Social Security, Full Tilt Poker, has 'Ponzi Scheme' ceased to have any meaning?
Sep 20, 2011

Social Security, Full Tilt Poker, has 'Ponzi Scheme' ceased to have any meaning?

First there was GOP presidential candidate Rick Perry further popularizing the notion that Social Security was a ponzi scheme, now we have the US DOJ claiming that the shenanigans at Full Tilt Poker is a ponzi scheme as well.

 A ponzi scheme isn't a general term, it doesn't just mean financial fraud, and it doesn't necessarily apply to something with an expanding client base. It means a very specific type of fraud whereby current clients are paid from the deposits of new clients, thus necessitating an inevitable collapse. This was exactly what Bernard Madoff's actual ponzi scheme did. In the case of FTP, there was lots of fraud going on relating to the financial tricks the company used to get around the 2006 UIGEA law that made their service illegal in the US.

More relevantly, in contrast to the rules of the Alderney Gambling Commission (a private regulator) FTP was not keeping all player funds 100% backed in an account the way Pokerstars, a competitor, was. Indeed, it seems a large portion of this was being given to the owners with only a fraction left in the accounts to pay back players. Prior to the April 18th "Black Friday", when the US shut down FTP, Pokerstars and Absolute/Ultimate Bet in the US, the DOJ had shut down many of the middlemen payment processors that FTP used so they didn't get the money while FTP continued to credit player accounts nonetheless. This quickly led to a rapid diminishing of liquid funds for FTP and hence, when they were finally shut down, it appears they have nowhere close to 100% of funds available.

 This is all really bad (I have money on the site), but it is not a ponzi scheme. FTP was a profitable business with a genuine revenue source, unlike a ponzi scheme. Yes they had a fractional reserve system which was bad because it was fraudulent but it doesn't make it a ponzi scheme in the same way every fractional reserve bank isn't a ponzi scheme. They could deal with a shrinking of the net player pool provided it happened sufficiently slowly, just the way a bank can lose customers despite being fractional reserve. However, they experienced a complete bank run, if you will, in the US and them worldwide when the Alderney Gambling commission shut them down. None of this is consistent with the notion of a ponzi scheme.

 In the case of Social Security, it is also hardly a ponzi scheme. Firstly, it isn't fraudulent. Everything to do with the rules and how it works is entirely legal, transparent, and knowable by anybody who cares to look. The main reason people suggest it is a ponzi scheme is because the one generation pays for the previous generation and is paid by the subsequent generation, and further, for demographic reasons each generation has, and likely will, get larger. So it is clearly vaguely related.

 The key difference, however, is that one can, in theory, modulate the balance of expenditures and revenues so that Social Security is solvent in perpetuity. This might take dramatic changes (although usually the need for this is overstated) such as increasing the retirement age, increasing premiums and decreasing the quality of care. Yet it can still function, it could even function hypothetically in a shrinking population. It is true that keeping the benefits and revenue entirely fixed, then in time it would become insolvent. However, insolvency doesn't define a ponzi scheme and one can fix this insolvency by increasing revenue or decreasing expenditures.

 There are, of course, legitimate ways to criticize Social Security. One can say that the Social Security trust fund has not been meaningfully saved when it invests in T-bills and instead has all been spent by the government. One can point out the demographic challenges and rising costs of living and how expenditures and revenues will have to change in the future. These things are all part of a really important debate that must happen.

 When we just misapply the label of ponzi scheme to this, it makes it difficult to have a meaningful debate. The problems are not that it is a ponzi scheme - and saying that distracts from the real problems that should be debated.

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