The Ponzi Factor | More than half of Madoff's accounts were WINNERS!

Most people understand that a Ponzi scheme is a scam, but what most people don't realize is that a Ponzi scheme can also produce a lot of winners. It's not a scam where everyone loses money; a lot of investors who are involved and unaware of the scam can make money too. Bernard Madoff ran the biggest Ponzi scheme to date. After his fifty billion dollar scam was exposed in 2008, investigators found that more than half of his accounts showed a profit. The total amount of money lost in his scam was greater, of course, but as far as the accounts were concerned, more than half of them actually showed a net profit, as in those accounts withdrew more than they contributed.

The fraudulent aspect of a Ponzi scheme is not its inability to produce winners. The issue is in the mechanics and where that money comes from, and how investors who make money are taking it from other investors who also want to make money. One thing that tends to be true about Ponzi schemes and scams in general is that there's always something about the scenario that looks too good to be true. If you were to look at a chart of Tesla Motors' stock price from 2010 to 2017, it would show how their stock shot up from $20 a share to over three hundred and eighty dollars a share during this seven-year period.

Question: How much money do you think Tesla made during this time? No need to think of an exact number, but do you think they made a lot of money or a little? Answer: Tesla lost four point three billion dollars. Tesla didn't make any profit; they didn't break even, they lost four point three billion dollars during this period. Now, this is interesting because the early investors who bought into the company in 2010 could have made a lot of money while the company they owned actively bled out four point three billion dollars. But how can that logically happen? How is it possible for investors to walk away cash rich in profits, with real money in their hands, when the company they invested in never made any money?

In a legitimate investment scenario, that can never happen. Investors should only be able to make money when the company they invest in makes money. However, a situation like this can occur if the early investors' profits are dependent on cash from new investors rather than the performance of the underlying company. If you ask people in finance how Tesla's early investors could have gotten rich while their company lost billions, they will respond with something vague and infallible like, "the market trades on future information" or "the price of a stock is a reflection of future earnings" or "the company has value and Tesla's going to make money in the future."

The philosopher Karl Popper calls these unfalsifiable statements and classifies them as empirically uninformative pseudoscience ideas that cannot be proven right or wrong. In this case, they also assume there are people who can see into the future. Financial professionals are masters at giving unfalsifiable answers, but what they will never allude to is the clear and provable fact that Tesla's investors' profits came from other investors. The reason why they don't want to acknowledge the obvious is because they don't want to think of the stock market as a system that shuffles money between investors, just like a Ponzi scheme.