April 26, 2024 • 61 mins
Cautionary Tales will be LIVE on stage in London this May. Tickets are on sale now: https://www.tegeurope.com/events/cautionary-tales/
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.
Speaker 2 (00:19):
Hello, dear listener, Tim Harford, here have some very exciting
news to share with you. On the evening of Tuesday,
the twenty first of May, I will be bringing a
special live edition of Cautionary Tales to the stage in London.
There will be music, there will be actors, hello, and
(00:43):
there will be plenty of hair raising, spine tingling, twists
and turns. Tickets are on sale now through the link
in the episode description, so get them while they last.
Once again, Cautionary Tales will be live in London on Tuesday,
the twenty first of May. I can't wait to see
(01:05):
you there. 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,
(01:51):
are you already excellent? Okay, so we will begin. Sophie
and Julia were relaxing on the riverside terrace of a
fancy London spa, two rich girls joined by an even
(02:16):
richer one, Tatiana, the glamorous wife of an investment banker.
Tatiana ordered another bottle of champagne and launched into her
sales pitch.
Speaker 3 (02:28):
You simply must buy our heart.
Speaker 2 (02:31):
Julia and Sophie looked at 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.
(02:52):
Here's how it worked. You 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. They'd leave the pyramid. The two people
(03:14):
on the next level down would be promoted to the
top roll of receiver. 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
(03:36):
in the newly vacant layer beneath you. Six weeks later,
you would be a receiver and would get twenty four
thousand pounds, the equivalent of fifty thousand dollars today, and
a huge return. No matter how you measured it, the
(03:56):
money just 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.
(04:17):
This is transparently 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. It's really that simple.
(04:40):
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 Empowering Women.
(05:01):
Men weren't allowed.
Speaker 4 (05:03):
Men are more corruptible, they can't be trusted.
Speaker 2 (05:07):
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. Then Tatiana whispered
(05:30):
that apparently the supermodel Claudia 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 a phone call
(05:51):
from a lady called Elfie, who was collecting her boy
Archie from an exclusive London school.
Speaker 4 (05:59):
Darling, I must be quick, but I couldn't wait to
tell you the news. You've already moved up a line.
You're one step closer to become a receiver.
Speaker 2 (06:11):
Wonderful, replied Julia.
Speaker 4 (06:13):
So now you must send me three thousand pounds.
Speaker 2 (06:20):
I'm Tim Harford and you're listening to Cautionary Tales live
at the Bristol Festival of Economics. This is a cautionary
tale about investment scams and about the way that they
(06:42):
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 people
(07:03):
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 college
(07:24):
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 1 (07:46):
The weather is nice for this time of year, yes,
but today it looks like rain.
Speaker 2 (07:54):
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 things like this tended to happen
(08:15):
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 Janie. She was sensible, training to
be an accountant. It wasn't the ideal match.
Speaker 1 (08:38):
I hid everything from Janis.
Speaker 2 (08:40):
Sam Israel confessed to the Rolling Stone journalist Gee Lawson.
Speaker 5 (08:45):
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 2 (08:59):
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
(09:20):
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
(09:40):
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, some
good and some bad. Sam couldn't talk to Janis about
any of this, of course, But what Sam really couldn't
(10:04):
talk to Janis about was by you capital tit 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, of women empowering women. In eighteen seventy eight,
(10:28):
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 a
(10:49):
solid enough offering. The Lady's Deposit Company, however, paid eight
percent every month, deposit one hundred dollars, and by the
end of the year you'd have earned ninety six dollars,
nearly doubling your original investment. There were no rumors of
sus supermodels back in eighteen seventy eight, but the gossip
(11:12):
suggested 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
(11:34):
women 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
(11:56):
of huge importance. An 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.
(12:19):
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 Lady's Deposit Company, money poured out, and the
mechanics of how it all worked were conveniently obscure. One
(12:43):
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.
Speaker 4 (12:59):
We never disclose the methods by which we do business, was.
Speaker 2 (13:04):
All that the company's employees would say. 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
(13:28):
years earlier, but women never seem to get the credit
for inventing anything, even investment fraud. The local press soon
concluded that the Ladies Deposit Company was an obvious scam.
The Boston Daily Advertiser published an illustrated explainer, some articles
(13:49):
highlighting the stage psychic How's 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,
Sarah Howe decided that the best way forward was bluff.
(14:11):
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
of Boston were not reassured at all. They asked for
their money back, and when Sarah Howe didn't have it,
(14:34):
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
suck in an ever growing number of dupes to keep going,
and eventually that snowball of money rolling downhill, becoming bigger
(15:00):
and bigger, simply falls apart. It's too big. 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
(15:21):
investment of one hundred dollars from a little old lady
and steals it. By the end of the year, 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
(15:43):
following year, Sarah Howe needs to have given nearly two
hundred dollars to both of her investors. To do that,
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
(16:04):
investors to join the Ladies Deposit Company. Now you can
see the trap here. 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,
(16:30):
and yet she only 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
well as every tiny No wonder that so many fraudsters
eventually get caught, And no wonder perhaps that when they
(16:51):
do get caught, so many of them weep with relief.
There will be tears of plenty, but not much relief.
After the break in the summer of two thousand and three,
(17:27):
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'd sent
three thousand pounds to Elfie, the mother of Darling Archie
from the Fancy School, but Julia's own recruitment efforts were
(17:48):
going nowhere. Her rich friends sneered at her that had
already been approached so many times to invest in a
heart that the whole affair had become a boring 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,
(18:14):
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,
(18:37):
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
(19:00):
number of people have recently joined but not yet cashed out.
Julia was one of those people. 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
(19:22):
London mansions, champagne being quaffed with supermodels as suitcases of
cash were handed to people who'd reached the top of
the pyramid. That this recruitment party was in a hairdressers
instead of champagne. On ice. There was warm white wine
(19:43):
and a growing sense of irritation that Julia's failure to
recruit was letting down everyone above her in the pyramid.
There was, of course, no sign of Claudia Schieffer. The
brilliance of women empowering women is that it seems to
(20:03):
have been largely self organizing. Many scams, in contrast, require
a lot of hard work. Just ask Sam Israel. He
set up his ill fated hedge fund by you Capital
in nineteen ninety six, assisted by an accountant named Dan Marino,
(20:24):
who lived with his mother and dreamed of greatness. 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
(20:47):
skills of a Wantz Great trader whom Sam had 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 1 (21:04):
But it didn't.
Speaker 2 (21:06):
The Wantz 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 1 (21:19):
He used to.
Speaker 2 (21:21):
After a couple of lackluster 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,
(21:42):
and Bayou 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
(22:03):
Stella results. 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,
(22:29):
Dan Marino simply 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
(22:51):
young Worldwide Web, 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
(23:15):
the snowball was 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.
(23:35):
Dan Marino was losing his mind at the fact that
Sam couldn't control himself.
Speaker 5 (23:41):
When they had a good month and made money, they
used that as the performance number.
Speaker 2 (23:45):
Complained Dan to the journalist Gee Lawson.
Speaker 1 (23:48):
When they had a bad month, they used a made
up number.
Speaker 2 (23:51):
That won't work. 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 1 (24:07):
We went with Grace fan RULs with integrity.
Speaker 2 (24:11):
Boasted Sam to his investors. Dan Marino knew the awful truth.
Speaker 5 (24:16):
I stopped tracking the published numbers against the real numbers.
Speaker 2 (24:19):
Said Marino. The snowball was already too big.
Speaker 1 (24:23):
Oh, it made me sick to my stomach.
Speaker 2 (24:27):
Four years after, the Ladies Deposit Company was exposed by
the Boston Daily Advertiser and collapsed, and Miss 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,
(24:53):
paid interest of seven percent per month. Too good to miss,
or alternatively.
Speaker 1 (25:04):
Too good to be true.
Speaker 2 (25:06):
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, as advertised, but
an ex convict by the name of Sarah Howe. Sarah
(25:29):
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 a wonderful investment
opportunity the Lady's Provident Aid Society was offering interest of
(25:51):
Oh never mind. The police caught up with Miss Sarah Howe,
shut down the Lady's Provident Aid Society, and soon enough
Miss Howe was back in prison. Worth it surely not
in character, most definitely, Sometimes when the snowball starts to roll,
(26:13):
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, a fortune to his name.
But appearances can be deceptive. Sam was a mess. He
(26:33):
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 and Dan had one advantage,
which is that a fraudulent hedge fund doesn't have a
(26:53):
cell by date. That's different from the other scams we've
heard about. Tatiana was promising Julia that women empowering women
would multiply her money in just six weeks. The Ladies
Deposit Company promised to almost double investors' money.
Speaker 1 (27:10):
After a year.
Speaker 2 (27:12):
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 ever be for Sam Israel to
(27:33):
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 swept out of the cloudless
(27:54):
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 had spectacularly backfired, while
(28:19):
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.
Speaker 1 (28:36):
Will go to jail. Please speG Marino.
Speaker 2 (28:40):
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 will be back in a moment.
(29:25):
In two thousand and three, Sam Israel was at home
leaning over a line of white powder with a rolled
twenty dollar bill up his nose. When his wife, Janice
walked in. She became upset. He became outraged. How dare
she suggests he was taking cocaine. She persuaded him to
(29:47):
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, you want urine. At
Thanksgiving that year, he passed out over the turkey. By
(30:09):
Christmas two thousand and three, Janice had thrown him out
of their house and secured a protective order. Sam rented
the most tasteless, ostentatious bachelor pad he could find, a
vast Tudor style manner, with outsized chandeliers, marble bathrooms, and
(30:31):
comically huge beds. Sam paid the monthly rent of twenty
two thousand dollars to the house's owner, a gentleman by
the name.
Speaker 1 (30:40):
Of Donald Trump.
Speaker 5 (30:43):
So good, so good, amazing house, huge beds.
Speaker 2 (30:50):
Sam hung around clubs, tipping the bartender to introduce him
to pretty women. He fitted the Trump mansion with the
latest trading equipment, 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
(31:12):
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.
(31:37):
Dan and Sam 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
(31:58):
an old saying, you can't cheat an honest man, and
there's truth in that saying, because the premise of a
scam is often simply.
Speaker 5 (32:09):
Doing crimes, and if you come and do crimes with me,
we'll both make money.
Speaker 2 (32:14):
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
(32:36):
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
(32:56):
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 1 (33:08):
Who exactly was running the world economy? Anyway?
Speaker 2 (33:12):
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 of
delusional beliefs. Sam became obsessed with finding the undocted footage
(33:38):
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
of such events. Above all, Sam came to believe in
(33:59):
a global conspiracy thirteen powerful families who truly rule the world,
whom he called the bus. It all gets very, very weird.
Do read the book. It's quite a trip. But for
our purposes, what we need to know is that Sam
Israel fell under the spell of a man called Robert
(34:23):
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
smoking James Bond. He swaggered around London City with tight
controls on firearms, with a revolver in a shoulder holster.
(34:47):
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
beg Nichols to give it to him. He'd do anything,
he said, Do you have one hundred million dollars in cash?
Speaker 1 (35:08):
Said Nichols, I've got one hundred million in cash. Do
you have one hundred and fifty million? Yes?
Speaker 2 (35:17):
Forget the special CIA program which monitors bank accounts, said Nichols,
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, you know, the octopus.
And just as Julia had said to Tatiana at the
(35:39):
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
(36:02):
of conspiracy theorist fraudstans, 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,
(36:24):
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
(36:47):
to find the exact same treasure.
Speaker 3 (36:50):
Can we have a recap?
Speaker 4 (36:52):
Of course, sam Israel was controlling one hundred million dollars
of Buyo Capital's money based on a fraud. He then
invested that money in Robert Nichols's fraud. Robert Nichols then
invested that money in yet another fraud.
Speaker 3 (37:06):
Exactly, thank you.
Speaker 2 (37:08):
Reassuringly, though so, 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. They were hard checks and
balances in place. Several times Sam Israel tried to invest
the one hundred million in one scam or another, and
(37:29):
a 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
(37:51):
he 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 man he
believed was an elite CIA operative. But i u's investors
(38:13):
asked for their money back, 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, as an act of
(38:37):
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
(38:57):
high over the Hudson River in upstate New York. He
left a suicide note and smudged in the dust on
his car's hood were the words suicide is paid. But
sam Israel's suicide note was as fictional as his investment returns.
The authorities tracked him down, alive and well, and a
(39:19):
campsite in Massachusetts. They promptly 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, were rather more mundane.
(39:46):
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 for not finding more recruits. Tricksy,
Pucky and Buttons all.
Speaker 1 (40:04):
Had their say.
Speaker 2 (40:05):
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 the snowball. Sarah
(40:28):
Howe went to prison twice. Sam Israel faked his own
suicide in a desperate attempt to escape. But the unknown
woman who.
Speaker 3 (40:39):
Created the whole spiel about hearts.
Speaker 2 (40:42):
And empowering other women, she's the exception to the rule
that fraud doesn't pay. She pushed a few snowballs 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.
(41:09):
The grumpy fairies could probably afford to lose the money,
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
(41:31):
lunch the women empowering women snowball had started to flatten
much 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
(41:54):
Davis's book Lying for Money, and for the astonishing story
of 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 McLachlin. The original music is the work
(42:17):
of Pascal Wise. Our b SL interpreter was Katherine Motson.
The show was produced by Alice.
Speaker 3 (42:24):
Fines, Marilyn Rusk, and Ryan Dilling.
Speaker 2 (42:26):
Sarah Nick said it took the script of sound engineer
was Andrew Bayless.
Speaker 3 (42:31):
The thanks to Zoe Seedman, Miilm and the team at
the British Best Level of Economics. Puchal Tails is a
production of Pushkin Industries.
Speaker 2 (42:39):
If you like the show, please remember to rate, share
and review to want to hear the show ad.
Speaker 3 (42:44):
Three sign up the Pushkin past on the show page
of Apple Podcasts of Pushkin FM, Slash Truce.
Speaker 1 (42:59):
Thank you that was fun.
Speaker 6 (43:02):
Thank you so much, guys.
Speaker 2 (43:04):
The Trump impression was okay?
Speaker 6 (43:06):
Was that?
Speaker 2 (43:14):
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 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.
(43:39):
We're back and I've been talking to my Financial Times
colleague Rob Armstrong about all things Ponzie for his podcast Unheedged.
Speaker 1 (43:54):
Pushkin.
Speaker 6 (43:57):
I love a good Ponzi scheme from Charles Ponzi himself
to Bernie Madoff. I suppose admire the wicked intelligence of
the puppet masters, and I 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
(44:19):
me is Tim Harford, my fellow FT columnist and master
of his own podcast, Cautionary Tales. Tim, how are you?
Speaker 2 (44:27):
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 roll whenever
I read one of your wonderful columns about satoial elegance.
The subtext is this column is written at you, Harford,
you slob, and so it just feels sloody guilty about
(44:49):
the whole thing.
Speaker 6 (44:50):
But yeah, you'll be glad to know I'm sitting in
my bedroom in a tea shirt and a pair of jeans.
So I hope that puts you at ease.
Speaker 2 (44:55):
Okay, Yeah, I feel better now, Thank you, Rob.
Speaker 6 (44:58):
I was fascinated to listen to the most recent episode
of Cautionary Tales. It gave a lot of terrific examples,
starting with the immortal Sarah Howe of Ponzy Schemers. Yeah,
tell us what that Ponzy scheme fundamentally is and what
you discovered about them doing that episode.
Speaker 2 (45:17):
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. It's outrageous, outrageous for
(45:39):
another woman forgotten by history, unfairly forgotten by history, all
the credit taken by Ponsey. 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
(46:01):
no way of actually making that return. And so, as
with all Ponzi schemes, people investing in 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 Ponzi scheme. Early investors who are trying to
cash out get paid not out of the productive return
(46:26):
from the productive activity, because there is no productive activity.
They get paid because other people are also pouring money in.
And that's the basic genius of the idea. And Cautioning
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 Sam Israel, which
(46:50):
is described in Gee Lawson's book The Octopus, which is
absolutely bonkers because it just goes utterly down a whirlpool
of conspiracy, theorism and so on. So it's great fun.
Speaker 6 (47:01):
I want listeners to know that this is not a
parochial phenomena of my home city Boston. I have a
good friend and this connection 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
(47:22):
meeting of other women and they were going to talk
about investment opportunity and so forth. And 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
(47:43):
you will become a receiver of funds from other people
in the you know, Ladies Empowerment Club of Brooklyn or whatever.
And my friend, who has her head screwed quite tightly
onto her shoulders, looked around at these well meaning, kind
of semi bohemian, semi business class Brooklyn ladies and said,
(48:06):
you're all going to jail if you do this. This
is a Ponzi scheme. And now looked at her a
gas like they they had no idea that they were
engaged in something untoward or possibly illegal.
Speaker 1 (48:18):
Yeah.
Speaker 2 (48:18):
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 the 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
in the phrase that everyone likes to.
Speaker 6 (48:40):
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 in size?
Speaker 2 (48:55):
I love it. So it's like a decentralized Ponzi scheme, right.
Speaker 6 (48:58):
It's a It's a naturally occurring decentralized organic Ponzi scheme
where you know something the magnificent seven tech stocks start
to go bananas and run 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
(49:19):
up by constantly 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's
draw into the market bubble, at which point the bubble
collapses in an exact reversal of the social structure that
(49:40):
built it.
Speaker 2 (49:41):
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,
(50:05):
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 into this thing. And the reason it's not a
Ponzi scheme, well, there's two things. One is there's no
(50:26):
fraud because Amazon was perfectly honest about the accounts and
perfully honest that it was losing money, and so there's
no deception, there's 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 turn into something productive, and
everybody can get paid back. So the first part of
(50:48):
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 stocks in the nineteen nineties never did,
and people could make a lot of money as long
as they got out in time. And that's very ponziish.
Speaker 6 (51:07):
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,
(51:28):
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
(51:48):
because it wasn't paying money to investors, it was reinvesting
in itself because the investors had that faith.
Speaker 2 (51:54):
So I think we now have a typology. So if
you're putting money in and early investors get repaid by
from later investors and the accounts are a sham. That's
a Ponzi scheme, and someone's to jail. If the early
investors get repaid by the late investors putting money in,
(52:15):
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 genius of capitalism.
Speaker 6 (52:36):
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.
Speaker 7 (52:51):
In a bubble, the people involved in it in markets
actually acknowledge that prices are no longer connected to economic
fundamentals or the productivity of the companies involved.
Speaker 6 (53:04):
They start using words like momentum right, and they say
you can't get in front of momentum. The market is
pushing upwards. If you get out now, you're going to
regret it. It's fear of 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
(53:26):
pay more, and I will be out of this game
and somebody else will be left to hold the bat.
Speaker 2 (53:30):
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
(53:52):
was something to do with the arbitrage of international postal
reply coupons. Really that's going to work, but you know,
people believed it.
Speaker 6 (54:01):
There's another question I wanted to ask you, which is
all of the Ponzi's 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. These all turn out very poorly
for the puppet masters very poorly. So there's a question.
There's a question about why US suckers fall for them.
(54:25):
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. Why do they do it?
Speaker 2 (54:35):
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
(54:56):
his attempts to swing for the fences had paid off.
But ultimately, there's a really interesting idea which I was
introduced to by the writer Dan Davis, who hate the
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
(55:18):
a little old lady and you steal it okay. Now
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
(55:39):
little old ladies. So that's all kind of obvious, and
it's obvious that that can't keep going forever. That's an
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.
(56:00):
The frauds that only stole one hundred dollars, and somehow
now they're responsible for maintaining this normalmous fraud, and no wonder,
so many the men crying with relief when they're finally arrested, like,
thank goodness, I don't have to do this anymoyss. So
I don't know why people do this.
Speaker 6 (56:17):
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. Something goes slightly wrong,
(56:40):
and okay, just one month, I'm going to fudge the
numbers so I can pitch to one more investor, and
then that takes on a life of its own. 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 Madoff scheme as having
some of that character. And you can read Madoff's actions
(57:04):
late in the scheme as desperately trying to keep the
thing under control, turning investors away as it because he
couldn't handle it.
Speaker 2 (57:15):
And it just gets so huge that in the end,
the gap between the underlying reality of the investments about
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.
(57:36):
Did they mean it to be a Ponzi scheme or
did they actually think they were investment geniuses and 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 (57:51):
Tim, If you give me one hundred dollars, I have
a brilliant idea. I'm on it. This is a long
short that portion of the show where we go long
something we like or short something we don't like. Tim,
are you long or short something?
Speaker 2 (58:12):
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.
(58:33):
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. And what that means is that the
person who sets up each individual pyramid scheme can cash
(58:58):
out and walk away. And in fact, the pyramid scheme
I describe in the cautionary tail, we have no idea
who set it up. She seems to have got fairly
rich and just walked away. And she never went to
say she.
Speaker 1 (59:10):
Tim.
Speaker 8 (59:10):
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 6 (59:24):
Well, let me ask you a question. Is bitcoin a
Ponzi or a pyramid?
Speaker 2 (59:28):
Neither or neither? 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
(59:49):
closer to a pyramid scheme.
Speaker 6 (59:51):
I'm going to be sure bitcoin just because I'm a coward.
Speaker 2 (59:54):
Well, I think that that's your inalienable, right, Robin. I
think I might join you in your cowardice.
Speaker 6 (01:00:00):
Thanks for being on the show.
Speaker 2 (01:00:02):
Oh that's a real pleasure. Thank you, Bob. I loved it.
Speaker 6 (01:00:05):
Listeners. If you like Unheedged, you will of cautionary tales
Tim's podcast Unhedged. We'll go back in your feed before
you know it. Thanks for listening. Unhedged is produced by
Jake Harper and edited by Brian ertstap Our executive producer
is Jacob Goldstein. You have additional help from Toeprah. Forehead
(01:00:26):
Cheryl Brumley is the FT's global head of Audio. Special
thanks Laura Clark, Alistair Mackey, Branda Cone, Marilyn rust Here
Posey and Natalie Sadler. FT Premium subscribers can get the
Unhedged newsletter for free. My thirty day free trial is
available to everyone else. Just go to ft dot com
(01:00:47):
slash Unhedged offering. I'm Rob Armstrong. Thanks for listening.
Speaker 2 (01:00:57):
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. Caution, de
Tales will be back in feed soon
Pushkin.
Speaker 2 (00:19):
Hello, dear listener, Tim Harford, here have some very exciting
news to share with you. On the evening of Tuesday,
the twenty first of May, I will be bringing a
special live edition of Cautionary Tales to the stage in London.
There will be music, there will be actors, hello, and
(00:43):
there will be plenty of hair raising, spine tingling, twists
and turns. Tickets are on sale now through the link
in the episode description, so get them while they last.
Once again, Cautionary Tales will be live in London on Tuesday,
the twenty first of May. I can't wait to see
(01:05):
you there. 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,
(01:51):
are you already excellent? Okay, so we will begin. Sophie
and Julia were relaxing on the riverside terrace of a
fancy London spa, two rich girls joined by an even
(02:16):
richer one, Tatiana, the glamorous wife of an investment banker.
Tatiana ordered another bottle of champagne and launched into her
sales pitch.
Speaker 3 (02:28):
You simply must buy our heart.
Speaker 2 (02:31):
Julia and Sophie looked at 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.
(02:52):
Here's how it worked. You 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. They'd leave the pyramid. The two people
(03:14):
on the next level down would be promoted to the
top roll of receiver. 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
(03:36):
in the newly vacant layer beneath you. Six weeks later,
you would be a receiver and would get twenty four
thousand pounds, the equivalent of fifty thousand dollars today, and
a huge return. No matter how you measured it, the
(03:56):
money just 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.
(04:17):
This is transparently 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. It's really that simple.
(04:40):
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 Empowering Women.
(05:01):
Men weren't allowed.
Speaker 4 (05:03):
Men are more corruptible, they can't be trusted.
Speaker 2 (05:07):
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. Then Tatiana whispered
(05:30):
that apparently the supermodel Claudia 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 a phone call
(05:51):
from a lady called Elfie, who was collecting her boy
Archie from an exclusive London school.
Speaker 4 (05:59):
Darling, I must be quick, but I couldn't wait to
tell you the news. You've already moved up a line.
You're one step closer to become a receiver.
Speaker 2 (06:11):
Wonderful, replied Julia.
Speaker 4 (06:13):
So now you must send me three thousand pounds.
Speaker 2 (06:20):
I'm Tim Harford and you're listening to Cautionary Tales live
at the Bristol Festival of Economics. This is a cautionary
tale about investment scams and about the way that they
(06:42):
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 people
(07:03):
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 college
(07:24):
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 1 (07:46):
The weather is nice for this time of year, yes,
but today it looks like rain.
Speaker 2 (07:54):
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 things like this tended to happen
(08:15):
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 Janie. She was sensible, training to
be an accountant. It wasn't the ideal match.
Speaker 1 (08:38):
I hid everything from Janis.
Speaker 2 (08:40):
Sam Israel confessed to the Rolling Stone journalist Gee Lawson.
Speaker 5 (08:45):
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 2 (08:59):
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
(09:20):
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
(09:40):
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, some
good and some bad. Sam couldn't talk to Janis about
any of this, of course, But what Sam really couldn't
(10:04):
talk to Janis about was by you capital tit 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, of women empowering women. In eighteen seventy eight,
(10:28):
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 a
(10:49):
solid enough offering. The Lady's Deposit Company, however, paid eight
percent every month, deposit one hundred dollars, and by the
end of the year you'd have earned ninety six dollars,
nearly doubling your original investment. There were no rumors of
sus supermodels back in eighteen seventy eight, but the gossip
(11:12):
suggested 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
(11:34):
women 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
(11:56):
of huge importance. An 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.
(12:19):
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 Lady's Deposit Company, money poured out, and the
mechanics of how it all worked were conveniently obscure. One
(12:43):
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.
Speaker 4 (12:59):
We never disclose the methods by which we do business, was.
Speaker 2 (13:04):
All that the company's employees would say. 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
(13:28):
years earlier, but women never seem to get the credit
for inventing anything, even investment fraud. The local press soon
concluded that the Ladies Deposit Company was an obvious scam.
The Boston Daily Advertiser published an illustrated explainer, some articles
(13:49):
highlighting the stage psychic How's 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,
Sarah Howe decided that the best way forward was bluff.
(14:11):
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
of Boston were not reassured at all. They asked for
their money back, and when Sarah Howe didn't have it,
(14:34):
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
suck in an ever growing number of dupes to keep going,
and eventually that snowball of money rolling downhill, becoming bigger
(15:00):
and bigger, simply falls apart. It's too big. 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
(15:21):
investment of one hundred dollars from a little old lady
and steals it. By the end of the year, 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
(15:43):
following year, Sarah Howe needs to have given nearly two
hundred dollars to both of her investors. To do that,
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
(16:04):
investors to join the Ladies Deposit Company. Now you can
see the trap here. 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,
(16:30):
and yet she only 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
well as every tiny No wonder that so many fraudsters
eventually get caught, And no wonder perhaps that when they
(16:51):
do get caught, so many of them weep with relief.
There will be tears of plenty, but not much relief.
After the break in the summer of two thousand and three,
(17:27):
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'd sent
three thousand pounds to Elfie, the mother of Darling Archie
from the Fancy School, but Julia's own recruitment efforts were
(17:48):
going nowhere. Her rich friends sneered at her that had
already been approached so many times to invest in a
heart that the whole affair had become a boring 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,
(18:14):
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,
(18:37):
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
(19:00):
number of people have recently joined but not yet cashed out.
Julia was one of those people. 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
(19:22):
London mansions, champagne being quaffed with supermodels as suitcases of
cash were handed to people who'd reached the top of
the pyramid. That this recruitment party was in a hairdressers
instead of champagne. On ice. There was warm white wine
(19:43):
and a growing sense of irritation that Julia's failure to
recruit was letting down everyone above her in the pyramid.
There was, of course, no sign of Claudia Schieffer. The
brilliance of women empowering women is that it seems to
(20:03):
have been largely self organizing. Many scams, in contrast, require
a lot of hard work. Just ask Sam Israel. He
set up his ill fated hedge fund by you Capital
in nineteen ninety six, assisted by an accountant named Dan Marino,
(20:24):
who lived with his mother and dreamed of greatness. 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
(20:47):
skills of a Wantz Great trader whom Sam had 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 1 (21:04):
But it didn't.
Speaker 2 (21:06):
The Wantz 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 1 (21:19):
He used to.
Speaker 2 (21:21):
After a couple of lackluster 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,
(21:42):
and Bayou 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
(22:03):
Stella results. 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,
(22:29):
Dan Marino simply 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
(22:51):
young Worldwide Web, 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
(23:15):
the snowball was 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.
(23:35):
Dan Marino was losing his mind at the fact that
Sam couldn't control himself.
Speaker 5 (23:41):
When they had a good month and made money, they
used that as the performance number.
Speaker 2 (23:45):
Complained Dan to the journalist Gee Lawson.
Speaker 1 (23:48):
When they had a bad month, they used a made
up number.
Speaker 2 (23:51):
That won't work. 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 1 (24:07):
We went with Grace fan RULs with integrity.
Speaker 2 (24:11):
Boasted Sam to his investors. Dan Marino knew the awful truth.
Speaker 5 (24:16):
I stopped tracking the published numbers against the real numbers.
Speaker 2 (24:19):
Said Marino. The snowball was already too big.
Speaker 1 (24:23):
Oh, it made me sick to my stomach.
Speaker 2 (24:27):
Four years after, the Ladies Deposit Company was exposed by
the Boston Daily Advertiser and collapsed, and Miss 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,
(24:53):
paid interest of seven percent per month. Too good to miss,
or alternatively.
Speaker 1 (25:04):
Too good to be true.
Speaker 2 (25:06):
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, as advertised, but
an ex convict by the name of Sarah Howe. Sarah
(25:29):
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 a wonderful investment
opportunity the Lady's Provident Aid Society was offering interest of
(25:51):
Oh never mind. The police caught up with Miss Sarah Howe,
shut down the Lady's Provident Aid Society, and soon enough
Miss Howe was back in prison. Worth it surely not
in character, most definitely, Sometimes when the snowball starts to roll,
(26:13):
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, a fortune to his name.
But appearances can be deceptive. Sam was a mess. He
(26:33):
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 and Dan had one advantage,
which is that a fraudulent hedge fund doesn't have a
(26:53):
cell by date. That's different from the other scams we've
heard about. Tatiana was promising Julia that women empowering women
would multiply her money in just six weeks. The Ladies
Deposit Company promised to almost double investors' money.
Speaker 1 (27:10):
After a year.
Speaker 2 (27:12):
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 ever be for Sam Israel to
(27:33):
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 swept out of the cloudless
(27:54):
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 had spectacularly backfired, while
(28:19):
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.
Speaker 1 (28:36):
Will go to jail. Please speG Marino.
Speaker 2 (28:40):
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 will be back in a moment.
(29:25):
In two thousand and three, Sam Israel was at home
leaning over a line of white powder with a rolled
twenty dollar bill up his nose. When his wife, Janice
walked in. She became upset. He became outraged. How dare
she suggests he was taking cocaine. She persuaded him to
(29:47):
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, you want urine. At
Thanksgiving that year, he passed out over the turkey. By
(30:09):
Christmas two thousand and three, Janice had thrown him out
of their house and secured a protective order. Sam rented
the most tasteless, ostentatious bachelor pad he could find, a
vast Tudor style manner, with outsized chandeliers, marble bathrooms, and
(30:31):
comically huge beds. Sam paid the monthly rent of twenty
two thousand dollars to the house's owner, a gentleman by
the name.
Speaker 1 (30:40):
Of Donald Trump.
Speaker 5 (30:43):
So good, so good, amazing house, huge beds.
Speaker 2 (30:50):
Sam hung around clubs, tipping the bartender to introduce him
to pretty women. He fitted the Trump mansion with the
latest trading equipment, 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
(31:12):
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.
(31:37):
Dan and Sam 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
(31:58):
an old saying, you can't cheat an honest man, and
there's truth in that saying, because the premise of a
scam is often simply.
Speaker 5 (32:09):
Doing crimes, and if you come and do crimes with me,
we'll both make money.
Speaker 2 (32:14):
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
(32:36):
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
(32:56):
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 1 (33:08):
Who exactly was running the world economy? Anyway?
Speaker 2 (33:12):
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 of
delusional beliefs. Sam became obsessed with finding the undocted footage
(33:38):
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
of such events. Above all, Sam came to believe in
(33:59):
a global conspiracy thirteen powerful families who truly rule the world,
whom he called the bus. It all gets very, very weird.
Do read the book. It's quite a trip. But for
our purposes, what we need to know is that Sam
Israel fell under the spell of a man called Robert
(34:23):
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
smoking James Bond. He swaggered around London City with tight
controls on firearms, with a revolver in a shoulder holster.
(34:47):
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
beg Nichols to give it to him. He'd do anything,
he said, Do you have one hundred million dollars in cash?
Speaker 1 (35:08):
Said Nichols, I've got one hundred million in cash. Do
you have one hundred and fifty million? Yes?
Speaker 2 (35:17):
Forget the special CIA program which monitors bank accounts, said Nichols,
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, you know, the octopus.
And just as Julia had said to Tatiana at the
(35:39):
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
(36:02):
of conspiracy theorist fraudstans, 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,
(36:24):
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
(36:47):
to find the exact same treasure.
Speaker 3 (36:50):
Can we have a recap?
Speaker 4 (36:52):
Of course, sam Israel was controlling one hundred million dollars
of Buyo Capital's money based on a fraud. He then
invested that money in Robert Nichols's fraud. Robert Nichols then
invested that money in yet another fraud.
Speaker 3 (37:06):
Exactly, thank you.
Speaker 2 (37:08):
Reassuringly, though so, 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. They were hard checks and
balances in place. Several times Sam Israel tried to invest
the one hundred million in one scam or another, and
(37:29):
a 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
(37:51):
he 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 man he
believed was an elite CIA operative. But i u's investors
(38:13):
asked for their money back, 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, as an act of
(38:37):
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
(38:57):
high over the Hudson River in upstate New York. He
left a suicide note and smudged in the dust on
his car's hood were the words suicide is paid. But
sam Israel's suicide note was as fictional as his investment returns.
The authorities tracked him down, alive and well, and a
(39:19):
campsite in Massachusetts. They promptly 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, were rather more mundane.
(39:46):
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 for not finding more recruits. Tricksy,
Pucky and Buttons all.
Speaker 1 (40:04):
Had their say.
Speaker 2 (40:05):
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 the snowball. Sarah
(40:28):
Howe went to prison twice. Sam Israel faked his own
suicide in a desperate attempt to escape. But the unknown
woman who.
Speaker 3 (40:39):
Created the whole spiel about hearts.
Speaker 2 (40:42):
And empowering other women, she's the exception to the rule
that fraud doesn't pay. She pushed a few snowballs 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.
(41:09):
The grumpy fairies could probably afford to lose the money,
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
(41:31):
lunch the women empowering women snowball had started to flatten
much 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
(41:54):
Davis's book Lying for Money, and for the astonishing story
of 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 McLachlin. The original music is the work
(42:17):
of Pascal Wise. Our b SL interpreter was Katherine Motson.
The show was produced by Alice.
Speaker 3 (42:24):
Fines, Marilyn Rusk, and Ryan Dilling.
Speaker 2 (42:26):
Sarah Nick said it took the script of sound engineer
was Andrew Bayless.
Speaker 3 (42:31):
The thanks to Zoe Seedman, Miilm and the team at
the British Best Level of Economics. Puchal Tails is a
production of Pushkin Industries.
Speaker 2 (42:39):
If you like the show, please remember to rate, share
and review to want to hear the show ad.
Speaker 3 (42:44):
Three sign up the Pushkin past on the show page
of Apple Podcasts of Pushkin FM, Slash Truce.
Speaker 1 (42:59):
Thank you that was fun.
Speaker 6 (43:02):
Thank you so much, guys.
Speaker 2 (43:04):
The Trump impression was okay?
Speaker 6 (43:06):
Was that?
Speaker 2 (43:14):
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 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.
(43:39):
We're back and I've been talking to my Financial Times
colleague Rob Armstrong about all things Ponzie for his podcast Unheedged.
Speaker 1 (43:54):
Pushkin.
Speaker 6 (43:57):
I love a good Ponzi scheme from Charles Ponzi himself
to Bernie Madoff. I suppose admire the wicked intelligence of
the puppet masters, and I 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
(44:19):
me is Tim Harford, my fellow FT columnist and master
of his own podcast, Cautionary Tales. Tim, how are you?
Speaker 2 (44:27):
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 roll whenever
I read one of your wonderful columns about satoial elegance.
The subtext is this column is written at you, Harford,
you slob, and so it just feels sloody guilty about
(44:49):
the whole thing.
Speaker 6 (44:50):
But yeah, you'll be glad to know I'm sitting in
my bedroom in a tea shirt and a pair of jeans.
So I hope that puts you at ease.
Speaker 2 (44:55):
Okay, Yeah, I feel better now, Thank you, Rob.
Speaker 6 (44:58):
I was fascinated to listen to the most recent episode
of Cautionary Tales. It gave a lot of terrific examples,
starting with the immortal Sarah Howe of Ponzy Schemers. Yeah,
tell us what that Ponzy scheme fundamentally is and what
you discovered about them doing that episode.
Speaker 2 (45:17):
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. It's outrageous, outrageous for
(45:39):
another woman forgotten by history, unfairly forgotten by history, all
the credit taken by Ponsey. 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
(46:01):
no way of actually making that return. And so, as
with all Ponzi schemes, people investing in 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 Ponzi scheme. Early investors who are trying to
cash out get paid not out of the productive return
(46:26):
from the productive activity, because there is no productive activity.
They get paid because other people are also pouring money in.
And that's the basic genius of the idea. And Cautioning
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 Sam Israel, which
(46:50):
is described in Gee Lawson's book The Octopus, which is
absolutely bonkers because it just goes utterly down a whirlpool
of conspiracy, theorism and so on. So it's great fun.
Speaker 6 (47:01):
I want listeners to know that this is not a
parochial phenomena of my home city Boston. I have a
good friend and this connection 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
(47:22):
meeting of other women and they were going to talk
about investment opportunity and so forth. And 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
(47:43):
you will become a receiver of funds from other people
in the you know, Ladies Empowerment Club of Brooklyn or whatever.
And my friend, who has her head screwed quite tightly
onto her shoulders, looked around at these well meaning, kind
of semi bohemian, semi business class Brooklyn ladies and said,
(48:06):
you're all going to jail if you do this. This
is a Ponzi scheme. And now looked at her a
gas like they they had no idea that they were
engaged in something untoward or possibly illegal.
Speaker 1 (48:18):
Yeah.
Speaker 2 (48:18):
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 the 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
in the phrase that everyone likes to.
Speaker 6 (48:40):
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 in size?
Speaker 2 (48:55):
I love it. So it's like a decentralized Ponzi scheme, right.
Speaker 6 (48:58):
It's a It's a naturally occurring decentralized organic Ponzi scheme
where you know something the magnificent seven tech stocks start
to go bananas and run 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
(49:19):
up by constantly 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's
draw into the market bubble, at which point the bubble
collapses in an exact reversal of the social structure that
(49:40):
built it.
Speaker 2 (49:41):
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,
(50:05):
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 into this thing. And the reason it's not a
Ponzi scheme, well, there's two things. One is there's no
(50:26):
fraud because Amazon was perfectly honest about the accounts and
perfully honest that it was losing money, and so there's
no deception, there's 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 turn into something productive, and
everybody can get paid back. So the first part of
(50:48):
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 stocks in the nineteen nineties never did,
and people could make a lot of money as long
as they got out in time. And that's very ponziish.
Speaker 6 (51:07):
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,
(51:28):
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
(51:48):
because it wasn't paying money to investors, it was reinvesting
in itself because the investors had that faith.
Speaker 2 (51:54):
So I think we now have a typology. So if
you're putting money in and early investors get repaid by
from later investors and the accounts are a sham. That's
a Ponzi scheme, and someone's to jail. If the early
investors get repaid by the late investors putting money in,
(52:15):
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 genius of capitalism.
Speaker 6 (52:36):
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.
Speaker 7 (52:51):
In a bubble, the people involved in it in markets
actually acknowledge that prices are no longer connected to economic
fundamentals or the productivity of the companies involved.
Speaker 6 (53:04):
They start using words like momentum right, and they say
you can't get in front of momentum. The market is
pushing upwards. If you get out now, you're going to
regret it. It's fear of 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
(53:26):
pay more, and I will be out of this game
and somebody else will be left to hold the bat.
Speaker 2 (53:30):
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
(53:52):
was something to do with the arbitrage of international postal
reply coupons. Really that's going to work, but you know,
people believed it.
Speaker 6 (54:01):
There's another question I wanted to ask you, which is
all of the Ponzi's 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. These all turn out very poorly
for the puppet masters very poorly. So there's a question.
There's a question about why US suckers fall for them.
(54:25):
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. Why do they do it?
Speaker 2 (54:35):
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
(54:56):
his attempts to swing for the fences had paid off.
But ultimately, there's a really interesting idea which I was
introduced to by the writer Dan Davis, who hate the
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
(55:18):
a little old lady and you steal it okay. Now
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
(55:39):
little old ladies. So that's all kind of obvious, and
it's obvious that that can't keep going forever. That's an
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.
(56:00):
The frauds that only stole one hundred dollars, and somehow
now they're responsible for maintaining this normalmous fraud, and no wonder,
so many the men crying with relief when they're finally arrested, like,
thank goodness, I don't have to do this anymoyss. So
I don't know why people do this.
Speaker 6 (56:17):
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. Something goes slightly wrong,
(56:40):
and okay, just one month, I'm going to fudge the
numbers so I can pitch to one more investor, and
then that takes on a life of its own. 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 Madoff scheme as having
some of that character. And you can read Madoff's actions
(57:04):
late in the scheme as desperately trying to keep the
thing under control, turning investors away as it because he
couldn't handle it.
Speaker 2 (57:15):
And it just gets so huge that in the end,
the gap between the underlying reality of the investments about
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.
(57:36):
Did they mean it to be a Ponzi scheme or
did they actually think they were investment geniuses and 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 (57:51):
Tim, If you give me one hundred dollars, I have
a brilliant idea. I'm on it. This is a long
short that portion of the show where we go long
something we like or short something we don't like. Tim,
are you long or short something?
Speaker 2 (58:12):
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.
(58:33):
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. And what that means is that the
person who sets up each individual pyramid scheme can cash
(58:58):
out and walk away. And in fact, the pyramid scheme
I describe in the cautionary tail, we have no idea
who set it up. She seems to have got fairly
rich and just walked away. And she never went to
say she.
Speaker 1 (59:10):
Tim.
Speaker 8 (59:10):
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 6 (59:24):
Well, let me ask you a question. Is bitcoin a
Ponzi or a pyramid?
Speaker 2 (59:28):
Neither or neither? 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
(59:49):
closer to a pyramid scheme.
Speaker 6 (59:51):
I'm going to be sure bitcoin just because I'm a coward.
Speaker 2 (59:54):
Well, I think that that's your inalienable, right, Robin. I
think I might join you in your cowardice.
Speaker 6 (01:00:00):
Thanks for being on the show.
Speaker 2 (01:00:02):
Oh that's a real pleasure. Thank you, Bob. I loved it.
Speaker 6 (01:00:05):
Listeners. If you like Unheedged, you will of cautionary tales
Tim's podcast Unhedged. We'll go back in your feed before
you know it. Thanks for listening. Unhedged is produced by
Jake Harper and edited by Brian ertstap Our executive producer
is Jacob Goldstein. You have additional help from Toeprah. Forehead
(01:00:26):
Cheryl Brumley is the FT's global head of Audio. Special
thanks Laura Clark, Alistair Mackey, Branda Cone, Marilyn rust Here
Posey and Natalie Sadler. FT Premium subscribers can get the
Unhedged newsletter for free. My thirty day free trial is
available to everyone else. Just go to ft dot com
(01:00:47):
slash Unhedged offering. I'm Rob Armstrong. Thanks for listening.
Speaker 2 (01:00:57):
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. Caution, de
Tales will be back in feed soon
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