reasons because he himself appeared to believe that he had found a way to generate (legally) large profits. Today's schemes are considerably more sophisticated.
The idea behind the Ponzi scheme is fairly straightforward, and exploits the basic human trait of greed. Here is a typical scenario:
An advertisement is placed promising extraordinary returns on an investment - for example 20% 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", "futures trading", "high yield investment programs", etc.
With no "proven track record", only a few investors are tempted, usually for smaller sums (say $5000). Sure enough, 30 days later, the investor receives $6000 - the original capital plus the 20% return ($1000). At this point, greed starts to overcomes reason: the investor will put in more 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 (and quite 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", "futures trading", or "high yield investment" 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.
On reason that the scheme works so well is that early investors - those who actually got paid the large returns - quite commonly keep their money in the scheme (it does, after all, pay out much better than any alternative investment). Thus those running the scheme don't have to actually pay out that much (net) - they simply have to send statements to investors that show how much the investors have made by keeping the money in a what looks like a great place to earn a high return.
The catch is that at some point one of three things will happen: (a) the promoters will vanish, taking all the investment money (less payouts) with them; (b) 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); or (c) the scheme is exposed, because much of the "assets" that are on the accounting records of the so-called enterprise do not (cannot) really exist.
Compare: Pyramid scheme
[edit]
Examples of Ponzi schemes
Ponzi went from anonymity to being a well known Boston millionaire in six months using such a scheme in 1920, with profits to come from exchanging international postal reply coupons. He promised 50% interest (return) on investments in ninety days. About 40,000 people invested about $15,000,000 (they would get back about a third of this).
More recently, the Bennett Funding Group defrauded investors of $700 million, the largest known ponzi scheme in the United States. Investors were told the funds were to finance leases on office equipment.
In 1997 the government of Albania officially endorsed a series of pyramid investment funds. When the inevitable end came, the people of Albania, who had lost $1.2 billion, took their protest to the streets in a revolt that toppled the government.
[edit]
Are state pensions Ponzi schemes?
It has been suggested that some state pension systems, such as the U.S. Social Security system and the U.K. State pension systems are actually large-scale Ponzi schemes. Under these systems, incoming payments (taxes) are not saved or invested to pay for future benefits. Instead, the taxes (perhaps with some general government revenues) are used to pay for current benefits. (Any excess receipts may result in the creation of government bonds that are "held" by the system, but these bonds are essentially "IOUs" from one part of the government to the other.)
State pension systems lack a number of basic features that define Ponzi schemes, and so are fundamentally different:
There is no belief that there are large profits coming from something; rather, it is clear that these are pay-as-you go systems, where workers (at any given time) are providing money to those who have retired (and paid into the system earlier).
There is no growth driven by the enticement of high returns over a short period of time, with new investors continually entering in order to support payouts to early investors.
Because receipts (taxes) and payouts (entitlements) can be calculated quite accurately in the short term (five to ten years), and predicted (with a range of assumptions) for periods beyond that timeframe, there will never be a sudden collapse.
General tax revenues can be used to supplement worker payments into the systems, although many taxpayers will be unhappy with such supplementation.
Market Data 
Markets 
AI
