Transcript for The Fraudster's Guide to Magic Money

Dealing with pests can be a pain. But relax, terminics can help because when pests show up, so does terminics. With over 95 years of experience, they have what it takes to take on any pest problem fast. If your home or business has pests, don't stress it, terminics it. Visit terminix.com to book your appointment online today. That's T-E-R-M-I-N-I-X.com. Hello dear listener, Tim Halford here. I have some very exciting news to share with you. On the evening of Tuesday, the 21st of May, I will be bringing a special live edition of caution retails to the stage in London. There will be music. There will be actors.

And 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 21st of May. I can't wait to see 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. Are you all ready? 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 richer one, Tatiana. The glamorous wife of an investment banker. Tatiana ordered another bottle of champagne and launched into her sales pitch.

Julia and Sophie looked at each other and sighed. This wasn't the first time that heard the spiel. It was the summer of 2003, and hearts with a capital H were all the rage among the champagne drinking horse riding banca marrying ladies of great Britain. He's how it worked. You donated £3,000 to buy a heart. and join the scheme at the bottom of a pyramid. That's about $6,000 in today's money. Your money would go to the person at the top called the receiver, the head, leave the pyramid. The two people on the next level down would be promoted to the top role of receiver. In fact, pyramid would then split into two so that both of them would be at the top of their own pyramid. Everyone would move up a level. And everyone on the lowest layer, including you, would recruit two people to buy a heart and fill in the newly vacant layer beneath you. Six weeks later, You'd be a receiver and would get 24,000 pounds. The equivalent of $50,000 today and a huge return no matter how you measured it. The 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. This is, transparently, a pyramid scheme. And pyramid schemes don't make money. They just move it around. If someone's going to make 24,000 pounds, then that money must come from other members. So, eight other people must lose their investment of 3,000 pounds. It's really that simple. 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. Men weren't allowed.

As Tatiana explained, She also added that she had spent her first winfall 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 that apparently the supermodel Claudia Schiefer 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 from a lady called Elphi. Who is collecting her boy Archie from an exclusive London school?

Wonderful, replied Julia.

I'm Tim Hartford, 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 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. Some of them are not. Few people are less anonymous than Samuel Israel III. 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 1978, dropping out of college to run errands for one of Wall Street's most famous share traders. Sometimes those errands merely meant fetching pizza. Sometimes they involved going to a particular room in the Pierre Hotel on the Upper East Side and speaking a code phrase to a Swiss gentleman.

The Swiss man gave Sam a satchel. Sam didn't look inside it. until his boss showed him that it was filled with $100 bills. When over $100,000, at a time when $100,000 was real money, odd things like this tended to happen from time to time and to 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 Janice. She was sensible, training to be an accountant. It wasn't the idea on match. I hid everything from Janice. Sam is rail confessed to the Rolling Stone Journalist, Guy Lawson.

And what was really going on? That depends on when you asked the question. In 1978, Sam was quietly being a career of satials full of $100 bills. the night before he married Janice Sam was having a threesome with two expensive call girls paid for by his Wall Street trader boss as a wedding gift. In 1987, 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 swooped in printing money to prop up the market. In the early 1990s, 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 Janice about any of this, of course. But what Sam really couldn't talk to Janice about was by you capital. By you capital 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 1878, refined ladies of Boston, Massachusetts were intrigued to hear of a wonderful investment opportunity. A new bank founded by women, four women, and called the ladies deposit company paid interest of 8%. 8% a year would be a solid enough offering. The latest deposit company, however, paid 8% every month. Deposit $100 and by the end of the year you'd have earned $96 nearly doubling your original investment. There were no rumors of supermodels back in 1878, but the gossip suggested something even more reassuring. The latest deposit company was said to be backed by a quaker charity. Doing many unspecified good works. Only unmarried women need to apply. Such unprotected 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 of huge importance. And 8% a month, two good to miss, or alternatively, two good to be true. The ladies deposit company was not founded by Quakers, but by a stage psychic and professional fortune teller named Ms. Sarah Howell. 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 ladies deposit company, money poured out, and the mechanics of how it all worked were conveniently obscure. One intrepid reporter even disguised himself as a woman, one could only presume that no female journalist were available. In order to gain entry to the deposit company's headquarters, but he didn't learn much.

Was 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 50 years earlier, but women never seem to get the credit for inventing anything, even investment fraud, The local press soon concluded that the latest deposit company was an obvious scam. The Boston Daily advertiser published an illustrated explainer, some articles highlighting the stage psychic house 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. 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, she went to jail. The latest deposit company is a wonderful illustration of what Dan Davis 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 and bigger, simply falls apart. It's too big. Remember, Sarah Howell was offering to almost double your money in a year if you invested with her. So let's watch the snowball from a safe distance. Imagine that Sarah receives an investment of $100 from a little old lady and steals it. By the end of the year, that little old lady expects her $100 back on top of $96 in interest. Sarah finds two more investors, steals their money and gives it to the little old lady. But by the end of the following year, Sarah Howe needs to have given nearly $200 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 $800 back, she just needs to find eight new investors to join the latest deposit company. Now, you can see the trap here. Eventually, there will be no more lady depositors for the latest deposit company. But what's perhaps less immediately obvious is that in this little story, Sarah Howe will soon owe $1,600 to 8 investors. And yet she only ever stole $100 for herself. For growing snowball of fraud is huge and it needs to keep getting huge. The profit for the fraudster is relatively tiny. No wonder that so many fraudsters eventually get caught. And no wonder perhaps that when they do get caught, so many of them weep with relief. There will be tears of plenty, but not much relief after the break.

As a loyal listener to cautionary tales, you probably consider yourself pretty smart and you are. But how smart is your wallet? When you're looking to upgrade your wallet, it's time to turn. To nerd wallet. Their expert team of nerds has the financial smarts to help you find the right financial products for you. Before nerd wallet, you might have paid for vacations with whatever was in your wallet. But you could have been missing out on miles you didn't even know you were leaving on the table. Now you can get a new card with more miles and more upgrades. What could future you do with more travel rewards? A hotel upgrade, lounge access? Where if you go next, make it happen with a smarter travel credit card. Don't wait to make smart financial decisions, compare and find smarter credit cards, savings accounts, and more today at nerdwallet.com. Nerdwallet, finance, smarter. As with all cards, credit is subject to lender approval and terms apply. This episode is brought to you by Terminix. Terminix may not be able to rewrite history or take on societies problems, but they can help you solve one of the peskyest problems at home. Pests. You know, the answer you're catching, the roaches under your sink even the termites in the walls, because when pests show up, so this terminix. No matter what type of pest it is, they can terminix it fast with personalized pest care that puts you in control. Their expertly trained technicians know your local pests the best. So even though they don't know in depth world history, you can bet they know how to make your past problem history. And with customized plans tailored to your specific situation, you get everything you need to not just get pasts out, but keep them out for good. Between their speedy service, caring technicians and over 95 years of experience, it's no mystery why they're trusted by homes and businesses everywhere. So if you have a pest problem, don't stress it, terminix it. Visit terminix.com to book your appointment online today. That's T-E-R-M-I-N-I-X.com to book online today. In the summer of 2003, 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 £3,000 to Elfie, the mother of Darling Archie from the fancy school. But Julia's own recruitment efforts were going nowhere. Her rich friends sneered at her. They'd 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, for everyone who makes 24,000 pounds in a pyramid scheme, there must be eight people who lose 3,000 pounds. But how can it be that so many people lose out? But 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 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 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 London mansions, champagne being co-oft with supermodels, as suitcases of cash were handed to people who'd reached the top of the pyramid. But this recruitment party was in a hairdressers. Instead of champagne on ice, there was warm white wine and a growing sense of irritation that Julius failure to recruit was letting down everyone above her in the pyramid. There was of course no sign of Claudia Schiefer. The brilliance of women empowering women is that it seems to 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 UCapital in 1996, assisted by an accountant named Dan Marino, 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 your capital, would use a new computer algorithm he'd developed, plus the skills of a once-great trader who Sam had hired after he'd 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, but it didn't. The once great trader was washed up. He made a lot of bad calls. The computer algorithm seemed to misfire as often as it worked. And Sam didn't have the same insider access that he used to. 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 and buy you capital would collapse. Or alternatively, Sam and his colleagues, the washed up trader, and the accountant who lived with his mum, could them lie? Could publish audited accounts, which claimed stellar results? Like Sarah Howe, there'd be offering fantastic returns. Unlike Sarah Howe, who would simply steal money from new depositors and pay it out as interest, They'd need to show some kind of evidence that they were making profitable investments. To do that, they'd need a fraudulent auditor. No problem. Dan Marino simply 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 the Dan Marino. It probably didn't hurt that if anyone ever tried to search for Dan Moreno on the still young World Wide Web, they were sure to get Dan Moreno the unimaginably famous Miami Dolphins quarterback rather than Dan Moreno the crooked accountant. For a while, the plan was that Sam would go on a profitable streak, and actually make the profits that Dan Marino's fake accounts were claiming. But the snowball was starting to grow. The more profit they said they were making, the larger the fictional pot of money was growing, and the harder it was for Sam and his partner to catch up to their own lies, It didn't help that Sam kept claiming to outperform the market. Dan Marino was losing his mind at the fact that Sam couldn't control himself. 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.

Posted Sam to his investors. Dan Marino knew the awful truth.

Said Marino, the snowball was already too big.

Four years after the latest deposit company was exposed by the Boston Daily Advertiser and collapsed. And Ms. Sarah Howe was sent to prison. refined women of Boston, Massachusetts, were intrigued to hear of a wonderful investment opportunity. A new bank founded four women by women and called the Boston Women's Bank, paid interest of seven percent per month, two good to miss. or alternatively, too good to be true. After a couple of years, the Boston Daily advertiser discovered and published the truth. The manager of the Boston Women's Bank was not Mrs. J.C. Uall, as advertised, but an ex-convict by the name of Sarah Howell. Sarah Howe had learned one lesson. This time she skipped town and moved to Chicago. In due course, the refined ladies of Chicago were intrigued to hear of a wonderful investment opportunity. The ladies' profinent aid society was offering interest of our never mind. The police caught up with Ms. Sarah Howe, shut down the ladies' profinent aid society and soon enough, Ms. Howe was back in prison. Worth it? Surely not. In character, most definitely. Sometimes, when the snowball starts to roll, the fraudster just can't quit. Sam is well seen 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 was taking too much cocaine, and drinking far too much booze, and, like so many people, he'd 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 sell 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 latest deposit company promised to almost double investors money after a year. But by your 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 biocapital snowball grew, the harder it would ever be for Sam Israel to trade his way out of the lie. One September Friday, his computer algorithm suggested a big bet on shares going up in the next week. Sam made that bet. The following Tuesday morning, two airliners swept out of the cloudless sky above Manhattan and crashed into the World Trade Center. The world reeled with the implications of the atrocity. But for Sam Israel and Dan Moreno, the only thing that mattered was how it changed their own twisted financial world. Sam was a guest that is bettered spectacularly backfired while Dan Moreno spotted an opportunity. Close the fund, said Dan Moreno, and tell investors he lost most of their money in the aftermath of 9-11 and give the dregs back. Everyone will yell, but nobody will suspect anything, and neither you nor I will go to jail. Please, spec marino, but Sam is well wouldn't do it. He knew that if by your capital folded, he might escape jail, but it still loses fancy home. He should have listened to marino, because within two years, he was going to lose his home anyway. Corsion retails will be back in a moment.

As a loyal listener to cautionary tales, you probably consider yourself pretty smart and you are. But how smart is your wallet? When you're looking to upgrade your wallet, it's time to turn to nerd wallet. Their expert team of nerds has the financial smarts to help you find the right financial products for you. Before nerd wallet, you might have paid for vacations with whatever was in your wallet. but you could have been missing out on miles you didn't even know you were leaving on the table. Now you can get a new card with more miles and more upgrades. What could future you do with more travel rewards? A hotel upgrade, lounge access, wherever you go next, make it happen with a smarter travel credit card. Don't wait to make smart financial decisions, compare and find smarter credit cards, savings accounts, and more today at nerdwollet.com. Nerdwollet, finance, smarter. As with all cards, credit is subject to lender approval and terms apply. This episode is brought to you by Terminix. Terminix may not be able to rewrite history or take on societies problems, but they can help you solve one of the peskyest problems at home. Pests. You know, the answer you're catching, the roaches under your sink even the termites in the walls, because when pests show up, so this terminix, no matter what type of pest it is, they can terminix it fast with personalized pest care to put you in control. Their expertly trained technicians know your local pests the best. So even though they don't know in depth world history, you can bet they know how to make your past problem history. And with customized plans tailored to your specific situation, you get everything you need to not just get pasts out, but keep them out for good. Between their speedy service, care and technicians are over 95 years of experience. It's no mystery why they're trusted by homes and businesses everywhere. So if you have a pest problem, don't stress it, terminix it. Visit terminix.com to book your appointment online today. That's T-E-R-M-I-N-I-X.com to book online today. In 2003, Sam Israel was at home, leaning over a line of white powder with a rolled $20 bill up his nose. When his wife Janis walked in, she became upset. He became outraged. How dare she suggest he was taking cocaine? She persuaded him to take urine tests to ensure he stayed off the drugs. Until one evening he angrily unzipped his pants and went all over the bathroom floor, bellowing.

Thanksgiving that year. He passed out over the turkey. By Christmas 2003, Janis 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, chewed-a-style manner, with outside chandeliers, marble bathrooms, and comically huge beds. Sam paid the monthly rent of $22,000 to the house's owner.

Sam hung around clubs, tipping the bartender to introduce him to pretty women. He fitted the Trump mansion with the latest trading equipment, 17 screens, so he could work from home. He was still looking for a way to make all the money back. But the fraud snowball at Bayou was getting bigger and bigger. And Dan Marino had had a 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 counter-parties 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. 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 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, I'm doing crimes.

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 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'd seen the Federal Reserve magic money out of thin air after that great crash of 1987 when Sam had made so much money and could have made more if the Fed hadn't stepped in. The Fed stepped in after 9-11, too. Who exactly was running the world economy anyway? Sam started to run in strange conspiratorial circles. If you want the full story, it's told in incredible cringe-making detail in Guy 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 undocked footage showing who really killed JFK. He believed it'd been attacked by an assassin on the streets of Hamburg, and that it 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 a global conspiracy. 13 powerful families who truly rule the world, whom he called the octopus. It all gets very, very weird, but 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 Booz Nichols, who was claimed to be a top CIA agent. whose bare hands was head 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. Sam believed that nickels had access to a special CIA program, which monitored every bank transaction on the planet, and insider traders dream. And he flew out to London to beg Nichols to give it to him. Hit do anything, he said. Do you have $100 million in cash, said Nichols? I do.

Yes. 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 13 families who together secretly rule the world, you know, the octopus. And just as Julia had said to Tatiana, at the Riverside Spa, Sam Israel said to Nichols, sign me up, but not for 3,000 pounds. for more than $100 million. with nickels by his side, whispering into his ear. Sam Israel joined an absolutely bizarre world full of conspiracy theorist fraudsters, all claiming to believe in the existence of a secret market that can multiply your money tenfold overnight, all secretly frustrated that they personally have never been able to get access to that entirely fictional market, and all trying to repeat each other off. At one stage, Nichols got Sam Israel to give him $10 million 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 conman persuaded Nichols to give him $1 million to help finance an expedition to find the exact same treasure.

Are you sure, though, it's quite hard to give a hundred million dollars to a fraudster to invest in a special market protected by assassins and controlled by the 13 families who really rule the world. There are checks and balances in place. Several times, Sam Israel tried to invest the 100 million in one scam or another, and a banker or a stock broker simply refused to process the transaction until there was proof that it was genuine, and the never was. In the end, the Bayou Capital Ponzi scheme was exposed. But it wasn't because Sam Israel's investors believed that he'd lost his mind. Or even that he'd 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. by using investors asked for their money back, which would have been fine, except that most of that money had only ever existed in Dan Morino's fraudulent accounts. The snowball had grown enormous. The fraud was at last, exposed. Sam Israel was given a sentence of 20 years, and as an actor of leniency that seems to be common for white collar criminals, eight weeks of freedom to get his affairs in order before reporting to jail. Listener, he did not report to jail. Police found his car parked on the bare mountain bridge, high over the Hudson River in upstate New York. He left a suicide note and smudged in the dust on his car's hood, with the words, suicide is painless. But Sammy's whale's suicide note was as fictional as his investment returns. The authorities tracked him down alive and well, and a campsite in Massachusetts, they promptly 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. Julius investment troubles, thankfully, were rather more mundane. Having invested 3,000 pounds in the women empowering women pyramid, she found herself feeling ever more strident calls from people further up the pyramid, berating her for not finding more recruits. Tricksie, Pucky and buttons all have their say. It was, says Julia.

But the curious thing about women empowering women Nobody knows who started it. We think, although 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 Howell went to prison twice. Sam Israel faked his own suicide in a desperate attempt to escape. But the unknown woman, who created the whole speel about hearts 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 casualty has began to mount down below, she walked away. But those casualtys did exist, and Julia met them. The grumpy ferris could probably afford to lose the money, But it was less funny to receive voice mails from distraught Filipino cleaners who'd bought hearts, and now feared their lose £3,000, they definitely could not afford to squander. Having run out of spa-going, pony riding ladies who lunch, the women, empowering women's noble, 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 Stevenson's article, Broken Hearts Club, Daniel Davis's book, Lying For Money, and for the astonishing story of Sam Israel, Guy Larson's book, Octopus. This live edition of cautionary tales was written by me, Tim Hartford, with Andrew Wright. Tonight, you heard the voice talents of Sarah Job and Stuart McLaughlin! The original music is that we're a Kaskar-Wars, our 3S-7 circuiter is Catherine Moxson. The show is produced by Alice Hines, Marilyn Roths, and Ryan Dilling. Sarah McSettler took the script. A sound engineer was Andrew Bayless. The thanks to very seven million, let's see with the British festival of economics. Four-stroke hails is a production of Fischken Industries. If you like the show, please remember to rate, share, and review. Want to hear the show at free, sign up for Fischken Cross on the show page at the podcast. Fischken FM slash cross. Thank you, that was fun. Thank you so much, guys. The Trump impression was okay. If you've enjoyed this special live episode about Pyramid and Ponzi schemes, don't go away. I sat down with one of the smartest people I know in financial journalism. My financial times colleague Rob Armstrong, one of the hosts of the unheached podcast, and we asked, what if everything is a Ponzi scheme? We'll be back with that in a moment.

As a loyal listener to cautionary tales, you probably consider yourself pretty smart and you are. But how smart is your wallet? When you're looking to upgrade your wallet, it's time to turn to nerd wallet. Their expert team of nerds has the financial smarts to help you find the right financial products for you. Before nerd wallet, you might have paid for vacations with whatever was in your wallet. but you could have been missing out on miles you didn't even know you were leaving on the table. Now you can get a new card with more miles and more upgrades. What could future you do with more travel rewards? A hotel upgrade, lounge access, wherever you go next, make it happen with a smarter travel credit card. Don't wait to make smart financial decisions, compare and find smarter credit cards, savings accounts, and more today at nerdwollet.com. Nerdwollet, finance, smarter. As with all cards, credit is subject to lender approval and terms apply. This episode is brought to you by Terminix. Terminix may not be able to rewrite history or take on societies problems, but they can help you solve one of the peskyest problems at home. Pests. You know, the answer you're catching, the roaches under your sink even the termites in the walls, because when pests show up, so just Terminix. No matter what type of pest it is, they can terminix it fast with personalized pest care that puts you in control. Their expertly trained technicians know your local pests the best. So even though they don't know in depth world history, you can bet they know how to make your past problem history. And with customized plans tailored to your specific situation, you get everything you need to not just get pasts out, but keep them out for good. Between their speedy service, care and technicians are over 95 years of experience. It's no mystery why they're trusted by homes and businesses everywhere. So if you have a pest problem, don't stress it, terminix it. Visit terminix.com to book your appointment online today. That's T-E-R-M-I-N-I-X.com to book online today. We're back, and I've been talking to my financial times colleague Rob Armstrong about all things Ponzi for his podcast Unheached.

I'm great Robin. Pleasure to finally get on, unheged, I'm a loyal listener, although I always feel terribly badly dressed. whenever I, whenever I even think of you, or whenever I read one of your wonderful columns about Satorial elegance, the subtext is this column is written at you half-ered, you slog. And so it just feels that he guilty about the whole thing.

Okay, yeah, I feel better now. Thank you, Rob.

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 Ponzi schemes and pyramid schemes. which are obviously always a terrible idea, but they have a lot of lessons for us and Sarah, how invented the Ponzi scheme and can you believe that it isn't called a house scheme? It's outrageous.

Yeah, she was even operating in the same city in Austin, Massachusetts. So Sam, a house set up the ladies deposit company and basically offered to pay a ladies 8% a month, which is basically doubling your money in a year. And of course, there's no way of actually making that return. And so as with all Plansy 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. 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 Cochrane tells talks about Sarah Howe 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 is described in Guy Lawson's book, The Octopus, which is absolutely bonkers because it just goes utterly down a whirlpool of conspiracy theories and so on.

Yeah, part of the issue is that it is not always straightforward to figure out whether something is a Ponzi scheme or not, because superficially, I mean, there's a lot of stuff in a capitalist economy that involves where you invest some capital and you take a risk and if things go well, you get paid back 10x in the phrase that everyone likes to use.

I love it. So like a decentralized Ponzi scheme, right?

So I love this idea. So let's use 2020 hindsight. Let's go back and let's think about Amazon 25 years ago. And I think a little bit of hindsight clarifies things. So what distinguishes Amazon from a Ponzi scheme? Because if you think about it, this is an organization which in the 1990s and the early 2000s was not making money. Losers a lot of money. Yes, 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, it's two things. One is, there's no fraud, right? Because Amazon was perfectly honest about the accounts and perfectly 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 that them being honest. Okay, that's 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.com stocks in the 1990s never did and people could make a lot of money as long as they got out in time and that's very positive.

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 going to jail. If the early investors get repaid by the late investors putting money in, but there's no accounting fraud, people are just overexuberant and the whole thing all collapses and it's pet.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 investment such as Amazon, it's neither a Ponzi scheme nor a bubble, it's the genius of capitalism.

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 we'll do. I'm greedy now and a lot of the Ponzi stories. So it got me Charles Ponzi's original story was something to do with the arbitrage of international postal reply coupons. Really, that's going to work. But people believed it.

Why do they do it? I really am not sure why they do it. As opposed, you could say, well, if the pawnsy 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 Bayou Capital Ponzi scheme, maybe he would have gotten away with it if one of 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 had this terrific book about fraud called Lying for Money. And he basically points out that if you take a typical Ponzi scheme, so let's say you're promising to double people's money every year. Okay, so you take $100 from a little old lady and you steal it. Okay, now in a year you need to pay her $200. 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 earning twice as much money and you need to defraud twice as many little old ladies to pay the previous little old ladies. So that's all kind of obvious. And it's obvious that that can't keep going forever. That's an 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 $100 theft. the fraudster only stole a hundred dollars. And somehow now their responsibility for maintaining this enormous fraud and no wonder so many of them are crying with relief when they're finally arrested. Like, good enough to do this, Eddie. Yes. So I don't know why people do this.

And it just gets so huge that in the end, the gap between the underlying reality of the investments, but how much money you are really generating in a 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. Did they mean it to be a Ponzi scheme or did they actually think they were investment geniuses that everyone would get paid back? There is often an ambiguity at the start. But unless you're able to close that fraudulent gap early, it becomes so unbridgeable. You don't have a chance.

Can I go for a pad trade?

Excellent. So I'm going to go short Ponzi. and long pyramid schemes. So we should probably very briefly explain the difference. So our Ponzi scheme, someone's running a Ponzi scheme, they're lying, they're paying out earlier investors using money from later investors. Pyramid scheme works in a similar way, but 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 out and walk away. And in fact, the pyramid scheme I described in the cautionary tale, we have no idea who set it up. She seems to have got fairly rich and just walked away and she never went to jail and we don't know.

I couldn't possibly comment. Couldn't possibly comment. Well, okay, that I'm short Ponzi, long pyramid. Do you have a longer or short for us?

Or neither? Or neither? I mean, I think it's more, it's more bubbly than either, but it's not a pawn to your scheme because there's nobody in charge at 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, investing in Bitcoin, you get paid by other people coming in and buying your Bitcoin. So it's closer to a pyramid scheme.

Well, I think that's your inalienable right Robin. I think I might join you in your cowardice.

Oh, that's a real pleasure. Thank you Rob. I loved it.

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