Ponzi Mania

What Was Ponzi Mania?

Ponzi mania described the market atmosphere after the seemingly sudden recognition of Ponzi schemes that followed the arrest of Bernard Madoff for operating an illegal operation. Ponzi mania took full force in December of 2008 when federal investigators discovered that Bernard Madoff had operated a huge Ponzi scheme over the prior decade, defrauding investors of nearly $65 billion.

Understanding Ponzi Mania

In the wake of Madoff's arrest, the Securities and Exchange Commission and other federal investigators put their complete efforts into finding and shutting down illegal Ponzi schemes that were responsible for billions of dollars worth of losses to investors. Following the huge losses recognized by Bernard Madoff's investors, individual investors across the world became much more conscious of the signs of potential Ponzi and pyramid schemes, resulting in Ponzi mania.

In hindsight, the mania-like mood in the wake of the Madoff scandal should have been anticipated as it's a usual element to the market's boom and bust cycle. The notion of 'mania' dates back to the very first recorded speculative bubble: For instance, the Tulip mania of 1637. During the Dutch Golden Age, contract prices for new and fashionable tulip bulbs passed unthinkable levels before collapsing as people reached their senses. Since this first mania, subsequent bubbles have often been labeled or identified with the manic behavior of crowds. Scottish journalist Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds, first published in 1841 still stands as an early tome in crowd psychology.

What is perhaps most interesting about Bernie Madoff's Ponzi and the mania that followed is that he duped supposedly sophisticated or at least generally astute investors. Rather than the typical pyramid schemes that catch the everyday "Joe" (person) trying to make an easy buck, Madoff's approach deliberately targeted a well-heeled crowd. Perhaps his brazenness helped propel his scam on for longer than otherwise simpler cons.

What Is a Ponzi Scheme?

A Ponzi scheme is a fraudulent investing scam promising high rates of return with little risk to investors. A Ponzi scheme is a fraudulent investing scam that generates returns for earlier investors with money taken from later investors. This is similar to a pyramid scheme in that both are based on using new investors' funds to pay the earlier backers.

Both Ponzi schemes and pyramid schemes eventually bottom out when the flood of new investors dries up and there isn't enough money to go around. At that point, the schemes unravel.

The term "Ponzi Scheme" was coined after a swindler named Charles Ponzi in 1919. However, the first recorded instances of this sort of investment scam can be traced back to the mid-to-late 1800s, and these were orchestrated by Adele Spitzeder in Germany and Sarah Howe in the United States. In fact, the methods of what came to be known as the Ponzi Scheme were described in two separate novels written by Charles Dickens, Martin Chuzzlewit, published in 1844, and Little Dorrit in 1857.

Charles Ponzi's original scheme in 1919 was focused on the US Postal Service. The postal service, at that time, had developed international reply coupons that allowed a sender to pre-purchase postage and include it in their correspondence. The receiver would take the coupon to a local post office and exchange it for the priority airmail postage stamps needed to send a reply.