Buzzword: Ponzi scheme

What it means. According to Webster’s, a Ponzi scheme is “an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks.” The scheme is virtually assured of collapse because there are little to no earnings created from the money being brought in. And eventually the scheme runs out of new victims. The phrase takes its name from Charles Ponzi, a famous Roaring Twenties swindler.

Why the buzz? The collapse of Bernard L. Madoff Investment Securities last week, which may exceed $50 billion in losses, according to an estimate by Madoff cited in a complaint by federal prosecutors. Madoff allegedly issued fake statements to clients showing steady, positive results even during down markets and paid out returns and dividends to some investors using money from others.  Though Madoff allegedly said the firm had been insolvent for years, it seems that the market’s downturn brought the situation to a head. According to a press release issued by the Securities and Exchange Commission, Madoff himself told associates that his company was "basically, a giant Ponzi scheme."

Interestingly, many of the people involved with Madoff were financially astute investors, some of them big-name hedge fund managers. Despite the widely held view that elderly widows or financial illiterates are the types usually fleeced by investment scams, studies show that, in fact, well-educated retired businessmen are more likely to fall for them. The Consumer Reports Money Adviser newsletter reported on this phenomenon a while back.—Chris Fichera