April 26, 2024 • 60 mins
Sam Israel had a problem. The investors in his hedge fund, Bayou Capital, were expecting spectacular returns. Sam himself had spent years proclaiming the fund's brilliant results. But in reality, Sam had been marking his own homework, publishing fraudulent accounts and using these to lure in new investors.
What to do? Well, the logical thing of course: wait around for an extraordinary profitable streak, and in the meantime keep up the ruse...
This episode of Cautionary Tales was recorded live at the Bristol Festival of Economics and studies three incredible investment scams. How do pyramid and ponzi schemes snowball out of control, flattening victim and fraudster alike?
For a full list of sources, see the show notes at timharford.com.
See omnystudio.com/listener for privacy information.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:15):
Pushkin, Do you know your Ponzi schemes from your pyramid schemes?
The following episode digs into the pitfalls of get rich
Quick scams. It was recorded in front of a live
audience at the Bristol Festival of Economics. Gosh, wow, are
(01:01):
you already excellent? Okay, so we will begin. Sophie and
Julia were relaxing on the riverside terrace of a fancy
(01:21):
London spa, two rich girls joined by an even richer one, Tatiana,
the glamorous wife of an investment banker. Tatiana ordered another
bottle of champagne and launched into her sales pitch. You
simply must buy our heart. Julia and Sophie looked at
(01:43):
each other and sighed. This wasn't the first time they
had heard the spiel. It was the summer of two
thousand and three, and hearts with a capital H were
all the rage among the champagne drinking, horse riding banker
marrying ladies of Great Britain. Here's how it worked. You
(02:04):
donated three thousand pounds to buy a heart and join
the scheme at the bottom of a pyramid. That's about
six thousand dollars in today's money, Your money would go
to the person at the top, called the receiver.
Speaker 2 (02:21):
They'd leave the pyramid.
Speaker 1 (02:23):
The two people on the next level down would be
promoted to the top.
Speaker 2 (02:27):
Roll of receiver.
Speaker 1 (02:28):
In fact, the pyramid would then split into two, so
that both of them would be at the top of
their own pyramid. Everyone would move up a level, and
everyone on the lowest layer, including you, would recruit two
people to buy a heart and fill in the newly
vacant layer beneath you. Six weeks later, you would be
(02:52):
a receiver and would get twenty four thousand pounds, the
equivalent of fifty thousand dollars today, and a huge return.
Speaker 2 (03:03):
No matter how you measured it, the money just.
Speaker 1 (03:07):
Grew like a snowball rolling downhill until it became an avalanche.
If you're not halfway through your second bottle of lunchtime champagne,
you can probably spot the problem here. This is transparently
(03:29):
a pyramid scheme, and pyramid schemes don't make money, they
just move it around. If someone's going to make twenty
four thousand pounds, then that money must come from other members,
so eight other people must lose their investment of three
thousand pounds.
Speaker 2 (03:47):
It's really that simple.
Speaker 1 (03:50):
In order to persuade people to join a pyramid scheme,
there's often some sort of story designed to obscure this
implacable arithmetic. This one about buying a heart was marketed
as feminism. The whole project was called Women in Empowering Women.
Speaker 2 (04:11):
Men weren't allowed. Men are more corruptible.
Speaker 1 (04:15):
They can't be trusted, as Tatiana explained. She also added
that she had spent her first wind fall on a
little intimate plastic surgery that she preferred not to discuss
with her husband. Julia and Sophie were tempted, as Julia
later recalled in an article for the Mail on Sunday newspaper.
(04:37):
Then Tatiana whispered that apparently the supermodel Claudius Schieffer had
been spotted at a women Empowering Women party at a
mansion in central London. That was the clincher sign me up,
said Julia. Things moved quickly. The next day, Julia received
(05:00):
a phone call from a lady called Elfie, who was
collecting her boy Archie from an exclusive London school. Darling,
I must be quick, but I couldn't wait to tell
you the news. You've already moved up a line.
Speaker 3 (05:16):
You're one step closer to becoming a receiver.
Speaker 2 (05:21):
Wonderful, replied Julia.
Speaker 1 (05:23):
So now you must send me three thousand pounds. I'm
Tim Harford and you're listening to Cautionary Tales live at
the Bristol Festival of Economics. This is a cautionary tale
(05:48):
about investment scams and about the way that they snowball
out of control, often flattening not only the victims but
the fraudster too. Some of those fraudsters are anonymous figures. Julia,
Sophie and even Tatiana had no idea who set up
women empowering women, but some of them are not. Few
(06:12):
people are less anonymous than Samuel Israel, the Third. Let's
call him Sam Israel for short. Sam came from a
wealthy family of commodity traders in New Orleans, but was
determined to make his own way in life. He started
at the bottom in nineteen seventy eight, dropping out of
(06:34):
college to run errands for one of Wall Street's most
famous share traders. Sometimes those errands merely meant fetching pizza.
Sometimes they involved going to a particular room in the
Pierre Hotel on the Upper east Side and speaking a
code phrase to a Swiss gentleman.
Speaker 3 (06:55):
The weather is nice for this time of year, yes.
Speaker 1 (07:00):
But today it looks like rain. The Swiss man gave
Sam a satchel. Sam didn't look inside it until his
boss showed him that it was filled with one hundred
dollar bills, well over one hundred thousand dollars at a
time when one hundred thousand dollars was real money. Odd
(07:22):
things like this tended to happen from time to time,
and through it all, Sam Israel watched and learned and
kept his mouth shut, and he began to thrive on
Wall Street. Sam married a childhood sweetheart, an ice girl
called Janis. She was sensible, training to be an accountant.
(07:45):
It wasn't the ideal match. I hid everything from Janis,
Sam Israel confessed to the Rolling Stone journalist Gee Lawson.
Speaker 4 (07:55):
I've been hiding things from her since we were kids.
She was the responsible worker. I was the fuck up.
I smoked weed and snorted coke. I couldn't talk to
her about what was really going on because I couldn't
confide in her.
Speaker 1 (08:09):
And what was really going on That depends on when
you asked the question. In nineteen seventy eight, Sam was
quietly being a courier of satchels full one hundred dollar bills.
The night before he married Janis, Sam was having a
threesome with two expensive call girls, paid for by his
(08:30):
Wall Street trader boss as a wedding gift. In nineteen
eighty seven, Sam was making a small fortune by fortuitously
betting that the market would fall just before the largest
one day crash in Wall Street history. Sam always swore
he could have made more if the Federal Reserve hadn't
(08:50):
swooped in printing money to prop up the market. In
the early nineteen nineties, Sam was winning and losing huge
sums several times over by trading on insider tips.
Speaker 2 (09:03):
Some good and some bad.
Speaker 1 (09:07):
Sam couldn't talk to janisout any of this, of course.
But what Sam really couldn't talk to Janis about was
by you capital, By you capital was well, it was
a con. But let's come back to that. Let's talk
about a simpler con first. An early example, if you like,
(09:31):
of women empowering women.
Speaker 2 (09:35):
In eighteen seventy.
Speaker 1 (09:37):
Eight, refined ladies of Boston, Massachusetts, were intrigued to hear
of a wonderful investment opportunity. A new bank, founded by
women for women and called the Ladies Deposit Company, paid
interest of eight percent. Eight percent a year would be
(09:59):
a solid enough offering. The Lady's Deposit Company, however, paid
eight percent every month, deposit one hundred, and by the
end of the year you'd have earned ninety six dollars,
nearly doubling your original investment. There were no rumors of
supermodels back in eighteen seventy eight, but the gossip suggested
(10:23):
something even more reassuring. The Ladies Deposit Company was said
to be backed by a Quaker charity doing many unspecified
good works. Only unmarried women need apply. Such unprotected women
(10:44):
who lacked the security of a husband's income were in
a precarious position. Either they were poor and trying to
earn a wage in a world where women were barred
from well paid jobs, or they were of a social
background where they were expected to live off an inheritance.
The investment return on that inheritance, then was a matter
(11:06):
of huge importance, and eight percent a month too good
to miss, or alternatively, too good to be true. The
Ladies Deposit Company was not founded by Quakers, but by
a stage psychic and professional fortune teller named as Sarah Howe.
(11:28):
The company had some similarities with a pyramid scheme like
the Hearts of Women Empowering Women, but also some differences.
The grim arithmetic of the scheme was concealed. Money poured
into the Ladi's Deposit Company, money poured out, and the
mechanics of how it all worked were conveniently obscure. One
(11:53):
intrepid reporter even disguised himself as a woman one can
only presume that no female journalists were available in order
to gain entry to the Deposit Company's headquarters, but he
didn't learn much. We never disclose the methods by which
we do business, was all that the company's employees would say.
(12:17):
Sarah Howe had established what we'd now call a Ponzi scheme,
named after Charles Ponzi, a flamboyant Bostonian whose own cover
story was something to do with international postage coupons. Sarah
Howe had the same basic idea in the same city
nearly fifty years earlier. But women never seem to get
(12:41):
the credit for inventing anything, even investment fraud. The local
press soon concluded that the Ladies Deposit Company.
Speaker 2 (12:51):
Was an obvious scam.
Speaker 1 (12:53):
The Boston Daily Advertiser published an illustrated explainer, some articles
highlighting the stage psychic hows, rather questionable qualifications, and a
prediction that the whole thing would collapse in short order.
In the face of this negative publicity and some twitchy depositors,
(13:15):
Sarah Howe decided that the best way forward was bluff.
She announced that anyone who wanted their money back with
interest in full, could have it immediately. She hoped that
the ladies of Boston would be so reassured by this
offer that they wouldn't take it up. Alas, the ladies
(13:36):
of Boston were not reassured at all. They asked for
their money back, and when Sarah Howe didn't have it,
she went to jail. The Lady's Deposit Company is a
wonderful illustration of what Dan Davies in his book Lying
for Money calls the snowball effect. These scams need to
(14:00):
suck in an ever growing number of dupes to keep going,
and eventually that snowball of money rolling downhill, becoming bigger
and bigger, simply falls apart.
Speaker 2 (14:13):
It's too big.
Speaker 1 (14:15):
Remember, Sarah Howe was offering to almost double your money
in a year. If you invested with her. So let's
watch the snowball from a safe distance. Imagine that Sarah
receives an investment of one hundred dollars from a little
old lady and steals it. By the end of the year,
(14:38):
that little old lady expects her one hundred dollars back,
on top of ninety six dollars in interest. So Sarah
finds two more investors, steals their money, and gives it
to the little old lady. But by the end of
the following year, Sarah Howe needs to have given nearly
two hundred dollars to both of her investors. To do that,
(15:01):
she needs four new investors, who shouldn't be hard to
find if they think they're going to double their money.
When the four new investors want a total of eight
hundred dollars back, she just needs to find eight new
investors to join the Lady's Deposit Company.
Speaker 2 (15:17):
Now you can see the trap here.
Speaker 1 (15:20):
Eventually there will be no more lady depositors for the
Lady's Deposit Company. But what's perhaps less immediately obvious is
that in this little story, Sarah Howe will soon owe
sixteen hundred dollars to eight investors. And yet she only
(15:41):
ever stole one hundred dollars for herself. The growing snowball
of fraud is huge, and it needs to keep getting huger.
The profit for the fraudster as rellatively tiny. No wonder
that so many fraudsters eventually get caught, and no wonder
perhaps that when they do get caught, so many of
(16:03):
them weep with relief. There will be tears a plenty,
but not much relief.
Speaker 2 (16:13):
After the break.
Speaker 1 (16:34):
In the summer of two thousand and three, Julia started
to try to recruit investors to buy hearts for women,
empowering women. Julia had been signed up by Tatiana, the
banker's wife, over champagne at the Spa. She had sent
three thousand pounds to Elfie, the mother of Darling Archie
from the Fancy School, but Julia's own recruitment efforts were
(16:58):
going nowhere. Her rich friends sneered at her that had
already been approached so many times to invest in her
heart that the whole affair had become a bore ring joke.
Horror friends were less likely to have heard about the scheme,
but they were also less likely to have the money
to invest. I mentioned that as a matter of simple arithmetic.
(17:24):
For everyone who makes twenty four thousand pounds in a
pyramid scheme, there must be eight people who lose three
thousand pounds. But how can it be that so many
people lose out? Well, that's simple too. Every time a
new group of recruits is brought in, the entire operation
has to double in size. Every recruit finds two more recruits,
(17:47):
and every pyramid becomes two pyramids. The rolling snowball becomes
a vast snow boulder, then collapses into a destructive avalanche
of disappointment and loss. Pyramid schemes fail because they run
out of recruits just after becoming huge, when a vast
(18:10):
number of people have recently joined but not yet cashed out.
Speaker 2 (18:16):
Julia was one of those people.
Speaker 1 (18:19):
In growing desperation, Julia went to a recruitment party in
the hope of recruiting new investors. She'd been told tales
about parties in central London mansions, champagne being quaffed with
supermodels as suitcases of cash were handed to people who'd
(18:40):
reached the top of the pyramid. That this recruitment party
was in a hairdressers instead of champagne. On ice, there
was warm white wine, and a growing sense of irritation
that Julia's failure to recruit was letting down everyone above
(19:00):
her in the pyramid. There was, of course, no sign
of Claudia Schieffer. The brilliance of women empowering women is
that it seems to have been largely self organizing. Many scams,
in contrast, require.
Speaker 2 (19:19):
A lot of hard work. Just ask Sam Israel.
Speaker 1 (19:25):
He set up his ill fated hedge fund by you
Capital in nineteen ninety six, assisted by an accountant named
Dan Marino, who lived with his mother and.
Speaker 2 (19:37):
Dreamed of greatness.
Speaker 1 (19:40):
Apparently, Sam actually intended to run an honest hedge fund,
or if not quite honest, a hedge fund that would
make money for investors. His business plan, by You Capital
would use a new computer algorithm he had developed, plus
the skills of a once great trader whom Sam had
(20:00):
hired after he had fallen on hard times, plus a
few insider tips like in the old days when he'd
collect bags of cash from the Pierre Hotel. That should
do the trick, thought Sam.
Speaker 2 (20:14):
But it didn't.
Speaker 1 (20:16):
The once great trader was washed up. He made a
lot of bad calls. The computer algorithm seemed to misfire
as often as it worked, and Sam didn't have the
same insider access that.
Speaker 2 (20:29):
He used to. After a couple of lackluster.
Speaker 1 (20:32):
Years in which Sam loudly told his few investors that
the funds results were great, he pondered his options. The
results were not in fact great, and if he simply
published the firm's accounts showing a loss, the investors would
yell at him for all his empty boasts, and Bayou
(20:53):
Capital would collapse. Or alternatively, Sam and his colleagues, the
washed up trader and the accountant who lived with his mum,
could lie, could publish audited accounts which claimed stella results.
(21:15):
Like Sarah Howe, they'd be offering fantastic returns. Unlike Sarah Howe,
who would simply steal money from new depositors and pay
it out as interest, they'd need to show some kind
of evidence that they were making profitable investments. To do that,
they'd need a fraudulent auditor. No problem. Dan Marino simply
(21:40):
set up his own audit firm, marking his own homework.
Nobody ever checked that the auditor who was verifying that
Dan Marino was telling the truth was a Dan Marino.
It probably didn't hurt that if anyone ever tried to
search for Dan Marino on the still young worldwide Web,
(22:03):
they were sure to get Dan Marino, the unimaginably famous
Miami Dolphins quarterback, rather than Dan Marino the crooked accountant.
For a while, the plan was that Sam would go
on a profitable streak and actually make the profits that
Dan Marino's fake accounts were claiming. But the snowball was
(22:26):
starting to grow. The more profit they said they were making,
the larger the fictional pot of money was growing, and
the harder it was for Sam and his partner to
catch up to their own lies. It didn't help that
Sam kept claiming to outperform the market. Dan Marino was
(22:46):
losing his mind at the fact that Sam couldn't control himself.
Speaker 3 (22:50):
When they had a good month and made money, they
used that as the performance number.
Speaker 1 (22:55):
Complained Dan to the journalist Gee Lawson.
Speaker 3 (22:57):
When they had a bad month, they used a made
up number.
Speaker 2 (23:01):
That won't work.
Speaker 1 (23:03):
If you let the fraud snowball grow too big, you'll
never get it under control. Sam Israel would never be
able to catch up to his own lies because he
could never bring himself to pretend he'd had a bad
quarter when it had a good one.
Speaker 3 (23:17):
We went with grace and luls with integrity.
Speaker 1 (23:20):
Boasted Sam to his investors. Dan Marino knew the awful truth.
Speaker 3 (23:26):
I stopped tracking the published numbers against the real numbers.
Speaker 2 (23:29):
Said Marino.
Speaker 1 (23:30):
The snowball was already too big.
Speaker 3 (23:33):
Oh, it made me sick to my stomach.
Speaker 1 (23:37):
Four years after the Ladies Deposit Company was exposed by
the Boston Daily Advertiser and collapsed, ands Sarah Howe was
sent to prison. Refined women of Boston, Massachusetts, were intrigued
to hear of a wonderful investment opportunity. A new bank,
founded for women by women and called the Boston Women's Bank,
(24:03):
paid interest of seven percent per month. Too good to miss,
or alternatively, too good to be true. After a couple
of years, the Boston Daily Advertiser discovered and published the truth.
The manager of the Boston Women's Bank was not missus J. C. Ewle,
(24:29):
as advertised, but an ex convict by the name of
Sarah Howe. Sarah Howe had learned one lesson this time.
She skipped town and moved to Chicago. In due course,
the refined Ladies of Chicago, we're intrigued to hear of
(24:53):
a wonderful investment opportunity The Lady's Provident Aid Society was
offering interest of Oh never mind, the police caught up
with miss Sarah Howe shut down the Lady's Provident Aid Society,
and so enough.
Speaker 2 (25:10):
As Howe was back in prison.
Speaker 1 (25:12):
Worth it surely not in character, most definitely, Sometimes when
the snowball starts to roll, the fraudster just can't quit.
Sam Israel seemed to have it all, a loving wife
and children, a luxurious home, and at least on paper,
(25:35):
a fortune to his name. But appearances can be deceptive.
Sam was a mess. He was taking too much cocaine
and drinking far too much booze, and like so many people,
he had become addicted to painkillers after a back injury.
All the while, the fraud snowball was growing. But Sam
(25:58):
and Dan had one advantage, which is that a fraudulent
hedge fund doesn't have a cell by date. That's different
from the other scams we've heard about. Tatyana was promising
Julia that women empowering women would multiply her money in
just six weeks. The Ladies Deposit Company promised to almost
(26:18):
double investors' money after a year. But by you capital
was different because hedge fund investors didn't tend to withdraw
their money if things seemed to be going well. Instead,
they sat back and watched the snowball grow. But the
more by you capital snowball grew, the harder it would
(26:40):
ever be for Sam Israel to trade his way out
of the lie. One September Friday, his computer algorithm suggested
a big bet on shares going up in the next week.
Sam made that bet. The following Tuesday morning, two airliners
(27:02):
swept out of the cloudless sky above Manhattan and crashed
into the World Trade Center. The world reeled with the
implications of the atrocity, but for Sam Israel and Dan Marino,
the only thing that mattered was how it changed their
own twisted financial world. Sam was aghast that his bet
(27:25):
had spectacularly backfired, while Dan Marino spotted an opportunity close
the fund. Said Dan Marino and ten investors, he lost
most of their money in the aftermath of nine to eleven,
and give the dregs back. Everyone will yell, but nobody
will suspect anything, and neither you nor I will.
Speaker 3 (27:46):
Go to jail.
Speaker 1 (27:47):
Please speG Marino, But sam Israel wouldn't do it. He
knew that if by you capital folded, he might escape jail,
but it'd still lose his fancy home. He should have
listened to Marino, because within two years he was going
to lose his home anyway. Cautionary tales, We'll be back
(28:10):
in a moment. In two thousand and three, Sam Israel
(28:38):
was at home leaning over a line of white powder
with a rolled twenty dollar bill up his nose.
Speaker 2 (28:46):
When his wife.
Speaker 1 (28:46):
Janice walked in. She became upset. He became outraged. How
dare she suggests he was taking cocaine. She persuaded him
to take urine tests to ensure he stayed off the drugs,
until one evening he angrily unzipped his pants and went
all over the bathroom floor, bellowing.
Speaker 3 (29:08):
You want yourn.
Speaker 1 (29:10):
At Thanksgiving that year, he passed out over the turkey.
By Christmas two thousand and three, janis had thrown him
out of their house and secured a protective order. Sam
rented the most tasteless, ostentatious bachelor pad he could find,
(29:34):
a vast Tudor style manner, with outsized chandeliers, marble bathrooms,
and comically huge beds. Sam paid the monthly rent of
twenty two thousand dollars to the house's owner, a.
Speaker 2 (29:48):
Gentleman by the name of Donald Trump.
Speaker 3 (29:53):
So good, so good, amazing house, huge beds.
Speaker 1 (30:00):
Sam hung around clubs, tipping the bartender to introduce him
to pretty women. He fitted the Trump mansion with the
latest trading A seventeen screens so he could work from home.
He was still looking for a way to make all
the money back, but the fraud snowball that Bayou was
getting bigger and bigger, and Dan Marino had had a
(30:22):
couple of near misses when investors or regulators had asked
to see documents that would prove highly incriminating. Marino was
reduced to sending those incriminating documents to counterparties on a
Friday evening in the hope that they would be tossed
into a backlog file and then buried under the Monday
morning rush. Amazingly, that tactic worked, but it couldn't work forever.
Speaker 2 (30:47):
Dan and Sam.
Speaker 1 (30:49):
Were going to jail for sure unless Sam Israel could
find a sure fire scheme to make How big was
the snowball Now there were several hundred million dollars Sam
Israel was starting to get desperate. There's an old saying,
(31:10):
you can't cheat an honest man, and there's truth in
that saying, because the premise of a scam is often simply.
Speaker 3 (31:18):
I'm doing crimes, and if you come and do crimes
with me, we'll both make money.
Speaker 1 (31:24):
That's a sales pitch to drive away honest folk, but
it also has some appeal because it provides a logical
reason why there might be quick money to be made
for someone who could keep a secret. Sam Israel was
not an honest man. He'd seen enough cheating on Wall
Street to know that the game was often fixed, and
(31:46):
the crazy simplicity of the Bayou fraud, coupled perhaps with
the fact that Sam was taking a lot of drugs,
was just starting to make him doubt everything. How many
other hedge funds were just Ponzi schemes? What else was
a Ponzi scheme? He had seen the Federal Reserve magic
(32:06):
money out of thin air after that great crash of
nineteen eighty seven, when Sam had made so much money
and could have made more if the FED hadn't stepped in.
The FED stepped in after nine to eleven too.
Speaker 3 (32:18):
Who exactly was running the world economy.
Speaker 1 (32:20):
Anyway, Sam started to run in strange conspiratorial circles. If
you want the full story, it's told in incredible cringe
making detail in Gee Lawson's book Octopus, which describes an
astonishing cast of characters and an even more astonishing array
(32:42):
of delusional beliefs. Sam became obsessed with finding the undoctored
footage showing who really killed JFK. He believed he had
been attacked by an assassin on the streets of Hamburg,
and that had blown the man's brains out in self defense.
Needless to say, Hamburg's police have no record at all
(33:04):
of such events. Above all, Sam came to believe in
a global conspiracy thirteen powerful families who truly rule the world,
whom he called the Octopus. It all gets very, very weird.
Do read the book. It's quite a trip. But for
(33:26):
our purposes, what we need to know is that Sam
Israel fell under the spell of a man called Robert
Booth Nichols, who was claimed to be a top CIA agent,
whose bare hands were said to be deadly weapons, and
who was undoubtedly a confidence trickster. Like an aging chain
(33:48):
smoking James Bond. He swaggered around London City with tight
controls on firearms with a revolver in a shoulder holster.
Sam believed that Nichols had access to a special CIA
program which monitored every bank transaction on the planet, an
insider trader's dream, and he flew out to London to
(34:10):
beg Nichols to give it to him. He'd do anything,
he said. Do you have one hundred million dollars in cash?
Said Nichols, I do.
Speaker 3 (34:19):
I've got one hundred million in cash.
Speaker 2 (34:22):
Do you have one hundred and fifty million?
Speaker 3 (34:25):
Yes.
Speaker 1 (34:27):
Forget the special CIA program which monitors bank accounts.
Speaker 2 (34:30):
Said Nichols.
Speaker 1 (34:31):
We can make some real money together if we can
access a special secret market operated by the thirteen families
who together secretly rule the world.
Speaker 2 (34:42):
You know the octopus.
Speaker 1 (34:46):
And just as Julia had said to Tatiana at the
Riverside spa, Sam Israel said to Nichols, sign me up,
but not for three thousand pounds, for more than one
hundred million dollars. With Nichols by his side whispering into
his ear, Sam Israel joined an absolutely bizarre world full
(35:12):
of conspiracy theorist fraudsters, all claiming to believe in the
existence of a secret market that can multiply your money
tenfold overnight, all secretly frustrated that they personally have never
been able to get access to that entirely fictional market,
and all trying to rip each other off. At one stage,
(35:34):
Nichols got sam Israel to give him ten million dollars
in cash on the basis of a story about a
stash of treasure stolen and hidden by a Japanese general
in the Second World War and protected by poison gas
booby traps. Then another con man persuaded Nichols to give
him a million dollars to help the finance an expedition
(35:57):
to find the exact same treasure.
Speaker 2 (36:00):
Can we have a recap? Of course, sam Israel was
controlling one hundred million dollars of Buyo Capital's money based
on a fraud, invested that money in.
Speaker 3 (36:10):
Robert Nichols's fraud.
Speaker 1 (36:12):
Robert Nichols then invested that money in yet another fraud.
Speaker 2 (36:16):
Exactly, thank you, are you?
Speaker 1 (36:18):
Surely, though, it's quite hard to give one hundred million
dollars to a fraudster to invest in a special market
protected by assassins and controlled by the thirteen families who
really rule the world. There are hard checks and balances
in place. Several times Sam Israel tried to invest the
one hundred million in one scam or another, and a
(36:39):
banker or a stockbroker simply refused to process the transaction
until there was proof that it was genuine, and there
never was. In the end, the Bayou Capital ponzi scheme
was exposed. But it wasn't because Sam Israel's investors believed
that he had lost his mind, or even that he
(37:01):
had lost their money. They just believed that he'd lost
his touch. They noticed that sam wasn't spending much time
at work. Little did they know that this was because
he was in Europe being taught how to kill a
person with his bare hands by a manly believed was
an elite CIA operative. Bayou's investors asked for their money back,
(37:24):
which would have been fine, except that most of that
money had only ever existed in Dan Marino's fraudulent accounts.
The snowball had grown enormous. The fraud was at last exposed.
Sam Israel was given a sentence of twenty years, and,
(37:45):
as an act of leniency that seems to be common
for white collar criminals, eight weeks of freedom to get
his affairs in order before reporting to jail. Listener, he
did not report to jail. Police found his car parked
on the Bear Mountain Bridge high over the Hudson River
(38:09):
in upstate New York. He left a suicide note and
smudged in the dust on his car's hood were the
words suicide is painless. But Sam Israel's suicide note was
as fictional as his investment returns. The authorities tracked him down,
alive and well and a campsite in Massachusetts. They promptly
(38:31):
sent him to jail. By faking his own suicide, He
got just three more weeks of freedom, and of course
landed his girlfriend in trouble for helping him out. Worth
it surely not in character. Most definitely, Julia's investment troubles, thankfully,
(38:54):
were rather more mundane. Having invested three thousand pounds in
the Women Empowering Women pyramid, she found herself fielding ever
more strident calls from people further up the pyramid, berating
her not finding more recruits. Tricksy, Pucky and Buttons all
(39:14):
had their say. It was, says Julia, like being bullied
by a bunch of fairies. But the curious thing about
women empowering women. Nobody knows who started it. We think
that it's hard to be sure that most Ponzi schemes fail.
When they do, it's because of the relentless logic of
(39:36):
the snowball. Sarah Howe went to prison twice. Sam Israel
faked his own suicide in a desperate attempt to escape.
But the unknown woman who created the whole spiel about
hearts and empowering other women, she's the exception to the
rule that fraud doesn't pay. She pushed a few snowballs
(40:01):
down a steep snowy hill, decided that she'd made enough money,
and before the casualties began to mount down below, she
walked away. But those casualties did exist, and Julia met them.
The grumpy fairies could probably afford to lose the money,
(40:23):
but it was less funny to receive voicemails from distraught
Filipino cleaners who'd bought hearts and now feared they'd lose
three thousand pounds They definitely could not afford to squander,
having run out of spa going pony riding ladies who lunch.
The women empowering women Snowball had started to flatten much
(40:47):
poorer women, women who would struggle to pick themselves up
after the snowball had rolled on. Key sources for this
episode include Julius Stephenson's article Broken Hearts Club, Daniel Davis's
book Lying for Money, and for the astonishing story of
(41:08):
Sam Israel Gee Larson's book Octopus. This live edition of
Cautionary Tales was written by me Tim Harford with Andrew Wright.
Tonight you heard the voice talents of Sarah Job and
Stuart mclachlarn. The original music is the work of Pascal Wise.
(41:29):
Our b s N interpreter was Katherine Motson. The show
was produced by Alice Fines, Marilyn Rusk and Ryan Dilling.
Sarah Nick said it took the script of sound engineer
was Andrew Bayless. The thanks to Zoe Sedmand, Miilm and
a team at the British Best Level of Economics. Portional
Tales is a production of Pushkin Industries. If you like
(41:49):
the show, please remember to rate, share and review. Want
to hear the show ad free sign up the Pushkin
Class on the show page of Apple Podcasts of Pushkin FM,
slash Truce.
Speaker 2 (42:09):
Thank you that was fun. Thank you so much.
Speaker 1 (42:12):
Guys, the Trump impression was Okay. If you've enjoyed this
special live episode about pyramid and Ponzi schemes, don't go away.
I sat down with one of the smartest people I
(42:33):
know in financial journalism, my Financial Times colleague Rob Armstrong,
one of the hosts of the Unheedged podcast, and we asked,
what if everything is a Ponzi scheme. We'll be back
with that in a moment. We're back, and I've been
talking to my Financial Times colleague Rob Armstrong about all
(42:53):
things Ponzie for his podcast Unheedged.
Speaker 5 (43:04):
Pushkin.
Speaker 6 (43:07):
I love a good partsy scheme from Charles Ponzi himself
to Bernie Madoff. I both admire the wicked intelligence of
the puppet masters, and I'm fascinated by the persistent credulity
of the people who fall for Ponzi schemes. Here today
to discuss Ponzi's and pyramids and everything in between with
(43:29):
me is Tim Harford, my fellow FT columnist and master
of his own podcast, Cautionary Tales.
Speaker 5 (43:36):
Tim, how are you?
Speaker 1 (43:37):
I'm great, Robin, pleasure to finally get on Unhedged. I'm
a loyal listener, although I always feel terribly badly dressed.
Whenever I whenever I even think of you, Rob, whenever
I read one of your wonderful columns about sartorial elegance.
The subtext is, this column is written at you, Harford,
you slob, and so it just feels sloody guilty about
(43:59):
the whole thing.
Speaker 5 (44:00):
But yeah, you'll be glad to know I'm sitting in
my bedroom in a T shirt and a pair of jeans.
So I hope that puts you at ease.
Speaker 1 (44:05):
Okay, Yeah, I feel better now, Thank you, Rob.
Speaker 6 (44:08):
I was fascinated to listen to the most recent episode
of Cartiery Tales. It gave a lot of terrific examples,
starting with the immortal Sarah Howe of Ponzy Schemers. Yeah,
tell us what a Ponzi scheme fundamentally is and what
you discovered about them doing that episode.
Speaker 1 (44:27):
Yeah, we had lots of fun cautioning Tales as a
podcast about things going wrong and what we can learn.
And this particular episode is about ponzy schemes and pyramid schemes,
which are obviously always a terrible idea, but they have
a lot of lessons for us and Sarah how Sarah
Howe invented the Ponzi scheme, and can you believe that
it isn't called a house scheme.
Speaker 5 (44:47):
It's outrageous, outrage another woman forgotten by history, unfairly forgotten
by history, all the credit taken by Ponsey.
Speaker 1 (44:55):
Yeah, she was even operating in the same city, in Boston, Massachusetts.
So Sarah Howe set up the Ladies Deposit Company and
basically offered to pay a ladies eight percent a month,
which is basically doubling your money in a year. And
of course there's no way of actually making that return.
And so, as with all ponz schemes, people investing in
(45:17):
this opportunity, if they decide they want to withdraw their money,
then Sarah how just paid them out of incoming money
from other people who were eager to invest. And that's
the fundamental of a ponz scheme. Early investors who are
trying to cash out get paid not out of the
productive return from the productive activity, because there is no
(45:38):
productive activity. They get paid because other people are also
pouring money in. And that's the basic genius of the idea.
And so Cautionary Tales talks about Sarah how who did
this three times, talks about pyramid schemes, and also talks
about this insane Ponzi scheme run by a gentleman called
(45:58):
Sam Israel, which is described in Gye Lawson's book The Octopus,
which is absolutely bonkers because it just goes utterly down
a whirlpool of conspiracy theories, and said, it's quite fun.
Speaker 6 (46:11):
I want listeners to know that this is not a
parochial phenomenon.
Speaker 5 (46:14):
In my home city, Boston.
Speaker 6 (46:16):
I have a good friend and this connects nicely actually
to the Sarah Howe angle. I have a good friend
who about ten years ago in Brooklyn was she's quite
an entrepreneurial person, and was invited by another quite entrepreneurial
person to a meeting of other women and they were
going to talk about investment opportunity and so forth. And
(46:37):
as it turned out, what this meeting of ten or
twelve women was was, you know, I have this project
that I'm working on. I need seed money for this endeavor,
and you know each of you are going to contribute
X amount to my endeavor and then in the next round,
each of you will become a receiver of funds from
other people in the you know, Ladies Empowerment Club of
(46:59):
Brooklyn or whatever. And my friend, who has her head
screwed quite tightly onto her shoulders, looked around at these
well meant in kind of semi bohemian, semi business class
Brooklyn ladies and said, you're all going to jail.
Speaker 2 (47:17):
If you do this.
Speaker 6 (47:18):
This is a proxy scheme, and now looked at her
a gast like they they had no idea that they
were engaged in something untoward or possibly illegal.
Speaker 1 (47:28):
Yeah, part of the issue is that it is not
always straightforward to figure out whether something is a Ponzi
scheme or not, because superficially, I mean, there's a lot
of a lot of stuff in a capitalist economy that involves, well,
you invest some capital and you take a risk, and
if things go well, you get paid back ten x
(47:48):
in the phrase that everyone likes to.
Speaker 6 (47:50):
Use, exactly right, And this was the question listening to
your episode I most wanted to put to you. How
is a market in its bubble phase not exactly like
a Ponzi scheme snowballing insize.
Speaker 1 (48:05):
I love it. So it's like a decentralized Ponzi scheme, Right, It's.
Speaker 6 (48:08):
A decent, naturally occurring, decentralized organic Ponzi scheme where you
know something, the magnificent seven tech stocks start to go bananas,
and rather than a central schemer, a Ponzi or a
how figure, we all do our little part journalists like
you and I Tim. We hype things up by constantly
(48:30):
discussing one way or the other the different stocks. Brokers
have their role to play. Investor chat boards do the job,
and so we all kind of ponzi each other until
we're out of the next person to draw into the
market bubble, at which point the bubble collapses in an
exact reversal of the social structure that built it.
Speaker 1 (48:51):
So I love this idea. So let's use twenty twenty
hind sight. Let's go back and let's think about Amazon
twenty five years ago. And I think a little bit
of hindsight cliphies things. So what distinguishes Amazon from a
Ponzi scheme? Because if you think about it, this is
an organization which in the nineteen nineties, in the early
two thousands was not making money, losing a lot of money, yes,
(49:15):
but it's raising money from investors. So investors are putting
money in and if they wanted to get their money
out again, they could no problem. How do they get
paid well, because other investors are putting money in, so
there's a way to get paid, and more and more
money gets poured.
Speaker 2 (49:31):
Into this thing.
Speaker 1 (49:32):
And the reason it's not a Ponzi scheme, well, there's
two things. One is there's no fraud because Amazon was
perfectly honest about the accounts and perfully honest that it
was losing money, and so there's no deceptions, no fraud.
So that's one reason it's not a Ponzi scheme. The
second reason it's not a Ponzi scheme is in the
end it all comes good. All of that investment does
(49:52):
turn into something productive and everybody can get paid back.
So the first part of that them being honest, Okay,
that's important, but the second part could not be guaranteed.
There's no way of guaranteeing that Amazon would ever make money,
and indeed, lots of those dot com home stocks in
the nineteen nineties never did, and people could make a
(50:13):
lot of money as long as they got out in time,
and that's very ponziush.
Speaker 6 (50:17):
And what is so important about the Amazon example is
that the kind of faith, or if you prefer, kind
of credulity of Amazon's early investors is exactly what allowed
Amazon to become such a great business eventually. In other words,
(50:38):
because the investors didn't insist on being paid out of
the company's profits, Amazon was able to have this wonderful
cycle where it just reinvested all of its capital in
itself and built this incredibly strong, deep, moded, indestructible business
(50:58):
because it wasn't paying money to investors, it was reinvesting
in itself because the investors had that faith.
Speaker 1 (51:04):
So I think we now have a typology. So if
you're putting money in and bill investors get repaid by
from later investors, and the accounts are a sham, that's
a Ponzi scheme and someone's going to jail. If the
early investors get repaid by the late investors putting money
(51:25):
in but there's no accounting forward, people are just over
exuberant and the whole thing all collapses and it's pets
dot com, then no one goes to jail. That's not
a Ponzi scheme. That's a bubble. And if in the
end it turns into a wonderfully productive investments such as Amazon,
it's neither a Ponzi scheme nor a bubble. It's the
(51:45):
genius of capitalism.
Speaker 6 (51:46):
I would argue that the Ponzi scheme and the bubble
case are actually very close together. They're almost indistinguishably close
because other than the absence of the central figure pulling
all the strings, simply because at some point in a
bubble the people involved in it. In markets actually acknowledge
(52:08):
that races are no longer connected to economic fundamentals or
the productivity of the companies involved. They start using words
like momentum, right, and they say, you can't get in
front of momentum.
Speaker 7 (52:21):
The market is pushing upwards.
Speaker 6 (52:23):
If you get out now, you're going to regret it.
Speaker 7 (52:26):
It's fear of.
Speaker 6 (52:27):
Missing out, and to me, that moment you are living
Ponzi logic. In that moment, there will be another person
who will come along and pay more, and I will
be out of this game and somebody else will be
left to hold the bat.
Speaker 1 (52:40):
There's always a story about where the money comes from, right,
And I suppose the thing about bubbly markets is the
stories get less and less rigorous. People don't need a
particularly strong, data driven, compelling story. They're just like any
story will do. I'm greedy now and a lot of
the Ponzi stories. So, I mean, Charles Ponzi's original story
(53:02):
was something to do with the arbitrage of international postal
reply coupons. Really that's going to work, but people believed it.
Speaker 6 (53:11):
There's another question I wanted to ask you, which is
all of the ponzis you talked about in your podcast,
and indeed all the ones I know of, and I'm
thinking here, of course, of Bernie Madeoff, the most famous
of the recent ponzis.
Speaker 7 (53:25):
These all turn out very poorly.
Speaker 5 (53:27):
For the puppet masters, very poorly.
Speaker 7 (53:29):
So there's a question.
Speaker 6 (53:31):
There's a question about why US suckers fall for them.
But there's a way in which the puppet master is
the ultimate sucker. They've somehow believed their own Ponzi scheme
in some way and they end up in jail or
disgraced her.
Speaker 5 (53:44):
Why do they do it?
Speaker 1 (53:45):
I really am not sure why they do it. I
suppose you could say, well, if the Ponzi schemes do
somehow work out, if the international postal reply coupon arbitrage works,
then everyone gets paid back in the end. I guess
Sam Israel, who ran the Bayu Capital Ponzi scheme, maybe
he would have gotten away with it if one of
(54:05):
his attempts to swing for the fences.
Speaker 2 (54:08):
Had paid off.
Speaker 1 (54:09):
But ultimately, there's a really interesting idea which I was
introduced to by the writer Dan Davis, who wrote this
terrific book about fraud called Lying for Money, and he
basically points out that if you take a typical Ponzi scheme,
So let's say you're promising to the double people's money
every year. Okay, So you take one hundred dollars from
a little old lady and you steal it. Okay, Now
(54:31):
in a year, you need to pay her two hundred dollars.
That's okay. So you find two other little old ladies,
you steal their money and you pay the first little
old lady. Now, of course, in a year's time, you've
got to do it all again, and each year you're
owing twice as much money, and you need to defraud
twice as many little old ladies to pay the previous
little old ladies. So that's all kind of obvious, and
it's obvious that that can't keep going forever. That's an
(54:54):
exponential process that's all going to come unraveled. But what
Dan Davis pointed out is what is easy to miss
is that can balloon into thousands and thousands and thousands
of dollars based on the original one hundred dollar theft.
The frauds that only stole one hundred dollars, and somehow
now they're responsible for maintaining this enormous fraud, and no wonder,
(55:18):
so many of them are crying with relief when they're
finally arrested, like, thank goodness, I don't have to do
this anymore. So I don't know why people do this.
Speaker 6 (55:27):
It's the magician's apprentice story. You cast the spell, and
all of a sudden, it's much bigger than you are.
And I think there is a general point about fraudsters
that clearly applies to some Ponzi fraudsters is that they
do get into it by mistake. You start a fund,
you're struggling to be a legitimate investor.
Speaker 7 (55:48):
Something goes slightly wrong.
Speaker 6 (55:50):
And okay, just one month, I'm going to fudge the
numbers so I can pitch to one more investor.
Speaker 7 (55:57):
And then that takes on a life of its own.
Speaker 6 (55:59):
You get into it incrementally by small steps, and suddenly
the thing grows by leaps and bounds. And I think
there's a way to read the Bernie Madoffski as having
some of that character, and you can read Madeoff's actions
late in the scheme as desperately trying to keep the
thing under control, turning investors away as it because he
(56:24):
couldn't handle it.
Speaker 1 (56:25):
And it just gets so huge that in the end,
the gap between the underlying reality of the investments, like
how much money you are really generating in postal reply
coupon arbitrage, and the fiction what you're telling people you
are making, that gap eventually becomes impossible to bridge. A
lot of Ponzi schemes. I think it's ambiguous at the start.
(56:46):
Did they mean it to be a Ponzi scheme or
did they actually think they were investment geniuses that everyone
would get paid back. There is often an ambiguity at
the start, but unless you're able to close the fraudulent
gap early, it becomes so unbridgable you don't have a chance.
Speaker 6 (57:01):
Tim, If you give me one hundred dollars, I have
a brilliant idea.
Speaker 2 (57:06):
I'm always.
Speaker 6 (57:11):
This is long short, that portion of the show where
we go long something we like or short something we
don't like.
Speaker 5 (57:19):
Tim, are you long or short something?
Speaker 1 (57:22):
Can I go for a paired trade rather than do Greg.
So I'm going to go short Ponzi and long pyramid schemes.
So we should probably very briefly explain the difference. So
a Ponzi scheme, someone's running a Ponzi scheme. They're lying,
they're paying out earlier investors using money from later investors.
(57:43):
Pyramid scheme works in a similar way, but it's it's decentralized.
You basically get the later investors to send money to
the early investors, and then the later investors then have
to recruit even later investors to pay them. And it's
more transparent. But more to the point, there's nobody actually
running a thing.
Speaker 2 (58:01):
And what that means.
Speaker 1 (58:02):
Is that the person who sets up each individual pyramid
scheme can cash out and walk away. And in fact,
the pyramid scheme I describe in the cautionary tale, we
have no idea who set it up. She seems to
have got fairly rich and just walked away and she never.
Speaker 5 (58:18):
Went to jail.
Speaker 8 (58:19):
And we don't you say she, Tim? You say she,
But I think we're talking about you, Tim, or are we?
I couldn't possibly comment, couldn't possibly come in. Well, okay,
I'm short ponzi, long pyramid? Do you have a long
or a short for us?
Speaker 5 (58:34):
Well, let me ask you a question. Is bitcoin a
ponzi or a pyramid? Neither or neither?
Speaker 1 (58:40):
I mean I think it's more it's more bubbly than either.
But it's not a Ponzi scheme because there's nobody in charge.
That's the whole point of bitcoin, right, Nobody is in charge.
So if it's anything, it's closer to a pyramid scheme,
where transparently, if you want to get paid for investing
in bitcoin, you get paid by other people coming in
and buying your bitcoin, So it's closer to a pyramid scheme.
Speaker 5 (59:01):
I'm going to be sure bitcoin just because I'm a coward.
Speaker 1 (59:04):
Well, I think that that's your inalienable, right, Robin. I
think I might join you in your.
Speaker 5 (59:09):
Cowdi Thanks for being on the show.
Speaker 1 (59:12):
Oh that's a real pleasure.
Speaker 5 (59:13):
Thank you. I loved it. Listeners.
Speaker 6 (59:16):
If you like Unhedged, you will love cautionary tales Tim's
podcast Unhedged. We'll be back in your feed before you
know it. Thanks for listening. Unhedged is produced by Jake
Harper and edited by Brian Ernstadt. Our executive producer is
Jacob Goldstein.
Speaker 5 (59:33):
You have additional help from.
Speaker 6 (59:35):
Toeprah foreheaz Cheryl Brumley is the FT's global head of Audio.
Special thanks Laura Clark, Alistair Mackey, Branda Cone, Marilyn Rust,
Kira Posey, and Natalie Sadler. FT Premium subscribers can get
the Unhedged newsletter for free.
Speaker 7 (59:52):
My thirty day free trial is available to everyone else.
Speaker 5 (59:55):
Just go to ft dot com slash Unhedged offer. I'm
Rob Armstrong. Thanks for listening.
Speaker 1 (01:00:07):
That was a special episode of the Unhedged podcast. If
you liked what you heard, you know where to find Unhedged,
the same place you find all good podcasts. Cautionary tales
will be back in this feed soon
Pushkin, Do you know your Ponzi schemes from your pyramid schemes?
The following episode digs into the pitfalls of get rich
Quick scams. It was recorded in front of a live
audience at the Bristol Festival of Economics. Gosh, wow, are
(01:01):
you already excellent? Okay, so we will begin. Sophie and
Julia were relaxing on the riverside terrace of a fancy
(01:21):
London spa, two rich girls joined by an even richer one, Tatiana,
the glamorous wife of an investment banker. Tatiana ordered another
bottle of champagne and launched into her sales pitch. You
simply must buy our heart. Julia and Sophie looked at
(01:43):
each other and sighed. This wasn't the first time they
had heard the spiel. It was the summer of two
thousand and three, and hearts with a capital H were
all the rage among the champagne drinking, horse riding banker
marrying ladies of Great Britain. Here's how it worked. You
(02:04):
donated three thousand pounds to buy a heart and join
the scheme at the bottom of a pyramid. That's about
six thousand dollars in today's money, Your money would go
to the person at the top, called the receiver.
Speaker 2 (02:21):
They'd leave the pyramid.
Speaker 1 (02:23):
The two people on the next level down would be
promoted to the top.
Speaker 2 (02:27):
Roll of receiver.
Speaker 1 (02:28):
In fact, the pyramid would then split into two, so
that both of them would be at the top of
their own pyramid. Everyone would move up a level, and
everyone on the lowest layer, including you, would recruit two
people to buy a heart and fill in the newly
vacant layer beneath you. Six weeks later, you would be
(02:52):
a receiver and would get twenty four thousand pounds, the
equivalent of fifty thousand dollars today, and a huge return.
Speaker 2 (03:03):
No matter how you measured it, the money just.
Speaker 1 (03:07):
Grew like a snowball rolling downhill until it became an avalanche.
If you're not halfway through your second bottle of lunchtime champagne,
you can probably spot the problem here. This is transparently
(03:29):
a pyramid scheme, and pyramid schemes don't make money, they
just move it around. If someone's going to make twenty
four thousand pounds, then that money must come from other members,
so eight other people must lose their investment of three
thousand pounds.
Speaker 2 (03:47):
It's really that simple.
Speaker 1 (03:50):
In order to persuade people to join a pyramid scheme,
there's often some sort of story designed to obscure this
implacable arithmetic. This one about buying a heart was marketed
as feminism. The whole project was called Women in Empowering Women.
Speaker 2 (04:11):
Men weren't allowed. Men are more corruptible.
Speaker 1 (04:15):
They can't be trusted, as Tatiana explained. She also added
that she had spent her first wind fall on a
little intimate plastic surgery that she preferred not to discuss
with her husband. Julia and Sophie were tempted, as Julia
later recalled in an article for the Mail on Sunday newspaper.
(04:37):
Then Tatiana whispered that apparently the supermodel Claudius Schieffer had
been spotted at a women Empowering Women party at a
mansion in central London. That was the clincher sign me up,
said Julia. Things moved quickly. The next day, Julia received
(05:00):
a phone call from a lady called Elfie, who was
collecting her boy Archie from an exclusive London school. Darling,
I must be quick, but I couldn't wait to tell
you the news. You've already moved up a line.
Speaker 3 (05:16):
You're one step closer to becoming a receiver.
Speaker 2 (05:21):
Wonderful, replied Julia.
Speaker 1 (05:23):
So now you must send me three thousand pounds. I'm
Tim Harford and you're listening to Cautionary Tales live at
the Bristol Festival of Economics. This is a cautionary tale
(05:48):
about investment scams and about the way that they snowball
out of control, often flattening not only the victims but
the fraudster too. Some of those fraudsters are anonymous figures. Julia,
Sophie and even Tatiana had no idea who set up
women empowering women, but some of them are not. Few
(06:12):
people are less anonymous than Samuel Israel, the Third. Let's
call him Sam Israel for short. Sam came from a
wealthy family of commodity traders in New Orleans, but was
determined to make his own way in life. He started
at the bottom in nineteen seventy eight, dropping out of
(06:34):
college to run errands for one of Wall Street's most
famous share traders. Sometimes those errands merely meant fetching pizza.
Sometimes they involved going to a particular room in the
Pierre Hotel on the Upper east Side and speaking a
code phrase to a Swiss gentleman.
Speaker 3 (06:55):
The weather is nice for this time of year, yes.
Speaker 1 (07:00):
But today it looks like rain. The Swiss man gave
Sam a satchel. Sam didn't look inside it until his
boss showed him that it was filled with one hundred
dollar bills, well over one hundred thousand dollars at a
time when one hundred thousand dollars was real money. Odd
(07:22):
things like this tended to happen from time to time,
and through it all, Sam Israel watched and learned and
kept his mouth shut, and he began to thrive on
Wall Street. Sam married a childhood sweetheart, an ice girl
called Janis. She was sensible, training to be an accountant.
(07:45):
It wasn't the ideal match. I hid everything from Janis,
Sam Israel confessed to the Rolling Stone journalist Gee Lawson.
Speaker 4 (07:55):
I've been hiding things from her since we were kids.
She was the responsible worker. I was the fuck up.
I smoked weed and snorted coke. I couldn't talk to
her about what was really going on because I couldn't
confide in her.
Speaker 1 (08:09):
And what was really going on That depends on when
you asked the question. In nineteen seventy eight, Sam was
quietly being a courier of satchels full one hundred dollar bills.
The night before he married Janis, Sam was having a
threesome with two expensive call girls, paid for by his
(08:30):
Wall Street trader boss as a wedding gift. In nineteen
eighty seven, Sam was making a small fortune by fortuitously
betting that the market would fall just before the largest
one day crash in Wall Street history. Sam always swore
he could have made more if the Federal Reserve hadn't
(08:50):
swooped in printing money to prop up the market. In
the early nineteen nineties, Sam was winning and losing huge
sums several times over by trading on insider tips.
Speaker 2 (09:03):
Some good and some bad.
Speaker 1 (09:07):
Sam couldn't talk to janisout any of this, of course.
But what Sam really couldn't talk to Janis about was
by you capital, By you capital was well, it was
a con. But let's come back to that. Let's talk
about a simpler con first. An early example, if you like,
(09:31):
of women empowering women.
Speaker 2 (09:35):
In eighteen seventy.
Speaker 1 (09:37):
Eight, refined ladies of Boston, Massachusetts, were intrigued to hear
of a wonderful investment opportunity. A new bank, founded by
women for women and called the Ladies Deposit Company, paid
interest of eight percent. Eight percent a year would be
(09:59):
a solid enough offering. The Lady's Deposit Company, however, paid
eight percent every month, deposit one hundred, and by the
end of the year you'd have earned ninety six dollars,
nearly doubling your original investment. There were no rumors of
supermodels back in eighteen seventy eight, but the gossip suggested
(10:23):
something even more reassuring. The Ladies Deposit Company was said
to be backed by a Quaker charity doing many unspecified
good works. Only unmarried women need apply. Such unprotected women
(10:44):
who lacked the security of a husband's income were in
a precarious position. Either they were poor and trying to
earn a wage in a world where women were barred
from well paid jobs, or they were of a social
background where they were expected to live off an inheritance.
The investment return on that inheritance, then was a matter
(11:06):
of huge importance, and eight percent a month too good
to miss, or alternatively, too good to be true. The
Ladies Deposit Company was not founded by Quakers, but by
a stage psychic and professional fortune teller named as Sarah Howe.
(11:28):
The company had some similarities with a pyramid scheme like
the Hearts of Women Empowering Women, but also some differences.
The grim arithmetic of the scheme was concealed. Money poured
into the Ladi's Deposit Company, money poured out, and the
mechanics of how it all worked were conveniently obscure. One
(11:53):
intrepid reporter even disguised himself as a woman one can
only presume that no female journalists were available in order
to gain entry to the Deposit Company's headquarters, but he
didn't learn much. We never disclose the methods by which
we do business, was all that the company's employees would say.
(12:17):
Sarah Howe had established what we'd now call a Ponzi scheme,
named after Charles Ponzi, a flamboyant Bostonian whose own cover
story was something to do with international postage coupons. Sarah
Howe had the same basic idea in the same city
nearly fifty years earlier. But women never seem to get
(12:41):
the credit for inventing anything, even investment fraud. The local
press soon concluded that the Ladies Deposit Company.
Speaker 2 (12:51):
Was an obvious scam.
Speaker 1 (12:53):
The Boston Daily Advertiser published an illustrated explainer, some articles
highlighting the stage psychic hows, rather questionable qualifications, and a
prediction that the whole thing would collapse in short order.
In the face of this negative publicity and some twitchy depositors,
(13:15):
Sarah Howe decided that the best way forward was bluff.
She announced that anyone who wanted their money back with
interest in full, could have it immediately. She hoped that
the ladies of Boston would be so reassured by this
offer that they wouldn't take it up. Alas, the ladies
(13:36):
of Boston were not reassured at all. They asked for
their money back, and when Sarah Howe didn't have it,
she went to jail. The Lady's Deposit Company is a
wonderful illustration of what Dan Davies in his book Lying
for Money calls the snowball effect. These scams need to
(14:00):
suck in an ever growing number of dupes to keep going,
and eventually that snowball of money rolling downhill, becoming bigger
and bigger, simply falls apart.
Speaker 2 (14:13):
It's too big.
Speaker 1 (14:15):
Remember, Sarah Howe was offering to almost double your money
in a year. If you invested with her. So let's
watch the snowball from a safe distance. Imagine that Sarah
receives an investment of one hundred dollars from a little
old lady and steals it. By the end of the year,
(14:38):
that little old lady expects her one hundred dollars back,
on top of ninety six dollars in interest. So Sarah
finds two more investors, steals their money, and gives it
to the little old lady. But by the end of
the following year, Sarah Howe needs to have given nearly
two hundred dollars to both of her investors. To do that,
(15:01):
she needs four new investors, who shouldn't be hard to
find if they think they're going to double their money.
When the four new investors want a total of eight
hundred dollars back, she just needs to find eight new
investors to join the Lady's Deposit Company.
Speaker 2 (15:17):
Now you can see the trap here.
Speaker 1 (15:20):
Eventually there will be no more lady depositors for the
Lady's Deposit Company. But what's perhaps less immediately obvious is
that in this little story, Sarah Howe will soon owe
sixteen hundred dollars to eight investors. And yet she only
(15:41):
ever stole one hundred dollars for herself. The growing snowball
of fraud is huge, and it needs to keep getting huger.
The profit for the fraudster as rellatively tiny. No wonder
that so many fraudsters eventually get caught, and no wonder
perhaps that when they do get caught, so many of
(16:03):
them weep with relief. There will be tears a plenty,
but not much relief.
Speaker 2 (16:13):
After the break.
Speaker 1 (16:34):
In the summer of two thousand and three, Julia started
to try to recruit investors to buy hearts for women,
empowering women. Julia had been signed up by Tatiana, the
banker's wife, over champagne at the Spa. She had sent
three thousand pounds to Elfie, the mother of Darling Archie
from the Fancy School, but Julia's own recruitment efforts were
(16:58):
going nowhere. Her rich friends sneered at her that had
already been approached so many times to invest in her
heart that the whole affair had become a bore ring joke.
Horror friends were less likely to have heard about the scheme,
but they were also less likely to have the money
to invest. I mentioned that as a matter of simple arithmetic.
(17:24):
For everyone who makes twenty four thousand pounds in a
pyramid scheme, there must be eight people who lose three
thousand pounds. But how can it be that so many
people lose out? Well, that's simple too. Every time a
new group of recruits is brought in, the entire operation
has to double in size. Every recruit finds two more recruits,
(17:47):
and every pyramid becomes two pyramids. The rolling snowball becomes
a vast snow boulder, then collapses into a destructive avalanche
of disappointment and loss. Pyramid schemes fail because they run
out of recruits just after becoming huge, when a vast
(18:10):
number of people have recently joined but not yet cashed out.
Speaker 2 (18:16):
Julia was one of those people.
Speaker 1 (18:19):
In growing desperation, Julia went to a recruitment party in
the hope of recruiting new investors. She'd been told tales
about parties in central London mansions, champagne being quaffed with
supermodels as suitcases of cash were handed to people who'd
(18:40):
reached the top of the pyramid. That this recruitment party
was in a hairdressers instead of champagne. On ice, there
was warm white wine, and a growing sense of irritation
that Julia's failure to recruit was letting down everyone above
(19:00):
her in the pyramid. There was, of course, no sign
of Claudia Schieffer. The brilliance of women empowering women is
that it seems to have been largely self organizing. Many scams,
in contrast, require.
Speaker 2 (19:19):
A lot of hard work. Just ask Sam Israel.
Speaker 1 (19:25):
He set up his ill fated hedge fund by you
Capital in nineteen ninety six, assisted by an accountant named
Dan Marino, who lived with his mother and.
Speaker 2 (19:37):
Dreamed of greatness.
Speaker 1 (19:40):
Apparently, Sam actually intended to run an honest hedge fund,
or if not quite honest, a hedge fund that would
make money for investors. His business plan, by You Capital
would use a new computer algorithm he had developed, plus
the skills of a once great trader whom Sam had
(20:00):
hired after he had fallen on hard times, plus a
few insider tips like in the old days when he'd
collect bags of cash from the Pierre Hotel. That should
do the trick, thought Sam.
Speaker 2 (20:14):
But it didn't.
Speaker 1 (20:16):
The once great trader was washed up. He made a
lot of bad calls. The computer algorithm seemed to misfire
as often as it worked, and Sam didn't have the
same insider access that.
Speaker 2 (20:29):
He used to. After a couple of lackluster.
Speaker 1 (20:32):
Years in which Sam loudly told his few investors that
the funds results were great, he pondered his options. The
results were not in fact great, and if he simply
published the firm's accounts showing a loss, the investors would
yell at him for all his empty boasts, and Bayou
(20:53):
Capital would collapse. Or alternatively, Sam and his colleagues, the
washed up trader and the accountant who lived with his mum,
could lie, could publish audited accounts which claimed stella results.
(21:15):
Like Sarah Howe, they'd be offering fantastic returns. Unlike Sarah Howe,
who would simply steal money from new depositors and pay
it out as interest, they'd need to show some kind
of evidence that they were making profitable investments. To do that,
they'd need a fraudulent auditor. No problem. Dan Marino simply
(21:40):
set up his own audit firm, marking his own homework.
Nobody ever checked that the auditor who was verifying that
Dan Marino was telling the truth was a Dan Marino.
It probably didn't hurt that if anyone ever tried to
search for Dan Marino on the still young worldwide Web,
(22:03):
they were sure to get Dan Marino, the unimaginably famous
Miami Dolphins quarterback, rather than Dan Marino the crooked accountant.
For a while, the plan was that Sam would go
on a profitable streak and actually make the profits that
Dan Marino's fake accounts were claiming. But the snowball was
(22:26):
starting to grow. The more profit they said they were making,
the larger the fictional pot of money was growing, and
the harder it was for Sam and his partner to
catch up to their own lies. It didn't help that
Sam kept claiming to outperform the market. Dan Marino was
(22:46):
losing his mind at the fact that Sam couldn't control himself.
Speaker 3 (22:50):
When they had a good month and made money, they
used that as the performance number.
Speaker 1 (22:55):
Complained Dan to the journalist Gee Lawson.
Speaker 3 (22:57):
When they had a bad month, they used a made
up number.
Speaker 2 (23:01):
That won't work.
Speaker 1 (23:03):
If you let the fraud snowball grow too big, you'll
never get it under control. Sam Israel would never be
able to catch up to his own lies because he
could never bring himself to pretend he'd had a bad
quarter when it had a good one.
Speaker 3 (23:17):
We went with grace and luls with integrity.
Speaker 1 (23:20):
Boasted Sam to his investors. Dan Marino knew the awful truth.
Speaker 3 (23:26):
I stopped tracking the published numbers against the real numbers.
Speaker 2 (23:29):
Said Marino.
Speaker 1 (23:30):
The snowball was already too big.
Speaker 3 (23:33):
Oh, it made me sick to my stomach.
Speaker 1 (23:37):
Four years after the Ladies Deposit Company was exposed by
the Boston Daily Advertiser and collapsed, ands Sarah Howe was
sent to prison. Refined women of Boston, Massachusetts, were intrigued
to hear of a wonderful investment opportunity. A new bank,
founded for women by women and called the Boston Women's Bank,
(24:03):
paid interest of seven percent per month. Too good to miss,
or alternatively, too good to be true. After a couple
of years, the Boston Daily Advertiser discovered and published the truth.
The manager of the Boston Women's Bank was not missus J. C. Ewle,
(24:29):
as advertised, but an ex convict by the name of
Sarah Howe. Sarah Howe had learned one lesson this time.
She skipped town and moved to Chicago. In due course,
the refined Ladies of Chicago, we're intrigued to hear of
(24:53):
a wonderful investment opportunity The Lady's Provident Aid Society was
offering interest of Oh never mind, the police caught up
with miss Sarah Howe shut down the Lady's Provident Aid Society,
and so enough.
Speaker 2 (25:10):
As Howe was back in prison.
Speaker 1 (25:12):
Worth it surely not in character, most definitely, Sometimes when
the snowball starts to roll, the fraudster just can't quit.
Sam Israel seemed to have it all, a loving wife
and children, a luxurious home, and at least on paper,
(25:35):
a fortune to his name. But appearances can be deceptive.
Sam was a mess. He was taking too much cocaine
and drinking far too much booze, and like so many people,
he had become addicted to painkillers after a back injury.
All the while, the fraud snowball was growing. But Sam
(25:58):
and Dan had one advantage, which is that a fraudulent
hedge fund doesn't have a cell by date. That's different
from the other scams we've heard about. Tatyana was promising
Julia that women empowering women would multiply her money in
just six weeks. The Ladies Deposit Company promised to almost
(26:18):
double investors' money after a year. But by you capital
was different because hedge fund investors didn't tend to withdraw
their money if things seemed to be going well. Instead,
they sat back and watched the snowball grow. But the
more by you capital snowball grew, the harder it would
(26:40):
ever be for Sam Israel to trade his way out
of the lie. One September Friday, his computer algorithm suggested
a big bet on shares going up in the next week.
Sam made that bet. The following Tuesday morning, two airliners
(27:02):
swept out of the cloudless sky above Manhattan and crashed
into the World Trade Center. The world reeled with the
implications of the atrocity, but for Sam Israel and Dan Marino,
the only thing that mattered was how it changed their
own twisted financial world. Sam was aghast that his bet
(27:25):
had spectacularly backfired, while Dan Marino spotted an opportunity close
the fund. Said Dan Marino and ten investors, he lost
most of their money in the aftermath of nine to eleven,
and give the dregs back. Everyone will yell, but nobody
will suspect anything, and neither you nor I will.
Speaker 3 (27:46):
Go to jail.
Speaker 1 (27:47):
Please speG Marino, But sam Israel wouldn't do it. He
knew that if by you capital folded, he might escape jail,
but it'd still lose his fancy home. He should have
listened to Marino, because within two years he was going
to lose his home anyway. Cautionary tales, We'll be back
(28:10):
in a moment. In two thousand and three, Sam Israel
(28:38):
was at home leaning over a line of white powder
with a rolled twenty dollar bill up his nose.
Speaker 2 (28:46):
When his wife.
Speaker 1 (28:46):
Janice walked in. She became upset. He became outraged. How
dare she suggests he was taking cocaine. She persuaded him
to take urine tests to ensure he stayed off the drugs,
until one evening he angrily unzipped his pants and went
all over the bathroom floor, bellowing.
Speaker 3 (29:08):
You want yourn.
Speaker 1 (29:10):
At Thanksgiving that year, he passed out over the turkey.
By Christmas two thousand and three, janis had thrown him
out of their house and secured a protective order. Sam
rented the most tasteless, ostentatious bachelor pad he could find,
(29:34):
a vast Tudor style manner, with outsized chandeliers, marble bathrooms,
and comically huge beds. Sam paid the monthly rent of
twenty two thousand dollars to the house's owner, a.
Speaker 2 (29:48):
Gentleman by the name of Donald Trump.
Speaker 3 (29:53):
So good, so good, amazing house, huge beds.
Speaker 1 (30:00):
Sam hung around clubs, tipping the bartender to introduce him
to pretty women. He fitted the Trump mansion with the
latest trading A seventeen screens so he could work from home.
He was still looking for a way to make all
the money back, but the fraud snowball that Bayou was
getting bigger and bigger, and Dan Marino had had a
(30:22):
couple of near misses when investors or regulators had asked
to see documents that would prove highly incriminating. Marino was
reduced to sending those incriminating documents to counterparties on a
Friday evening in the hope that they would be tossed
into a backlog file and then buried under the Monday
morning rush. Amazingly, that tactic worked, but it couldn't work forever.
Speaker 2 (30:47):
Dan and Sam.
Speaker 1 (30:49):
Were going to jail for sure unless Sam Israel could
find a sure fire scheme to make How big was
the snowball Now there were several hundred million dollars Sam
Israel was starting to get desperate. There's an old saying,
(31:10):
you can't cheat an honest man, and there's truth in
that saying, because the premise of a scam is often simply.
Speaker 3 (31:18):
I'm doing crimes, and if you come and do crimes
with me, we'll both make money.
Speaker 1 (31:24):
That's a sales pitch to drive away honest folk, but
it also has some appeal because it provides a logical
reason why there might be quick money to be made
for someone who could keep a secret. Sam Israel was
not an honest man. He'd seen enough cheating on Wall
Street to know that the game was often fixed, and
(31:46):
the crazy simplicity of the Bayou fraud, coupled perhaps with
the fact that Sam was taking a lot of drugs,
was just starting to make him doubt everything. How many
other hedge funds were just Ponzi schemes? What else was
a Ponzi scheme? He had seen the Federal Reserve magic
(32:06):
money out of thin air after that great crash of
nineteen eighty seven, when Sam had made so much money
and could have made more if the FED hadn't stepped in.
The FED stepped in after nine to eleven too.
Speaker 3 (32:18):
Who exactly was running the world economy.
Speaker 1 (32:20):
Anyway, Sam started to run in strange conspiratorial circles. If
you want the full story, it's told in incredible cringe
making detail in Gee Lawson's book Octopus, which describes an
astonishing cast of characters and an even more astonishing array
(32:42):
of delusional beliefs. Sam became obsessed with finding the undoctored
footage showing who really killed JFK. He believed he had
been attacked by an assassin on the streets of Hamburg,
and that had blown the man's brains out in self defense.
Needless to say, Hamburg's police have no record at all
(33:04):
of such events. Above all, Sam came to believe in
a global conspiracy thirteen powerful families who truly rule the world,
whom he called the Octopus. It all gets very, very weird.
Do read the book. It's quite a trip. But for
(33:26):
our purposes, what we need to know is that Sam
Israel fell under the spell of a man called Robert
Booth Nichols, who was claimed to be a top CIA agent,
whose bare hands were said to be deadly weapons, and
who was undoubtedly a confidence trickster. Like an aging chain
(33:48):
smoking James Bond. He swaggered around London City with tight
controls on firearms with a revolver in a shoulder holster.
Sam believed that Nichols had access to a special CIA
program which monitored every bank transaction on the planet, an
insider trader's dream, and he flew out to London to
(34:10):
beg Nichols to give it to him. He'd do anything,
he said. Do you have one hundred million dollars in cash?
Said Nichols, I do.
Speaker 3 (34:19):
I've got one hundred million in cash.
Speaker 2 (34:22):
Do you have one hundred and fifty million?
Speaker 3 (34:25):
Yes.
Speaker 1 (34:27):
Forget the special CIA program which monitors bank accounts.
Speaker 2 (34:30):
Said Nichols.
Speaker 1 (34:31):
We can make some real money together if we can
access a special secret market operated by the thirteen families
who together secretly rule the world.
Speaker 2 (34:42):
You know the octopus.
Speaker 1 (34:46):
And just as Julia had said to Tatiana at the
Riverside spa, Sam Israel said to Nichols, sign me up,
but not for three thousand pounds, for more than one
hundred million dollars. With Nichols by his side whispering into
his ear, Sam Israel joined an absolutely bizarre world full
(35:12):
of conspiracy theorist fraudsters, all claiming to believe in the
existence of a secret market that can multiply your money
tenfold overnight, all secretly frustrated that they personally have never
been able to get access to that entirely fictional market,
and all trying to rip each other off. At one stage,
(35:34):
Nichols got sam Israel to give him ten million dollars
in cash on the basis of a story about a
stash of treasure stolen and hidden by a Japanese general
in the Second World War and protected by poison gas
booby traps. Then another con man persuaded Nichols to give
him a million dollars to help the finance an expedition
(35:57):
to find the exact same treasure.
Speaker 2 (36:00):
Can we have a recap? Of course, sam Israel was
controlling one hundred million dollars of Buyo Capital's money based
on a fraud, invested that money in.
Speaker 3 (36:10):
Robert Nichols's fraud.
Speaker 1 (36:12):
Robert Nichols then invested that money in yet another fraud.
Speaker 2 (36:16):
Exactly, thank you, are you?
Speaker 1 (36:18):
Surely, though, it's quite hard to give one hundred million
dollars to a fraudster to invest in a special market
protected by assassins and controlled by the thirteen families who
really rule the world. There are hard checks and balances
in place. Several times Sam Israel tried to invest the
one hundred million in one scam or another, and a
(36:39):
banker or a stockbroker simply refused to process the transaction
until there was proof that it was genuine, and there
never was. In the end, the Bayou Capital ponzi scheme
was exposed. But it wasn't because Sam Israel's investors believed
that he had lost his mind, or even that he
(37:01):
had lost their money. They just believed that he'd lost
his touch. They noticed that sam wasn't spending much time
at work. Little did they know that this was because
he was in Europe being taught how to kill a
person with his bare hands by a manly believed was
an elite CIA operative. Bayou's investors asked for their money back,
(37:24):
which would have been fine, except that most of that
money had only ever existed in Dan Marino's fraudulent accounts.
The snowball had grown enormous. The fraud was at last exposed.
Sam Israel was given a sentence of twenty years, and,
(37:45):
as an act of leniency that seems to be common
for white collar criminals, eight weeks of freedom to get
his affairs in order before reporting to jail. Listener, he
did not report to jail. Police found his car parked
on the Bear Mountain Bridge high over the Hudson River
(38:09):
in upstate New York. He left a suicide note and
smudged in the dust on his car's hood were the
words suicide is painless. But Sam Israel's suicide note was
as fictional as his investment returns. The authorities tracked him down,
alive and well and a campsite in Massachusetts. They promptly
(38:31):
sent him to jail. By faking his own suicide, He
got just three more weeks of freedom, and of course
landed his girlfriend in trouble for helping him out. Worth
it surely not in character. Most definitely, Julia's investment troubles, thankfully,
(38:54):
were rather more mundane. Having invested three thousand pounds in
the Women Empowering Women pyramid, she found herself fielding ever
more strident calls from people further up the pyramid, berating
her not finding more recruits. Tricksy, Pucky and Buttons all
(39:14):
had their say. It was, says Julia, like being bullied
by a bunch of fairies. But the curious thing about
women empowering women. Nobody knows who started it. We think
that it's hard to be sure that most Ponzi schemes fail.
When they do, it's because of the relentless logic of
(39:36):
the snowball. Sarah Howe went to prison twice. Sam Israel
faked his own suicide in a desperate attempt to escape.
But the unknown woman who created the whole spiel about
hearts and empowering other women, she's the exception to the
rule that fraud doesn't pay. She pushed a few snowballs
(40:01):
down a steep snowy hill, decided that she'd made enough money,
and before the casualties began to mount down below, she
walked away. But those casualties did exist, and Julia met them.
The grumpy fairies could probably afford to lose the money,
(40:23):
but it was less funny to receive voicemails from distraught
Filipino cleaners who'd bought hearts and now feared they'd lose
three thousand pounds They definitely could not afford to squander,
having run out of spa going pony riding ladies who lunch.
The women empowering women Snowball had started to flatten much
(40:47):
poorer women, women who would struggle to pick themselves up
after the snowball had rolled on. Key sources for this
episode include Julius Stephenson's article Broken Hearts Club, Daniel Davis's
book Lying for Money, and for the astonishing story of
(41:08):
Sam Israel Gee Larson's book Octopus. This live edition of
Cautionary Tales was written by me Tim Harford with Andrew Wright.
Tonight you heard the voice talents of Sarah Job and
Stuart mclachlarn. The original music is the work of Pascal Wise.
(41:29):
Our b s N interpreter was Katherine Motson. The show
was produced by Alice Fines, Marilyn Rusk and Ryan Dilling.
Sarah Nick said it took the script of sound engineer
was Andrew Bayless. The thanks to Zoe Sedmand, Miilm and
a team at the British Best Level of Economics. Portional
Tales is a production of Pushkin Industries. If you like
(41:49):
the show, please remember to rate, share and review. Want
to hear the show ad free sign up the Pushkin
Class on the show page of Apple Podcasts of Pushkin FM,
slash Truce.
Speaker 2 (42:09):
Thank you that was fun. Thank you so much.
Speaker 1 (42:12):
Guys, the Trump impression was Okay. If you've enjoyed this
special live episode about pyramid and Ponzi schemes, don't go away.
I sat down with one of the smartest people I
(42:33):
know in financial journalism, my Financial Times colleague Rob Armstrong,
one of the hosts of the Unheedged podcast, and we asked,
what if everything is a Ponzi scheme. We'll be back
with that in a moment. We're back, and I've been
talking to my Financial Times colleague Rob Armstrong about all
(42:53):
things Ponzie for his podcast Unheedged.
Speaker 5 (43:04):
Pushkin.
Speaker 6 (43:07):
I love a good partsy scheme from Charles Ponzi himself
to Bernie Madoff. I both admire the wicked intelligence of
the puppet masters, and I'm fascinated by the persistent credulity
of the people who fall for Ponzi schemes. Here today
to discuss Ponzi's and pyramids and everything in between with
(43:29):
me is Tim Harford, my fellow FT columnist and master
of his own podcast, Cautionary Tales.
Speaker 5 (43:36):
Tim, how are you?
Speaker 1 (43:37):
I'm great, Robin, pleasure to finally get on Unhedged. I'm
a loyal listener, although I always feel terribly badly dressed.
Whenever I whenever I even think of you, Rob, whenever
I read one of your wonderful columns about sartorial elegance.
The subtext is, this column is written at you, Harford,
you slob, and so it just feels sloody guilty about
(43:59):
the whole thing.
Speaker 5 (44:00):
But yeah, you'll be glad to know I'm sitting in
my bedroom in a T shirt and a pair of jeans.
So I hope that puts you at ease.
Speaker 1 (44:05):
Okay, Yeah, I feel better now, Thank you, Rob.
Speaker 6 (44:08):
I was fascinated to listen to the most recent episode
of Cartiery Tales. It gave a lot of terrific examples,
starting with the immortal Sarah Howe of Ponzy Schemers. Yeah,
tell us what a Ponzi scheme fundamentally is and what
you discovered about them doing that episode.
Speaker 1 (44:27):
Yeah, we had lots of fun cautioning Tales as a
podcast about things going wrong and what we can learn.
And this particular episode is about ponzy schemes and pyramid schemes,
which are obviously always a terrible idea, but they have
a lot of lessons for us and Sarah how Sarah
Howe invented the Ponzi scheme, and can you believe that
it isn't called a house scheme.
Speaker 5 (44:47):
It's outrageous, outrage another woman forgotten by history, unfairly forgotten
by history, all the credit taken by Ponsey.
Speaker 1 (44:55):
Yeah, she was even operating in the same city, in Boston, Massachusetts.
So Sarah Howe set up the Ladies Deposit Company and
basically offered to pay a ladies eight percent a month,
which is basically doubling your money in a year. And
of course there's no way of actually making that return.
And so, as with all ponz schemes, people investing in
(45:17):
this opportunity, if they decide they want to withdraw their money,
then Sarah how just paid them out of incoming money
from other people who were eager to invest. And that's
the fundamental of a ponz scheme. Early investors who are
trying to cash out get paid not out of the
productive return from the productive activity, because there is no
(45:38):
productive activity. They get paid because other people are also
pouring money in. And that's the basic genius of the idea.
And so Cautionary Tales talks about Sarah how who did
this three times, talks about pyramid schemes, and also talks
about this insane Ponzi scheme run by a gentleman called
(45:58):
Sam Israel, which is described in Gye Lawson's book The Octopus,
which is absolutely bonkers because it just goes utterly down
a whirlpool of conspiracy theories, and said, it's quite fun.
Speaker 6 (46:11):
I want listeners to know that this is not a
parochial phenomenon.
Speaker 5 (46:14):
In my home city, Boston.
Speaker 6 (46:16):
I have a good friend and this connects nicely actually
to the Sarah Howe angle. I have a good friend
who about ten years ago in Brooklyn was she's quite
an entrepreneurial person, and was invited by another quite entrepreneurial
person to a meeting of other women and they were
going to talk about investment opportunity and so forth. And
(46:37):
as it turned out, what this meeting of ten or
twelve women was was, you know, I have this project
that I'm working on. I need seed money for this endeavor,
and you know each of you are going to contribute
X amount to my endeavor and then in the next round,
each of you will become a receiver of funds from
other people in the you know, Ladies Empowerment Club of
(46:59):
Brooklyn or whatever. And my friend, who has her head
screwed quite tightly onto her shoulders, looked around at these
well meant in kind of semi bohemian, semi business class
Brooklyn ladies and said, you're all going to jail.
Speaker 2 (47:17):
If you do this.
Speaker 6 (47:18):
This is a proxy scheme, and now looked at her
a gast like they they had no idea that they
were engaged in something untoward or possibly illegal.
Speaker 1 (47:28):
Yeah, part of the issue is that it is not
always straightforward to figure out whether something is a Ponzi
scheme or not, because superficially, I mean, there's a lot
of a lot of stuff in a capitalist economy that involves, well,
you invest some capital and you take a risk, and
if things go well, you get paid back ten x
(47:48):
in the phrase that everyone likes to.
Speaker 6 (47:50):
Use, exactly right, And this was the question listening to
your episode I most wanted to put to you. How
is a market in its bubble phase not exactly like
a Ponzi scheme snowballing insize.
Speaker 1 (48:05):
I love it. So it's like a decentralized Ponzi scheme, Right, It's.
Speaker 6 (48:08):
A decent, naturally occurring, decentralized organic Ponzi scheme where you
know something, the magnificent seven tech stocks start to go bananas,
and rather than a central schemer, a Ponzi or a
how figure, we all do our little part journalists like
you and I Tim. We hype things up by constantly
(48:30):
discussing one way or the other the different stocks. Brokers
have their role to play. Investor chat boards do the job,
and so we all kind of ponzi each other until
we're out of the next person to draw into the
market bubble, at which point the bubble collapses in an
exact reversal of the social structure that built it.
Speaker 1 (48:51):
So I love this idea. So let's use twenty twenty
hind sight. Let's go back and let's think about Amazon
twenty five years ago. And I think a little bit
of hindsight cliphies things. So what distinguishes Amazon from a
Ponzi scheme? Because if you think about it, this is
an organization which in the nineteen nineties, in the early
two thousands was not making money, losing a lot of money, yes,
(49:15):
but it's raising money from investors. So investors are putting
money in and if they wanted to get their money
out again, they could no problem. How do they get
paid well, because other investors are putting money in, so
there's a way to get paid, and more and more
money gets poured.
Speaker 2 (49:31):
Into this thing.
Speaker 1 (49:32):
And the reason it's not a Ponzi scheme, well, there's
two things. One is there's no fraud because Amazon was
perfectly honest about the accounts and perfully honest that it
was losing money, and so there's no deceptions, no fraud.
So that's one reason it's not a Ponzi scheme. The
second reason it's not a Ponzi scheme is in the
end it all comes good. All of that investment does
(49:52):
turn into something productive and everybody can get paid back.
So the first part of that them being honest, Okay,
that's important, but the second part could not be guaranteed.
There's no way of guaranteeing that Amazon would ever make money,
and indeed, lots of those dot com home stocks in
the nineteen nineties never did, and people could make a
(50:13):
lot of money as long as they got out in time,
and that's very ponziush.
Speaker 6 (50:17):
And what is so important about the Amazon example is
that the kind of faith, or if you prefer, kind
of credulity of Amazon's early investors is exactly what allowed
Amazon to become such a great business eventually. In other words,
(50:38):
because the investors didn't insist on being paid out of
the company's profits, Amazon was able to have this wonderful
cycle where it just reinvested all of its capital in
itself and built this incredibly strong, deep, moded, indestructible business
(50:58):
because it wasn't paying money to investors, it was reinvesting
in itself because the investors had that faith.
Speaker 1 (51:04):
So I think we now have a typology. So if
you're putting money in and bill investors get repaid by
from later investors, and the accounts are a sham, that's
a Ponzi scheme and someone's going to jail. If the
early investors get repaid by the late investors putting money
(51:25):
in but there's no accounting forward, people are just over
exuberant and the whole thing all collapses and it's pets
dot com, then no one goes to jail. That's not
a Ponzi scheme. That's a bubble. And if in the
end it turns into a wonderfully productive investments such as Amazon,
it's neither a Ponzi scheme nor a bubble. It's the
(51:45):
genius of capitalism.
Speaker 6 (51:46):
I would argue that the Ponzi scheme and the bubble
case are actually very close together. They're almost indistinguishably close
because other than the absence of the central figure pulling
all the strings, simply because at some point in a
bubble the people involved in it. In markets actually acknowledge
(52:08):
that races are no longer connected to economic fundamentals or
the productivity of the companies involved. They start using words
like momentum, right, and they say, you can't get in
front of momentum.
Speaker 7 (52:21):
The market is pushing upwards.
Speaker 6 (52:23):
If you get out now, you're going to regret it.
Speaker 7 (52:26):
It's fear of.
Speaker 6 (52:27):
Missing out, and to me, that moment you are living
Ponzi logic. In that moment, there will be another person
who will come along and pay more, and I will
be out of this game and somebody else will be
left to hold the bat.
Speaker 1 (52:40):
There's always a story about where the money comes from, right,
And I suppose the thing about bubbly markets is the
stories get less and less rigorous. People don't need a
particularly strong, data driven, compelling story. They're just like any
story will do. I'm greedy now and a lot of
the Ponzi stories. So, I mean, Charles Ponzi's original story
(53:02):
was something to do with the arbitrage of international postal
reply coupons. Really that's going to work, but people believed it.
Speaker 6 (53:11):
There's another question I wanted to ask you, which is
all of the ponzis you talked about in your podcast,
and indeed all the ones I know of, and I'm
thinking here, of course, of Bernie Madeoff, the most famous
of the recent ponzis.
Speaker 7 (53:25):
These all turn out very poorly.
Speaker 5 (53:27):
For the puppet masters, very poorly.
Speaker 7 (53:29):
So there's a question.
Speaker 6 (53:31):
There's a question about why US suckers fall for them.
But there's a way in which the puppet master is
the ultimate sucker. They've somehow believed their own Ponzi scheme
in some way and they end up in jail or
disgraced her.
Speaker 5 (53:44):
Why do they do it?
Speaker 1 (53:45):
I really am not sure why they do it. I
suppose you could say, well, if the Ponzi schemes do
somehow work out, if the international postal reply coupon arbitrage works,
then everyone gets paid back in the end. I guess
Sam Israel, who ran the Bayu Capital Ponzi scheme, maybe
he would have gotten away with it if one of
(54:05):
his attempts to swing for the fences.
Speaker 2 (54:08):
Had paid off.
Speaker 1 (54:09):
But ultimately, there's a really interesting idea which I was
introduced to by the writer Dan Davis, who wrote this
terrific book about fraud called Lying for Money, and he
basically points out that if you take a typical Ponzi scheme,
So let's say you're promising to the double people's money
every year. Okay, So you take one hundred dollars from
a little old lady and you steal it. Okay, Now
(54:31):
in a year, you need to pay her two hundred dollars.
That's okay. So you find two other little old ladies,
you steal their money and you pay the first little
old lady. Now, of course, in a year's time, you've
got to do it all again, and each year you're
owing twice as much money, and you need to defraud
twice as many little old ladies to pay the previous
little old ladies. So that's all kind of obvious, and
it's obvious that that can't keep going forever. That's an
(54:54):
exponential process that's all going to come unraveled. But what
Dan Davis pointed out is what is easy to miss
is that can balloon into thousands and thousands and thousands
of dollars based on the original one hundred dollar theft.
The frauds that only stole one hundred dollars, and somehow
now they're responsible for maintaining this enormous fraud, and no wonder,
(55:18):
so many of them are crying with relief when they're
finally arrested, like, thank goodness, I don't have to do
this anymore. So I don't know why people do this.
Speaker 6 (55:27):
It's the magician's apprentice story. You cast the spell, and
all of a sudden, it's much bigger than you are.
And I think there is a general point about fraudsters
that clearly applies to some Ponzi fraudsters is that they
do get into it by mistake. You start a fund,
you're struggling to be a legitimate investor.
Speaker 7 (55:48):
Something goes slightly wrong.
Speaker 6 (55:50):
And okay, just one month, I'm going to fudge the
numbers so I can pitch to one more investor.
Speaker 7 (55:57):
And then that takes on a life of its own.
Speaker 6 (55:59):
You get into it incrementally by small steps, and suddenly
the thing grows by leaps and bounds. And I think
there's a way to read the Bernie Madoffski as having
some of that character, and you can read Madeoff's actions
late in the scheme as desperately trying to keep the
thing under control, turning investors away as it because he
(56:24):
couldn't handle it.
Speaker 1 (56:25):
And it just gets so huge that in the end,
the gap between the underlying reality of the investments, like
how much money you are really generating in postal reply
coupon arbitrage, and the fiction what you're telling people you
are making, that gap eventually becomes impossible to bridge. A
lot of Ponzi schemes. I think it's ambiguous at the start.
(56:46):
Did they mean it to be a Ponzi scheme or
did they actually think they were investment geniuses that everyone
would get paid back. There is often an ambiguity at
the start, but unless you're able to close the fraudulent
gap early, it becomes so unbridgable you don't have a chance.
Speaker 6 (57:01):
Tim, If you give me one hundred dollars, I have
a brilliant idea.
Speaker 2 (57:06):
I'm always.
Speaker 6 (57:11):
This is long short, that portion of the show where
we go long something we like or short something we
don't like.
Speaker 5 (57:19):
Tim, are you long or short something?
Speaker 1 (57:22):
Can I go for a paired trade rather than do Greg.
So I'm going to go short Ponzi and long pyramid schemes.
So we should probably very briefly explain the difference. So
a Ponzi scheme, someone's running a Ponzi scheme. They're lying,
they're paying out earlier investors using money from later investors.
(57:43):
Pyramid scheme works in a similar way, but it's it's decentralized.
You basically get the later investors to send money to
the early investors, and then the later investors then have
to recruit even later investors to pay them. And it's
more transparent. But more to the point, there's nobody actually
running a thing.
Speaker 2 (58:01):
And what that means.
Speaker 1 (58:02):
Is that the person who sets up each individual pyramid
scheme can cash out and walk away. And in fact,
the pyramid scheme I describe in the cautionary tale, we
have no idea who set it up. She seems to
have got fairly rich and just walked away and she never.
Speaker 5 (58:18):
Went to jail.
Speaker 8 (58:19):
And we don't you say she, Tim? You say she,
But I think we're talking about you, Tim, or are we?
I couldn't possibly comment, couldn't possibly come in. Well, okay,
I'm short ponzi, long pyramid? Do you have a long
or a short for us?
Speaker 5 (58:34):
Well, let me ask you a question. Is bitcoin a
ponzi or a pyramid? Neither or neither?
Speaker 1 (58:40):
I mean I think it's more it's more bubbly than either.
But it's not a Ponzi scheme because there's nobody in charge.
That's the whole point of bitcoin, right, Nobody is in charge.
So if it's anything, it's closer to a pyramid scheme,
where transparently, if you want to get paid for investing
in bitcoin, you get paid by other people coming in
and buying your bitcoin, So it's closer to a pyramid scheme.
Speaker 5 (59:01):
I'm going to be sure bitcoin just because I'm a coward.
Speaker 1 (59:04):
Well, I think that that's your inalienable, right, Robin. I
think I might join you in your.
Speaker 5 (59:09):
Cowdi Thanks for being on the show.
Speaker 1 (59:12):
Oh that's a real pleasure.
Speaker 5 (59:13):
Thank you. I loved it. Listeners.
Speaker 6 (59:16):
If you like Unhedged, you will love cautionary tales Tim's
podcast Unhedged. We'll be back in your feed before you
know it. Thanks for listening. Unhedged is produced by Jake
Harper and edited by Brian Ernstadt. Our executive producer is
Jacob Goldstein.
Speaker 5 (59:33):
You have additional help from.
Speaker 6 (59:35):
Toeprah foreheaz Cheryl Brumley is the FT's global head of Audio.
Special thanks Laura Clark, Alistair Mackey, Branda Cone, Marilyn Rust,
Kira Posey, and Natalie Sadler. FT Premium subscribers can get
the Unhedged newsletter for free.
Speaker 7 (59:52):
My thirty day free trial is available to everyone else.
Speaker 5 (59:55):
Just go to ft dot com slash Unhedged offer. I'm
Rob Armstrong. Thanks for listening.
Speaker 1 (01:00:07):
That was a special episode of the Unhedged podcast. If
you liked what you heard, you know where to find Unhedged,
the same place you find all good podcasts. Cautionary tales
will be back in this feed soon
Host
Tim Harford
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