The age of the 5% Ponzi scheme

5 min read

James Saft

James Saft, Reuters Columnist

Things have come to a pretty pass when Ponzi schemes are luring in the chumps with promises of only a 5% 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.

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 US$6m, are unremarkable, save one: he was only promising a 5% annual return.

That 5% 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 US history by offering investors a metronome-like 12% 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% 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% 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% 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% figure was calibrated to attract sober-sided investors, and that the low returns in turn made them less likely to ask questions.

Still, 5% 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%.

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.

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% real returns.

“Every endowment and foundation will find 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 find 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% 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