Anatomy of a Modern Ponzi Scheme

Scams, Frauds and Cons… throughout history after ‘speculative bubbles’ have burst, the scum rises to the surface. But investors coming down off the ‘New Era’ high are beginning to see cons for what they really are. The Sovereign Society’s Mark Nestmann takes a look at the proliferating rate of modern ‘Ponzi’ schemes.

In 1919, a 42-year-old ex-vegetable dealer with a silver tongue borrowed $200, and in the space of six months, became Boston’s so-called "wizard of finance." Adored by the public as he rode throughout the city in his chauffeured limousine, Charles Ponzi promised that he would pay investors $15 for every $10 they invested with him for more than 90 days. With this appeal, he raised millions of dollars.

Ponzi told his investors, like himself, primarily Italian immigrants, that he would use their investments to purchase International Postal Union reply coupons overseas, then sell them elsewhere at a higher price. He claimed to be taking advantage of "currency fluctuations" and "specialized knowledge" to make 50% profits every 90 days. But in reality, Ponzi was pocketing the money to pay his debts. When an investor demanded his money back, Ponzi would pay out of incoming proceeds.

More than 80 years later, little has changed. What are now called "Ponzi schemes" operate in much the same way as Ponzi did decades ago. This column highlights one such scheme, carried out by John Wayne Zidar, 59, of Gardnerville, Nevada.

In the late 1990s, Zidar attracted conspiracy theorists to his "World Community Educational Society" Web site and other Web sites with claims that "the entire monetary system of the United States and the free world itself is nothing more than a giant Ponzi scheme."

While in our view, this is a rather accurate summation of fractional reserve banking, now carried out by every government worldwide, Zidar’s solution to this Ponzi scheme was worthy of Ponzi himself. Promising investors returns of 120% or more per year, he sold them "prime bank instruments," investments that he claimed are free of risk and government regulation. These "investments" were sold through investment clubs Zidar operated and at investment conferences, including conferences held by the Global Prosperity Group [an organization our friends at The Sovereign Society first warned members about in October 1998].

According to documents filed with the U.S. District Court of Western Washington, Zidar took in approximately $74 million from about 2,500 investors, primarily in the United States. Zidar and his associates used most of the money to pay off early depositors making withdrawals, giving them the false impression that they had actually reaped the promised profits on their investments. Most of the remaining funds were deposited in offshore bank accounts controlled by Zidar and his friends or spent on luxury homes and cars.

On August 14, 2002, a jury found Zidar guilty on 28 counts of fraud and money laundering. The jury also delivered a guilty verdict against one of Zidar’s accomplices, Steven Craig Moreland, 34, of Tyler, Texas, on 14 counts of fraud and money laundering.

Like Charles Ponzi, according to a report published in the Seattle Post-Intelligencer, Zidar "had little formal education or financial training" and, before turning to financial frauds, he "had worked as a car salesman and, as recently as 1997, as a night janitor at a chain steakhouse in Florida."

What led 2,500 investors to suspend judgment and invest $74 million in Zidar’s scheme? (Incidentally, the commercial crime bureau of the International Chamber of Commerce estimates $10 million is "invested" in similar schemes in North America daily.)

A possible explanation is that even reasonably intelligent people that would ordinarily avoid something "too good to be true," will embrace it if it is presented as "insider" or "specialist" information. Certainly, this is the way that scam artists market "prime bank instruments." Promoters claim to have inside information on a "secret" world market that is available only to the "super rich" – or to people who, like them, are "very well connected."

I came to this conclusion after spending a morning several years ago discussing "prime bank instruments" with a man who had invested more than $100,000 in such a program. He was about to invest another $50,000 based on the statements he had received "proving" that he had earned 100% in his first month of "trading."

I can’t say for certain what happened next, because I never heard from this person again. It’s probably safe to say, however, that unless he was one of the first investors to cash out, his money disappeared.

Even in this post-bubble environment, Ponzi schemes continue to proliferate. Recently, a company contacted me and offered to set me up in an investment paying approximately 60%/year. Trading statements supposedly verifying this return were said to be audited, but when I asked for a copy of the audited statements, I was told they were not available. The company also claimed a four-year track record despite only having been incorporated only a few months before contacting me.

The coup-de-grace was when I learned that the company president had recently attended a "get-rich-quick" course and then sued the promoter for failing to deliver on his promises!

Is this a Ponzi scheme? I have no way of knowing for certain. Am I going to invest?…not likely.

Cheers,

Mark Nestmann,
for The Daily Reckoning
December 6, 2002

P.S. On a practical note: How do you avoid prime bank schemes and similar frauds? Apart from shying away from deals that are "too good to be true," the answer is due diligence. Does the person promoting the investment have legitimate credentials – or is he gainfully employed as a school janitor?

"A professional investigator charging $75/hour or so can uncover enough information in a few hours to give you a good idea of whether the investment being considered is a reputable one," says offshore ‘scambuster’ David Marchant. "Of course, some companies charge much more. New York- headquartered Kroll Associates charges $200 per hour, plus expenses. Their services might be worth considering if you’re considering an investment in the hundreds of thousands of dollars, but might not otherwise be cost- effective."

Editor’s note: Editor of The Sovereign Individual, Mark Nestmann is a leading writer and speaker on offshore topics and financial privacy issues. His writings have appeared in many publications, including The Oxford Club Communiqué, Low Profile and Asset Protection International. For advice on securing your wealth, banking privacy and offshore investment strategies see:

The Sovereign Society

Stocks went down again yesterday. But who cares? They’ll go up and down a lot more before they finally reach a level where they are good investments again.

In the meantime, the interesting action is in gold and bonds. As we all know, Treasury bonds are supposed to fall…because the Fed has made it clear that it intends to print as many dollars as it takes to avoid deflation. But, so far, bonds have been holding up…

Of course, the Fed has been inflating for a long time. M2 is growing at 9% per year – 3 or 4 times the growth of the economy. But this is nothing new. And, so far, this ‘inflation’ has done little to boost consumer prices.

Instead, in the late ’90s, it went into stock prices, and more recently into real estate.

Since the beginning of 2001, the Fed has been trying rate cuts to reflate the economy. Even after 12 of them, auto sales, corporate profits, manufacturing, and prices for finished goods are still dropping. On the other hand, fewer people seem to be losing their jobs…and raw materials’ prices are on the rise.

"The economy is in great shape," says Milton Friedman. And don’t worry about deflation, says the Nobel Prize winner. "Deflation is a consequence of bad policy, not a cause of bad results." The Great Depression of the ’30s could have been avoided, he says, if the Fed had merely increased the supply of money fast enough.

Isn’t it wonderful, dear reader? We mean, that the economy is in such great shape….and that central bankers can avoid any really bad results simply by changing their policies! But hey, why didn’t they change their policies before $10 trillion got exterminated in the world’s stock markets? And before nearly 2 million Americans lost their jobs since the slump began in March of 2000? And who’s to say they won’t wait until another $10 trillion goes to money heaven before getting their policies right?

But now almost every economist and analyst in the world – including those with whom we normally agree….Sjuggerud, Grant, Gross, and our own Eric Fry…are convinced that the Fed can do with printing presses what it couldn’t do with rate cuts. Deflation is out of the question, they say…bonds are doomed…and gold will rise.

Gold rose again yesterday – to $325.60 an ounce. When central bankers come right out in the open and announce their intention to destroy the value of the paper currency they sponsor, who can blame investors for looking for an alternative?

To some extent, we admit that the whole inflation/deflation discussion is a waste of time. Nobody reads tomorrow’s papers. Maybe consumer prices will slip into outright deflation and maybe they won’t. Either way, gold is good protection.

Eric…over to you:

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Eric Fry in New York City…

– Old Man Winter paid a visit to New York City yesterday, dumping snow on the metropolis from dawn to dusk. The fierce, frosty storm seemed to put Wall Street into a deep freeze. The Dow suffered a fourth straight losing session, skidding 114 points to 8,623 – which means that the blue chips are 0-for-December. The Nasdaq slipped 19 to 1,410.

– The gold market, meanwhile, continues to bask in the warm glow of monetary instability and geopolitical uncertainty. The increasingly precious metal jumped $2.50 to $325.60 an ounce. Silver also joined in on the action by jumping more than 1% yesterday to $4.62 per ounce, its highest price since September.

– Are these two monetary metals, mute though they may be, trying to tell us something? Are they warning of incipient inflation? We wouldn’t rule out the possibility. In fact, as faithful Daily Reckoning readers are well aware, I’ve been predicting resurgent inflation for the last few months…

– To be sure, deflation remains the talk of the town and the widespread expectation of most investors. But resurgent inflation seems increasingly likely. On Wednesday, during my appearance as a co-host on CNNfn’s morning show, I announced, "Inflation is a buy. If it were a stock, it would be selling for eight times earnings and less than book value."

– Admittedly, the mighty forces of deflation and inflation are still battling each other in a fight to the death. But inflation seems to be prevailing, or at least that’s the implied verdict from several financial markets. Both the CRB Index of commodity prices and the gold price have been trending higher for more than a year. More recently, since early October, bonds have tanked, copper has surged and the dollar has failed to rally despite a powerful stock market rally.

– These various market phenomena – like financial antibodies – indicate that our economy has been exposed to the germ of inflation. Perhaps our economic immune system will ward off a full-blown outbreak of inflation. But that’s not a bet I’d make. Neither would Bill Gross, the hugely successful bond fund manager at PIMCO. – "The bond market’s salad days are over," Gross asserts in his latest monthly commentary. "The Fed and the Congress will make sure of that by conquering deflation, promoting inflation, and perhaps in the process creating even more financial and economic instability than we have seen in recent years."

– As evidence of the Fed’s determination to sow the seeds of inflation, Gross refers to Fed Governor Bernanke’s November 21st speech entitled "Deflation: Making Sure ‘It’ Doesn’t Happen Here."

– "The forcefulness of Bernanke’s speech tells observers plenty about the ultimate winner in the battle between inflation and deflation," Gross surmises. "Bernanke listed several heretofore rarely used policies that would be emphatically employed by the Fed to avoid deflation: (1) should conventional open market purchases of Treasuries not do the trick, the Fed would extend out on the yield curve to include even long-term bonds, (2) the Fed could influence the yields on privately issued securities – corporates and mortgages – in order to lower the cost of private credit, (3) the Fed would buy foreign government debt in a thinly disguised attempt to lower the dollar and increase U.S. competitiveness and inflation at the same time….I believe them. These people may be misguided, their policies might eventually do more harm than good, but I believe them. They will not allow the U.S. economy to deflate as long as the current regime (read: "Greenspan’s Fed") is in power."

– Paul Kasriel, economist extraordinaire at Northern Trust, is also inclined to take the Fed at it word when it promises to reflate. "World’s Largest Debtor (U.S.) Pledges To Pay You Back In Cheaper Dollars," quips Kasriel. "In effect, this is what one of the rookie members of the Federal Reserve Board, Ben Bernanke, announced to the world on November 21…So, fear not deflation. The Fed has implicitly pledged, to its dying breath, that it will crank up the currency printing presses to prevent it."

Stay tuned…

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Back in Paris…

*** It’s beginning to look a lot like Christmas. Christmas displays are up in the shop windows of Paris. And here in the headquarters of the Daily Reckoning, we put up a Christmas tree, complete with flashing lights, reindeer and angels.

Many of the people who work in our office are Muslim, but everyone seems to be getting in the holiday spirit.

*** Maria and I decided to go to the theatre last night. A version of The Glass Menagerie was our destination. But Maria misread the program and we ended up at a very avant- garde theatre waiting for a production of something we had never heard of before and wouldn’t mind if we never did again.

We tell you about this, dear reader, so that you may get the benefits of attending experimental theatre without the ennui of actually having to experience the dreadful thing. The theatre itself was housed in a converted public school building, with the interior stripped to bare concrete and spray-painted white. Everything was white. Metal, concrete, light bulbs, metal chairs, tables – everything was hard white, unrelieved by tablecloths, upholstery, posters or any color of any sort.

In the white, white interior, an assortment of Paris intellectuals and artists had accumulated – nearly every one of them dressed in black. One man had his hair matted down in dreadlocks. Another man with a goatee wore a long overcoat, which had the curious effect of making him look like a dwarf version of Sigmund Freud.

Still, your editor had his hopes up. At least, in these off-off-off Broadway productions, actresses sometimes take off their clothes. But in that respect, as in all others, the show was a disappointment. Not only were there no naked women, there were no women of any sort. No men either.

"Structure Multifonctions" had no actors, no plot, no stage, no music, no dialogue. No nothing. Instead, as near as we could figure, it was a light display. And…you guessed it…a white light display. Occasionally, we thought we saw a hint of pink…or maybe a tint of azure. Otherwise, it was all white light. And except for the occasional slamming of a door, as silent as an angry husband.

Still, the audience sat still. Were they admiring it? Were they wondering what it all meant? Had they fallen asleep? We didn’t know. But after a few minutes we gave up trying to figure it out.

"Did you like the show," asked the man in black at the door as we walked out in mid-show.

"Oh," said Maria. "Has it started?"