{"id":1812,"date":"2013-04-23T17:41:25","date_gmt":"2013-04-23T12:11:25","guid":{"rendered":"http:\/\/teekhapan.wordpress.com\/?p=1812"},"modified":"2013-04-23T17:41:25","modified_gmt":"2013-04-23T12:11:25","slug":"saradha-and-ponzi-schemes-why-there-will-be-more-suckers","status":"publish","type":"post","link":"https:\/\/vivekkaul.com\/2013\/04\/23\/saradha-and-ponzi-schemes-why-there-will-be-more-suckers\/","title":{"rendered":"Saradha and Ponzi schemes: Why there will be more suckers"},"content":{"rendered":"

\"Saradha-Group-headquarters-650x430\"<\/a><\/p>\n

Vivek Kaul<\/strong> <\/p>\n

In\u00a0<\/span><\/span><\/span>Ek Thi Daiyan<\/i><\/span><\/span><\/span>, the latest horror flick to come out of Bollywood, the dying\u00a0<\/span><\/span><\/span>daiyan<\/i><\/span><\/span><\/span>\u00a0(witch) says something to the effect of \u201c<\/span><\/span><\/span>main wapas aaongi<\/i><\/span><\/span><\/span>\u00a0(I’ll be back).\u201d Ponzi schemes are a tad like that. They keep coming back one after the other.\u00a0
Only sometime back we were talking\u00a0about the Stockguru Ponzi scheme<\/a>. Before that the emu ponzi scheme and Speak Asia had been in the news. More\u00a0recently the MMM Ponzi scheme\u00a0<\/a>and Saradha chit fund have taken up a lot of news space.
MMM India\u00a0recently put itself into what it calls a calm regime<\/a>\u00a0where operations like money transfer will remain suspended and hence those who have put money into the scheme won’t be able to withdraw it. The Saradha Chit fund has collapsed.\u00a0
The question is why do Ponzi schemes keep occurring over and over again in India? A popular explanation is that India is an under-banked country and that gets people to invest in Ponzi schemes rather than deposit money in the bank.
As\u00a0<\/span><\/span><\/span>The Economic Times<\/i><\/span><\/span><\/span>\u00a0points out in an editorial<\/a>\u00a0\u201c<\/span><\/span><\/span>the repeated sprouting of dubious Ponzi schemes across the country points to a failure of the formal saving and banking system.\u201d This maybe true to some extent but does not really explain why Ponzi schemes keep cropping up all the time and why people invest in them.\u00a0
Take the case of MMM India Ponzi scheme. To participate in it, an individual needed to have a bank account. To be a part of Speak Asia an individual had to participate in two online surveys per week. An individual who has access to an online connection is more than likely to have a bank account as well.\u00a0
So Ponzi schemes are not just about India having fewer banks. There is a clear mental dimension at play which makes individuals invest in Ponzi schemes over and over again. And this makes sure that there are always scamsters looking to cash in.\u00a0
Robert Shiller, an economist, defines a Ponzi scheme in a research paper\u00a0titled\u00a0<\/span><\/span><\/span>From Efficient Market Theory to Behavioural Finance\u00a0<\/i><\/span><\/span><\/span>as follows: A Ponzi Scheme involves a plausible but unverifiable story about how money is made for the investors. It creates a false perception of high returns for initial investors by distributing to them money brought in by subsequent investors. Initial investor response to the scheme tends to be weak, but as successive rounds of high returns generate excitement, the story becomes increasingly believable and exciting to investors. Finally, the scheme collapses when new investors are not prepared to enter the scheme.\u00a0
The phrase to mark in this definition is \u201chigh returns generate excitement\u201d. Very recently, MMM India promised returns of 100% per month to prospective investors. The prospect of high returns pushes individuals to take on the risky bet of investing in a Ponzi scheme.\u00a0
As Robert Shiller writes in\u00a0<\/span><\/span><\/span>Finance and the Good Society<\/i><\/span><\/span><\/span>\u201cThe mere presence of uncertainty in a positive direction creates a pleasurable sensation (in the brain), and so the reward system creates an incentive to take on risky positive bets…This human tendency also helps explain why people like to gamble, and why many people will return every day to bet a small sum in a lottery. It also helps explain why people are willing to speculate aggressively on investments.\u201d\u00a0
This gets individuals to invest in a Ponzi scheme. And after one lot of investors has invested in a Ponzi scheme it tends to take on a life of its own. The initial lot of investors then become the advertisers for the scheme.\u00a0<\/span><\/span><\/span>If a person wants to invest, the chances are he will look around to see what his acquaintances, neighbours or relatives are doing with their money. If the people around the potential investor invest in a certain way, there might be a tendency for him to follow them. Much like the \u2018circular mills\u2019 of ants. The mill is created when an army of ants find themselves separated from their colony. Once they are lost they obey a simple rule: Follow the ant in front of you.
Decisions of investors, much like the circular mills of the ants, are not made at the same time but in a sequence. People who invest in the Ponzi Scheme assume that the scheme is a good bet simply because some of the people they know have already invested in it. So everyone ends up making the wrong decision because the initial investors get into the scheme by chance.
This happens because the attraction of easy money is something that investors cannot resist. Ponzi Schemes offer the prospect of huge returns in a short period of time vis a vis other investments available in the market at that point of time. Greed also results when investors see people they know make money through the Ponzi Scheme. As Charles Kindleberger wrote in\u00a0<\/span><\/span><\/span>Manias, Panics and Crashes<\/i><\/span><\/span><\/span>\u00a0\u201cThere\u00a0is nothing so disturbing to one\u2019s well being and judgement as to see a friend get rich\u201d.\u00a0
Overconfidence also has a part to play. Most people are confident that they won’t become victims of financial frauds. This also leads them to invest in Ponzi schemes. Ove
\nrconfidence is also at play when investors understand that they are getting into a Ponzi scheme, but they are still willing to enter the scheme, because they feel that some greater fools could be depended on to enter the scheme after they have and this would give them handsome returns on their investments.
The contract effect is also at play. It becomes relevant in the context of a Ponzi Scheme when the prospective investor starts comparing the returns on the various other investment avenues available in the market for investment at that point of time. The high returns of offered by a Ponzi scheme stand out clearly and attracts investors.
So a Ponzi scheme just doesn’t spread only because of a weak banking structure though that might be true in case of Sahara or even Saradha chit fund. Also it is important to remember the first sentence in Shiller’s definition of a Ponzi scheme, which is: \u201c<\/span><\/span><\/span>A Ponzi Scheme involves a plausible but unverifiable story about how money is made for the investors.\u201d
So people running Ponzi schemes spend a lot of time in building a ‘supposed’ business model and building a great brand. The Saradha chit fund had built a huge media empire in West Bengal. It had also\u00a0purchased a motorcycle company<\/a>, to give some semblance of a business model to its investors.\u00a0
Sahara is similarly into a lot of businesses and even sponsors the Indian cricket team. Similarly,\u00a0<\/span><\/span><\/span>Speak Asia was in the magazine and survey business. It also advertised majorly in the publications of The Times Group, to build credibility. Emu Ponzi schemes were in the business of rearing and selling emus. And Stockguru helped investors make money by investing in stocks.\u00a0<\/span><\/span><\/span>
MMM, in its original Russian avatar, sponsored the Russian football team in the 1994 football worldcup. When questions were raised about the huge returns, it had promised, MMM stated that it had solid investments, but did not want to disclose them as its competitors might imitate its investment strategy.\u00a0
Over the years, investors have been fooled into investing their money into Ponzi Schemes which keep appearing in various forms. They ignore the most fundamental principle of investment theory: You cannot expect to make large profits without taking risk. Whenever a large amount of money is at stake, individuals should logically seek large amounts of information on where they should invest. But most investors do not do so. Few ask the right questions at the right time and are na\u00efve enough to believe in what is communicated to them by the people carrying out the fraud.\u00a0
Indeed, many Ponzi Schemes do not get reported as people do not like to admit that they have been fleeced because of their greed. The ones, which are reported and investigated, get stuck in the quagmire of our legal system. This encourages more people to run Ponzi Schemes. And every time a Ponzi scheme is exposed, the confidence of the investor in the financial system goes down.
The most commonly suggested solution for prevention of Ponzi Schemes is sharing more and more information with the investing public. But research in psychology shows that more information does not necessarily improve judgement. Any extra information is helpful only if it comes without any bias. But that is rarely the case. Moreover, the ability of the common man to assimilate information is limited.
Rather than assuming investors are knowledgeable about investment opportunities, the best solution to the problem of Ponzi schemes might be ensuring swift legal mechanisms to punish the unscrupulous masterminds behind the Ponzi Schemes. This will ensure that every prospective fraudster will think twice before launching another Ponzi scheme.<\/p>\n

The article <\/a>originally appeared on www.firstpost.com on April 23, 2013<\/span><\/span><\/span><\/p>\n

\u00a0<\/span>(Vivek Kaul is a writer. He tweets @kaul_vivek)<\/b><\/span><\/span><\/span><\/p>\n

\u00a0<\/span><\/p>\n

 <\/p>\n","protected":false},"excerpt":{"rendered":"

Vivek Kaul In\u00a0Ek Thi Daiyan, the latest horror flick to come out of Bollywood, the dying\u00a0daiyan\u00a0(witch) says something to the effect of \u201cmain wapas aaongi\u00a0(I’ll be back).\u201d Ponzi schemes are a tad like that. They keep coming back one after the other.\u00a0Only sometime back we were talking\u00a0about the Stockguru Ponzi scheme. Before that the emu … <\/p>\n

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