Ponzi scheme facts for kids
A Ponzi scheme is a type of fraud. It's a trick where someone (the schemer) gets people to invest money. They promise big, fast returns on their investment. But the truth is, the scheme doesn't actually make money from real investments. Instead, the money paid to early investors comes from new investors.
The schemer might say, "I have a secret way to make lots of money!" They encourage people to give them money to "invest." But a Ponzi scheme is like a house of cards. It needs a constant flow of new money to pay off earlier investors. When new investors stop joining, the whole system falls apart.
Ponzi schemes always end in one of three ways:
- The schemer takes all the money and runs away. This is often their goal.
- The schemer runs out of money. They can't pay back investors, who then panic. Everyone demands their money back at once.
- Police or other officials find out about the scheme and stop it. Sometimes, someone inside the scheme (a whistleblower) tells the authorities.
The scheme is named after Charles Ponzi. He moved to the United States from Italy in 1903. Ponzi ran a very large scheme in the 1920s. He promised big profits from buying and selling international postage stamps. But he mostly used new investors' money to pay old investors. He also kept a lot for himself.
Charles Ponzi didn't invent this type of fraud. In 1857, Charles Dickens wrote a book called Little Dorrit about a similar trick. Ponzi schemes can happen anywhere, even online. They are still being run today.
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How Ponzi Schemes Trick People
People who advertise Ponzi schemes often use fancy words. These words sound important but are actually very vague. They might talk about "Hedge Futures Trading" or "High-yield investment programs." These phrases are meant to confuse people.
Schemers often rely on people not knowing much about money. The Madoff scandal in 2008 showed this. Even smart people like bankers can fall for these tricks. People are fooled because the schemer seems very skilled or famous.
Sometimes, schemers claim their investment must be a secret. They say this is how they make so much money. For example, Bernard Madoff only let his brother-in-law's company check his "hedge fund." He said it had to be a secret to earn money.
Since the "investment" is often unclear, new investors might not come quickly. But the scheme often grows like this:
- An early investor gets money back. This money actually comes from a later investor. The early investor doesn't know this.
- This happy investor tells friends and family about the "great investment." They want to help others make money too.
- These new investors tell even more people, and so on.
Schemers often try to get early investors to "re-invest" their "earnings." They might send fake reports. These reports show how much money investors have supposedly "earned." They encourage them to keep "investing" even more.
Schemers also make it hard for new investors to take their money out. They might create strict rules. To make the scheme look good, the schemer might let a few investors withdraw money. This makes the "investment" seem real and successful.
What is Not a Ponzi Scheme
It's important to know the difference between a Ponzi scheme and other financial situations.
Pyramid Schemes
A multilevel pyramid scheme is similar to a Ponzi scheme. Both involve fake promises and investments. But there are some key differences:
- In a pyramid scheme, investors find their own new investors. Each "level" profits directly from the level below them. Ponzi schemes usually center around one main schemer.
- Pyramid schemes often brag about how much money you can make by finding new people. This can appeal to people who need money. Ponzi schemes brag about special, secret connections. This might appeal more to wealthy people.
- Pyramid schemes often "crash" faster. They depend completely on finding new victims. Ponzi schemers can keep going longer by getting early investors to re-invest their money.
Financial Bubbles
A bubble is about buying and selling. It happens when people buy a product to sell it for a higher price. They hope to keep selling it for more and more. The bubble "pops" when buyers stop paying high prices. Then, sellers are stuck with something they paid too much for. This can happen with anything, like houses or stocks.
Bubbles don't always need a central schemer. People can cause them by accident. For example, land prices can "bubble" if many people want to build near a popular area. When there's no more land, sellers are stuck with their property. Bubbles are often linked to the idea of a "greater fool." This means someone will always be "fooled" into paying a "greater" price.
"Robbing Peter to Pay Paul"
This phrase means borrowing money to pay off old debts. Then, you borrow more money to pay off that new debt. This is not a Ponzi scheme. People doing this were not promised big returns. Also, the lenders don't always make money from this situation.
Multi-Level Marketing
Multi-level marketing (MLM) is when companies sell products to people. These people then sell the products directly to customers. Re-sellers can also earn money by bringing new re-sellers into the company. This might sound like a pyramid scheme. However, honest and legal MLM companies exist. Many of them make money by buying products in large amounts and selling them.
Related pages
Images for kids
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Charles Ponzi
See also
In Spanish: Esquema Ponzi para niños
