View from City Road: Charles Ponzi is still with us

Charles Ponzi (188?-1949) was the archetypal confidence man, a swindler who in the space of eight months raised nearly dollars 15m from 40,000 investors by promising 'double your money' in 90 days. While Ponzi claimed to be taking advantage of arbitrage opportunities in international postal coupons, he was in reality operating a financial chain letter, using funds from new investors to pay off earlier investors.

Though Ponzi's name later became synonymous with this type of fraud, it in fact predates him by many hundreds, if not thousands, of years. Ponzi-style fraud has been around for as long as investment itself, and still it flourishes. The MMM scandal in Russia, which has incorrectly been described as an example of pyramid selling, is classic Ponzi. Less spectacular examples of the same thing have occurred throughout Eastern Europe since the shackles of communism were removed. There is still at least one other large-scale Ponzi scheme operating in Russia.

That schemes like this should spring up in newly liberated markets where not so long ago it was an imprisonable offence to sell even a stick of chewing gum is little surprise. In Russia and many other Eastern European states the laws are not yet in place to stop them. Nor is the culture of caveat emptor.

Most of those who invested in MMM - there are said to have been up to 10 million of them - understood fully what they were letting themselves in for, and like MMM's president, Sergei Mavrodi, blame the government for stepping in and stopping the music. With its 'do you sincerely want to be rich' TV advertisements (remember Bernie Cornfeld?), many saw no reason why the money merry-go-round should not go on for ever.

What comes as a rather bigger surprise is that such schemes still flourish in the West too. Nor are we talking here just about clearly fraudulent investment funds like Barlow Clowes. Low-key schemes such as the recently wound up Alchemy Marketing have been in operation on and off in Britain for years.

Stripped of its fraudulent connotations, the term Ponzi has also found its place in respectable economic theory. MMM's underlying way of operating is after all not so very different from many Third World - or even Western - governments, where cash payments on debt are met by increasing the amount of debt outstanding. As long as growth in debt is backed by growth in real assets, this should not matter. But when debts become backed by future debts, when all interest and repayments of principle have to be covered with additional borrowing, it is tantamount to insolvency and eventually, inevitably, ends in tears.

Investment bubbles, by no means a thing of the past, also have elements of Ponzi. The house price boom of the late 1980s certainly has strong parallels with MMM. Everyone knew it had to end yet somehow - call it wishful thinking, whatever - everyone came to believe it would go on for ever. Those who took out 100 per cent mortgages to participate are still feeling the pain.

Certainly the MMM collapse is a classic example of crude, raw, unregulated and unscrupulous capitalism in practice, but make no mistake about it - sophisticated versions of the same thing are all around us.