Ponzi Schemes, Pyramid Scams and Social Security

If you've ever worried that your Social Security Retirement program is really just another Ponzi Scheme or Pyramid Scam then read on to learn just what the Ponzi/Pyramid crimes involve and how your US Government Social Security Account works. There are three issues to grasp before you lose sleep about any of this. First of all, you need to know what defines a Ponzi Scheme and a Pyramid Scam. Next, you have to get some idea of how Social Security Funds are really collected, protected, invested and disbursed. Finally, you have to decide if any of these activities are connected and if their respective funds are similarly vulnerable. Once you learn the information in this article, then you will know if your worry is justified.

The term, "Ponzi Scheme" is all over the news these days but few people realize that the name comes from Charles or "Carlo" Ponzi, a native Italian who immigrated to the US in 1903. History tells us that sometime in 1918 or 1919, Ponzi became aware that he could purchase an international postal reply coupon abroad for about US 1 cent and exchange it at any US Post Office for US 6 cents worth of postage stamps. Carlo Ponzi tried to establish a business that purchased and redeemed these coupons in bulk. Problems with overseas agents, red tape and time delays resulted in lost money and no profits. Undismayed, Ponzi launched a new investment business in December of the same year based on the reply coupon exchange; he offered his investors the equivalent of doubling their money every 90 days. Early investors were paid off with funds from new investors and the scheme was off and running until it collapsed of its own weight and Ponzi was arrested and sentenced in US Federal court for mail fraud late 1920. It seems he held no quantity of international postal reply coupons after all. Today, "Ponzi scheme" is used to describe nearly any scam that relies on a "pyramid" of "investors" with new money coming in to pay out the previous investors. Interestingly, the original Ponzi Scheme indeed had a "pyramid of investors" but it was not a "Pyramid Scam".

The typical Pyramid Scam (or scheme) is also a non-sustainable collection business. The main difference from the Ponzi model is that people are paid for enrolling other people into the scam. There often isn't even a product or service involved in the true Pyramid Scam. Instead, the Pyramid's "victim" makes one payment then has to recruit other "investors" to also make one payment, from which the "victim" gets a share... and on and on. A chain is formed, then sub-chains and branch-chains; always with a share paid to each participant based on the people that they've brought into the "business". So, while it is true that a Pyramid Scam is always a Ponzi Scheme, the Ponzi is not always a Pyramid. Get it? Good.

Now we consider the way that the US Social Security Retirement system works. What is now known as the Social Security Administration was created in 1935 under President Franklin D. Roosevelt. Today, the SSA administers a wide variety of "social insurance programs" including disability, retirement and survivor's payments among others. These social insurance services are funded by premiums, paid as compulsory contributions (i.e., taxes), collected by pay-roll withholding and/or delivered to the US Government in the form of business tax payments. Since the Social Security system is defined by statute and applies to a well defined population it is, or course, "legal" and therefore cannot be (by definition) any sort of "scam" or "scheme". Recipient's "retirement" money is administered by the SSA in the Old-Age and Survivors Insurance (OASI) Trust Fund. However, you should understand this fact stated by the US Office of Management and Budget (OMB): "These (Trust Fund) balances are available to finance future benefit payments and other Trust Fund expenditures - but only in a bookkeeping sense... They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large Trust Fund balances, therefore, does not, by itself, have any impact on the Government's ability to pay benefits." (from FY 2000 Budget, Analytical Perspectives, p. 337).

The OMB statement makes it clear that the legal Social Security System is basically, "Pay-as-you-go". In other words, early beneficiaries are paid off by the compulsory contributions of more recent enrollees.

In conclusion, just keep in mind that Ponzi Schemes and Pyramid Scams are crimes that attract "victims" who realistically might be trying to obtain something for nothing. Social Security Retirement is a social insurance program, defined by statute and directed at a specific group of beneficiaries. It is quite legal and secured by the US Government. Reading this article has provided you with the OMB's assessment of the status of the OASI Trust Fund. If you now think that you're justified in worrying about the viability of Social Security funds, you should consider embarking on an alternative personal investment program to secure your financial future.