Cautionary Tales with Tim Harford - The Fraudster's Guide to Magic Money

Episode Date: April 26, 2024

Cautionary Tales will be LIVE on stage in London this May. Tickets are on sale now: https://www.tegeurope.com/events/cautionary-tales/ Sam Israel had a problem. The investors in his hedge fund, Bayou Capital, were expecting spectacular returns. Sam himself had spent years proclaiming the fund's brilliant results. But in reality, Sam had been marking his own homework, publishing fraudulent accounts and using these to lure in new investors.  What to do? Well, the logical thing of course: wait around for an extraordinary profitable streak, and in the meantime keep up the ruse... This episode of Cautionary Tales was recorded live at the Bristol Festival of Economics and studies three incredible investment scams. How do pyramid and ponzi schemes snowball out of control, flattening victim and fraudster alike? For a full list of sources, see the show notes at timharford.com.See omnystudio.com/listener for privacy information.

Pushkin Hello dear listener, Tim Harford here. I have some very exciting news to share with you. On the evening of Tuesday the 21st of May I will be bringing a special live edition of Cautionary tales to the stage in London. There will be music, there will be actors, and there will be plenty of hair raising, spine tingling twists and turns. Tickets are on sale now through the link in the episode description, so get them while they last. Once again, Cautionary Tales will be live in London on Tuesday 21st May and

I can't wait to see you there. Do you know your Ponzi schemes from your pyramid schemes? The following episode digs into the pitfalls of get-rich-quick scams. It was recorded in front of a live audience at the Bristol Festival of Economics. and please join me in welcoming Tim Harford to the stage. APPLAUSE Gosh, wow. Are you all ready? Excellent. OK, so we will begin. Sophie and Julia were relaxing on the riverside terrace of a fancy London spa.

Two rich girls joined by an even richer one, Tatiana, the glamorous wife of an investment banker. Tatiana ordered another bottle of champagne and launched into her sales pitch. You simply must buy a heart. Julia and Sophie looked at each other and sighed. This wasn't the first time they'd heard the spiel. It was the summer of 2003, and hearts with a capital H were all the rage

among the champagne-drinking, horse-riding, banker-marrying ladies of Great Britain. Here's how it worked. You donated three thousand pounds to buy a heart and join the scheme at the bottom of a pyramid. That's about six thousand dollars in today's money. Your money would go to the person at the top called the receiver. They'd leave the pyramid. The two people on the next level down would be promoted to the top role of Receiver. In fact, pyramid would then split into two so that both of them would be at the top of their own pyramid. Everyone would move up a level.

And everyone on the lowest layer, including you, would recruit two people to buy a heart and fill in the newly vacant layer beneath you. Six weeks later, you'd be a receiver and would get £24,000, the equivalent of $50,000 today and a huge return no matter how you measured it. The money just grew like a snowball rolling downhill until it became an avalanche. If you're not halfway through your second bottle of lunchtime champagne, you can probably spot the problem here. This is transparently a pyramid scheme.

And pyramid schemes don't make money. They just move it around. If someone's going to make £24,000, then that money must come from other members. So eight other people must lose their investment of 3,000 pounds. It's really that simple. In order to persuade people to join a pyramid scheme, there's often some sort of story designed to obscure this implacable arithmetic.

This one about buying a heart was marketed as feminism. The whole project was called Women Empowering Women. Men weren't allowed. Men are more corruptible. They can't be trusted. As Tatiana explained. She also added that she had spent her first windfall on a little intimate plastic surgery that she preferred not to discuss with her husband. Julia and Sophie were tempted, as Julia later recalled in an article for the Mail on Sunday newspaper. Then Tatiana whispered that apparently the supermodel Claudia Schieffer had been spotted at a women-empowering women party at a mansion in central London.

That was the clincher. Sign me up, said Julia. Things moved quickly. The next day, Julia received a phone call from a lady called Elfie, who was collecting her boy Archie from an exclusive London school. Darling, I must be quick but I couldn't wait to tell you the news. You've already moved up a line. You're one step closer to becoming a receiver.

Wonderful, replied Julia. So now you must send me three thousand pounds. I'm Tim Harford and you're listening to cautionary tales live at the Bristol Festival of Economics. This is a cautionary tale about investment scams and about the way that they snowball out of control, often flattening not only the victims but the fraudster too. Some of those fraudsters are anonymous figures. Julia, Sophie and even Tatiana had no idea who set up Women Empowering Women. But some of them are not. Few people are less anonymous than Samuel Israel III. Let's call him Sam Israel for short. Sam came from a wealthy family of commodity traders in New Orleans,

but was determined to make his own way in life. He started at the bottom in 1978, dropping out of college to run errands for one of Wall Street's most famous share traders. Sometimes those errands merely meant fetching pizza. Sometimes they involved going to a particular room in the Pierre hotel on the Upper East Side and speaking a code phrase to a Swiss gentleman. The weather is nice for this time of year. Yes, but today it looks like rain. The Swiss man gave Sam a satchel. Yes, but today it looks like rain. The Swiss man gave Sam a satchel. Sam didn't look inside it until his boss showed him that it was filled with hundred dollar

bills. Well over a hundred thousand dollars at a time when a hundred thousand dollars was real money. Odd things like this tended to happen from time to time and through it all Sam Israel watched and learned and kept his mouth shut and he began to thrive on Wall Street. Sam married a childhood sweetheart, a nice girl called Janice. She was sensible, training to be an accountant. It wasn't the ideal match.

I hid everything from Janice. Sam Israel confessed to the Rolling Stone journalist, Guy Lawson. I've been hiding things from her since we were kids. She was the responsible worker, I was the fuck up. I smoked weed and snorted coke. I couldn't talk to her about what was really going on because I couldn't confide in her. And what was really going on? That depends on when you asked the question. In 1978, Sam was quietly being a courier of satchels full of hundred dollar bills. The night before he married Janice, Sam was

having a threesome with two expensive call girls paid for by his Wall Street trader boss as a wedding gift. In 1987, Sam was making a small fortune by fortuitously betting that the market would fall just before the largest one-day crash in Wall Street history. Sam always swore he could have made more if the Federal Reserve hadn't swooped in printing money to prop up the market. In the early 1990s Sam was winning and losing huge sums several times over by trading on insider tips. Some good and some bad. Sam couldn't talk to Janice about any of this, of course. But what Sam really couldn't talk to Janice about was Bayou Capital. Bayou Capital was, well, it was a con. but let's come back to that. Let's talk about a simpler

con first. An early example, if you like, of women empowering women. In 1878, refined ladies of Boston, Massachusetts were intrigued to hear of a wonderful investment opportunity. A new bank founded by women for women and called the Ladies Deposit Company paid interest of 8%. 8% a year would be a solid enough offering. The ladies deposit company, however, paid 8% every month. Deposit $100 and by the end of the year, you'd have earned $96, nearly doubling your original investment. There were no rumors of supermodels back in 1878,

but the gossip suggested something even more reassuring. The ladies deposit company was said to be backed by a Quaker charity, doing many unspecified good works. Only unmarried women need apply. Such unprotected women who lacked the security of a husband's income were in a precarious position. Either they were poor and trying to earn a wage in a world where women were barred from well-paid jobs, or they were of a social background where they were expected to live off an inheritance. The investment return on that inheritance then was a matter of huge importance. And 8% a month, too good to miss.

Or alternatively, too good to be true. The ladies deposit company was not founded by Quakers, but by a stage psychic and professional fortune teller named Ms Sarah Howe. The company had some similarities with a pyramid scheme like the hearts of women empowering women, but also some differences. The grim arithmetic of the scheme was concealed. Money poured into the ladies deposit company, money poured out, and the mechanics of how it all worked were conveniently obscure. One intrepid reporter even disguised himself as a woman. One can only presume that no female journalists were available in order to gain entry to the

deposit company's headquarters. But he didn't learn much. We never disclose the methods by which we do business. Was all of the company's employees would say. Sarah Howe had established what we'd now call a Ponzi scheme, named after Charles Ponzi, a flamboyant Bostonian whose own cover story was something to do with international postage coupons. Sarah Howe had the same basic idea in the same city nearly 50 years earlier,

but women never seemed to get the credit for inventing anything. Even investment fraud. The local press soon concluded that the ladies deposit company was an obvious scam. The Boston Daily Advertiser published an illustrated explainer, some articles highlighting the stage psychic hows's rather questionable qualifications, and a prediction that the whole thing would collapse in short order. In the face of this negative publicity and some twitchy depositors,

Sarah Howe decided that the best way forward was bluff. She announced that anyone who wanted their money back with interest in full could have it immediately. She hoped that the ladies of Boston would be so reassured by this offer that they wouldn't take it up. Alas, the ladies of Boston were not reassured at all. They asked for their money back and when Sarah Howe didn't have it,

she went to jail. The Ladies' Deposit Company is a wonderful illustration of what Dan Davis, in his book, Lying for Money, calls the Snowball Effect. These scams need to suck in an ever-growing number of dupes to keep going, and eventually that snowball of money rolling downhill, becoming bigger and bigger, simply falls apart. It's too big. Remember, Sarah Howe was offering to almost double your money in a year if you invested with her. So let's watch the snowball

from a safe distance. Imagine that Sarah receives an investment of a hundred dollars from a little old lady and steals it. By the end of the year, that little old lady expects her hundred dollars back on top of $96 in interest. So Sarah finds two more investors, steals their money and gives it to the little old lady. But by the end of the following year, Sarah Howe needs to have given nearly $200 to both of her investors. To do that she needs four new investors.

Who shouldn't be hard to find if they think they're going to double their money? When the four new investors want a total of $800 back, she just needs to find eight new investors to join the ladies deposit company. Now you can see the trap here. Eventually there will be no more lady depositors for the ladies deposit company. But what's perhaps less immediately obvious is that in this little story Sarah Howe will soon owe $1600 to 8 investors and yet she only ever stole $100 for herself. The growing snowball of fraud is huge and it needs to keep getting huger.

The profit for the fraudster is relatively tiny. No wonder that so many fraudsters eventually get caught. And no wonder, perhaps, that when they do get caught, so many of them weep with relief. There will be tears aplenty, but not much relief after the break. In the 1980s and 90s, New York City needed a tough cop like Detective Luis Garcela. Putting bad guys away. There's no feeling like it in the world. He was the guy who made sure the worst killers were brought to justice.

That's one version. This guy is a piece of shit. Derrick Hamilton was put away from murder by Detective Scarcella. In prison, Derrick turned himself into the best jailhouse lawyer of his generation. And the law was my girlfriend. This is my only way to freedom.

Derrick and other convicted murderers started a law firm behind bars. We never knew we had the same cop in the case. Scarcella. We got to show that he's a corrupt cop. They can go fuck themselves. I'm C. Fishman. And I'm Dax Devlin Ross.

And this is The Burden. Listen to new episodes of The Burden on the iHeartRadio app, Apple Podcasts, or wherever you get your podcasts. And to hear episodes one week early and ad free with exclusive bonus content, subscribe to True Crime Clubhouse on Apple Podcasts. In the summer of 2003, Julia started to try to recruit investors to buy hearts for women empowering women. Julia had been signed up by Tatiana, the banker's wife, over champagne at the spa.

She'd sent £3,000 to Elfie, the mother of darling Archie from the fancy school. But Julia's own recruitment efforts were going nowhere. Her rich friends sneered at her. They'd already been approached so many times to invest in her heart that the whole affair had become a boring joke. Horror friends were less likely to have heard about the scheme but they were also less likely to have the money to invest. I mentioned that as a matter of simple arithmetic

for everyone who makes £24,000 in a pyramid scheme there must be eight people who lose £24,000 in a pyramid scheme, there must be 8 people who lose £3,000. But how can it be that so many people lose out? Well that's simple too. Every time a new group of recruits is brought in, the entire operation has to double in size. Every recruit finds two more recruits, and every pyramid becomes two pyramids. The rolling snowball becomes a vast snow boulder, then collapses into a destructive avalanche of

disappointment and loss. Pyramid schemes fail because they run out of recruits just after becoming huge, when a vast number of people have recently joined but not yet cashed out. Julia was one of those people. In growing desperation, Julia went to a recruitment party in the hope of recruiting new investors. She'd been told tales about parties in central London mansions, champagne being coiffed with supermodels, as suitcases of cash were handed to people who'd reached the top of the pyramid. But this recruitment party was in a hairdresser's.

Instead of champagne on ice, there was warm white wine and a growing sense of irritation that Julia's failure to recruit was letting down everyone above her in the pyramid. There was of course no sign of Claudia Schieffer. The brilliance of women empowering women is that it seems to have been largely self-organizing. Many scams, in contrast, require a lot of hard work. Just ask Sam Israel. He set up his ill-fated hedge fund Bayou Capital in 1996, assisted by an accountant named Dan Marino who lived with his mother and dreamed of

greatness. Apparently Sam actually intended to run an honest hedge fund or if not quite honest, a hedge fund that would make money for investors. His business plan? Buy you capital would use a new computer algorithm he'd developed, plus the skills of a once great trader who Sam had hired after he'd fallen on hard times. Plus a few insider tips, like in the old days when he'd collect bags of cash from the Pierre hotel. That should do the trick, thought Sam, but it didn't. The once great trader was washed up. He made a lot of bad calls. The computer algorithm seemed to misfire as often as it worked.

And Sam didn't have the same insider access that he used to. After a couple of lackluster years in which Sam loudly told his few investors that the funds results were great, he pondered his options. The results were not in fact great. And if he simply published the firm's accounts showing a loss the

investors would yell at him for all his empty boasts and Bayou Capital would collapse or alternatively Sam and his colleagues the washed-up trader and the accountant who lived with his mum could lie? Could publish audited accounts which claimed stellar results. Like Sarah Howe, they'd be offering fantastic returns. Unlike Sarah Howe, who would simply steal money from new depositors and pay it out as interest, they'd need to show some kind of evidence that they were making profitable investments. To do that, they'd need a fraudulent auditor. No problem. Dan Marino simply set up his own audit firm, marking his own homework. Nobody ever checked that the auditor who was verifying that Dan Marino was telling

the truth was Dan Marino. It probably didn't hurt that if anyone ever tried to search for Dan Marino on the still young World Wide Web, they were sure to get Dan Marino the unimaginably famous Miami Dolphins quarterback, rather than Dan Marino the crooked accountant. For a while, the plan was that Sam would go on a profitable streak and actually make the profits that Dan Marino's fake accounts were claiming. But the snowball was starting to grow. The more profit they said they were making, the larger the fictional pot of money was growing, and the harder it was for Sam and his partner to catch up to their own lies. It didn't help that Sam kept claiming to outperform the market.

Dan Marino was losing his mind at the fact that Sam couldn't control himself. When they had a good month and made money, they used that as the performance number, complained Dan to the journalist, Guy Lawson. When they had a bad month, they used the made up number. That won't work. If you let the fraud snowball grow too big, you'll never get it under control.

Sam Israel would never be able to catch up to his own lies If a fraud snowball grow too big, you'll never get it under control. Sam Israel would never be able to catch up to his own lies, because he could never bring himself to pretend he'd had a bad quarter when he'd had a good one. We win with grace and lose with integrity. Boasted Sam to his investors, Dan Marino knew the awful truth. I stopped tracking the published numbers against the real numbers. Said Marino, the snowball was already too big. Oh, it made me sick to my stomach.

Four years after the ladies deposit company was exposed by the Boston Daily Advertiser and collapsed, and Ms. Sarah Howe was sent to prison, collapsed and Ms Sarah Howe was sent to prison, refined women of Boston, Massachusetts were intrigued to hear of a wonderful investment opportunity. A new bank founded for women, by women and called the Boston Women's Bank paid interest of 7% per month. Too good to miss. Or, alternatively, too good to be true. After a couple of years, the Boston Daily Advertiser discovered and published the truth.

The manager of the Boston Women's Bank was not Mrs. J.C. Ewell as advertised, but an ex-convict by the name of Sarah Howe. Sarah Howe had learned one lesson. This time she skipped town and moved to Chicago. and moved to Chicago. In due course the refined ladies of Chicago were intrigued to hear of a wonderful investment opportunity. The Ladies' Provident Aid Society was offering interest of, oh never mind, the police caught up with Ms. Sarah Howe, shut down the Ladies' Provident Aid Society and soon enough Ms Howe was back in prison. Worth it? Surely not.

In character? Most definitely. Sometimes, when the snowball starts to roll, the fraudster just can't quit. Sam Israel seemed to have it all. A loving wife and children, a luxurious home, and, at least on paper, a fortune to his name. But appearances can be deceptive. Sam was a mess. He was taking too much cocaine and drinking far too much booze, and like so many people, he'd become addicted to painkillers after a back injury.

All the while, the fraud snowball was growing. But Sam and Dan had one advantage, which is that a fraudulent hedge fund doesn't have a sell-by date. That's different from the other scams we've heard about. Tatiana was promising Julia that women empowering women would multiply her money in just six weeks. The ladies deposit company promised to almost double investors' money after a year. But Bayou Capital was different,

because hedge fund investors didn't tend to withdraw their money if things seemed to be going well. Instead, they sat back and watched the snowball grow. But the more Bayou Capital's snowball grew, the harder it would ever be for Sam Israel to trade his way out of the lie. One September Friday his computer algorithm suggested a big bet on shares going up in the next week. Sam made that bet. The following Tuesday morning two airliners swept out of the cloudless sky above Manhattan and crashed into the World Trade Center. The world reeled with the implications of the atrocity. But for Sam Israel and Dan Marino, the only thing that mattered was how it

changed their own twisted financial world. Sam was aghast that his bet had spectacularly backfired while Dan Marino spotted an opportunity. Close the fund said Dan Marino and tell investors he lost most of their money in the aftermath of 9-11 and give the dregs back. Everyone will yell but nobody will suspect anything and neither you nor I will go to jail. Please! Begged Marino, but Sam Israel wouldn't do it. He knew that if Bayou Capital folded, he might escape jail, but it'd still lose his fancy

home. He should have listened to Marino, because within two years, he was going to lose his home anyway. Cautionary Tales, we'll be back in a moment. (*applause*) (*upbeat music*) In the 1980s and 90s, New York City needed a tough cop like Detective Louis Scarcella. Putting bad guys away, there's no feeling like it in the world. He was the guy who made sure the worst killers were brought to justice. That's one version.

This guy is a piece of s***. Derek Hamilton was put away for murder by Detective Scarcella. In prison, Derrick turned himself into the best jailhouse lawyer of his generation. The Lord was my girlfriend. This is my only way to freedom. Derrick and other convicted murderers started a law firm behind bars. We never knew we had the same cop in the case. Scarcella.

We got to show that he's a corrupt cop. They can go f*** themselves. I'm C. Fishman. And I'm Dax Devlin-Ross. And this is The Burden. Listen to new episodes of The Burden on the iHeartRadio app, Apple Podcasts, or wherever you get your podcasts.

And to hear episodes one week early and ad free with exclusive bonus content, subscribe to True Crime Clubhouse on Apple Podcasts. In 2003, Sam Israel was at home, leaning over a line of white powder with a rolled $20 bill up his nose. When his wife Janice walked in, she became upset. He became outraged. How dare she suggest he was taking cocaine! She persuaded him to take urine tests to ensure he stayed off the drugs until one evening

he angrily unzipped his pants and went all over the bathroom floor bellowing, you want urine? At Thanksgiving that year, he passed out over the turkey. Oh. By Christmas 2003, Janice had thrown him out of their house and secured a protective order. Sam rented the most tasteless, ostentatious bachelor pad he could find.

A vast Tudor-style manor with outsized chandeliers, marble bathrooms and comically huge beds. Sam paid the monthly rent of $22,000 to the house's owner. A gentleman by the name of... Donald Trump? So good, so good. Amazing house, huge beds. LAUGHTER Sam hung around clubs, tipping the bartender to introduce him to pretty women.

He fitted the Trump mansion with the latest trading equipment, 17 screens, so he could work from home. He was still looking for a way to make all the money back but the fraud snowball at Bayou was getting bigger and bigger and Dan Marino had had a couple of near misses when investors or regulators had asked to see documents that would prove highly incriminating. Marino was reduced to sending those incriminating documents to counterparties on a Friday evening in the hope that they would be tossed into

a backlog file and then buried under the Monday morning rush. Amazingly that tactic worked but it couldn't work forever. Dan and Sam were going to jail for sure. Unless Sam Israel could find a surefire scheme to make how big was the snowball now? Several hundred million dollars. Sam Israel was starting to get desperate. There's an old saying, you can't cheat an honest man. And there's truth in that saying, because the premise of a scam is often simply, I'm doing crimes, and if you come and do crimes with me, we'll both make money. That's a sales pitch to drive away honest folk, but it also has some appeal, because it provides a logical reason why there might be quick

money to be made for someone who could keep a secret. Sam Israel was not an honest man. He'd seen enough cheating on Wall Street to know that the game was often fixed and the crazy simplicity of the Bayou fraud coupled perhaps with the fact that Sam was taking a lot of drugs, was just starting to make him doubt everything. How many other hedge funds were just Ponzi schemes? What else was a Ponzi scheme? He had seen the Federal Reserve magic money out of thin air after that great crash of 1987 when Sam had made so much money and could have made more if the Fed hadn't stepped in. The Fed stepped in after 9-11 too.

Who exactly was running the world economy anyway? Sam started to run in strange, conspiratorial circles. If you want the full story, it's told in incredible, cringe-making detail in Guy Lawson's book Octopus, which describes an astonishing cast of characters and an even more astonishing array of delusional beliefs. Sam became obsessed with finding the undocked footage showing who really killed JFK. He believed he'd been attacked by an assassin on the streets of Hamburg and that he'd blown the man's brains out in self-defense. Needless to say, Hamburg's police have no record at all of such events.

Above all, Sam came to believe in a global conspiracy. Thirteen powerful families who truly rule the world whom he called the octopus. It all gets very very weird but do read the book it's quite a trip. But for our purposes what we need to know is that Sam Israel fell under the spell of a man called Robert Booth Nichols, who was claimed to be a top CIA agent, whose bare hands were said to be deadly weapons, and who was undoubtedly a confidence trickster. Like an aging, chain-smoking James Bond, he swaggered around London, a city with tight controls on firearms,

with a revolver in a shoulder holster. Sam believed that Nichols had access to a special CIA program which monitored every bank transaction on the planet, an insider trader's dream. And he flew out to London to beg Nichols to give it to him. He'd do anything, he said. Do you have $100 million in cash, said Nichols? I do, I've got 100 million in cash. Do you have 150 million? Yes. Forget the special CIA program

which monitors bank accounts, said Nichols. We can make some real money together if we can access a special secret market Operated by the 13 families who together secretly rule the world you know the octopus And just as Julia had said to Tatiana at the Riverside Spa Sam Israel said to Nichols, sign me up. But not for 3,000 pounds, for more than $100 million. With Nichols by his side, whispering into his ear,

Sam Israel joined an absolutely bizarre world full of conspiracy theorist fraudsters, all claiming to believe in the existence of a secret market that can multiply your money tenfold overnight, all secretly frustrated that they personally have never been able to get access to that entirely fictional market, and all trying to rip each other off. At one stage, Nichols got Sam Israel to give him $10 million in cash on the basis of a

story about a stash of treasure stolen and hidden by a Japanese general in the Second World War and protected by poison gas booby traps. Then another conman persuaded Nichols to give him a million dollars to help finance an expedition to find the exact same treasure. Can we have a recap? Of course. Sam Israel was controlling a hundred million dollars of Bayou Capital's money based on a fraud. He then invested that money in Robert Nichols' fraud. Robert Nichols then invested that money in Robert Nichols' fraud. Robert Nichols then invested that money in yet another fraud. Exactly. Thank you.

Reassuringly though, it's quite hard to give a hundred million dollars to a fraudster to invest in a special market protected by assassins and controlled by the 13 families who really rule the world. There are checks and balances in place. Several times, Sam Israel tried to invest the hundred million in one scam or another and a banker or a stockbroker simply refused to process the transaction until there was proof that it was genuine and there never was. In the end, the Bayou Capital Ponzi scheme was exposed. But it wasn't because Sam Israel's investors believed that he'd lost his mind.

Or even that he'd lost their money. They just believed that he'd lost his touch. They noticed that Sam wasn't spending much time at work. Little did they know that this was because he was in Europe being taught how to kill a person with his bare hands by a man he believed was an elite CIA operative. Bayou's investors asked for their money back, which would have been fine,

except that most of that money had only ever existed in Dan Marino's fraudulent accounts. The snowball had grown enormous. The fraud was at last exposed. Sam Israel was given a sentence of 20 years and as an act of leniency that seems to be common for white collar criminals, eight weeks of freedom to get his affairs in order

before reporting to jail. Listener, he did not report to jail. Police found his car parked on the Bear Mountain Bridge, high over the Hudson River in upstate New York. He left a suicide note and smudged in the dust on his car's hood with the words, suicide is painless. But Sam Israel's suicide note was as fictional as his investment returns. The authorities tracked him down, alive and well, and a campsite in Massachusetts, they promptly sent him to jail. By faking

his own suicide he got just three more weeks of freedom and of course landed his girlfriend in trouble for helping him out. Worth it? Surely not. In character? Most definitely. Julia's investment troubles, thankfully, were rather more mundane. Having invested £3,000 in the women-empowering women pyramid, she found herself fielding ever more strident calls from people further up the pyramid, berating her for not finding more recruits. Trixie, Pucky and Buttons all had their say. It was, says Julia, like being bullied by a bunch of fairies. But the curious thing

about women empowering women, nobody knows who started it. We think, although it's hard to be sure, that most Ponzi schemes fail. When they do, it's because of the relentless logic of the snowball. Sarah Howe went to prison twice. Sam Israel faked his own suicide in a desperate attempt to escape. But the unknown woman, who created the whole spiel about hearts and empowering other women. She's the exception to the rule that fraud doesn't pay. She pushed a few snowballs down a steep snowy hill, decided that she'd made enough money and before the casualties began to mount down below she walked away. But those casualties did exist and

Julia met them. The grumpy ferrets could probably afford to lose the money but it was less funny to receive voicemails from distraught Filipino cleaners who'd bought hearts and now feared they'd lose £3,000, they definitely could not afford to squander. Having run out of spar going, pony riding ladies who lunch, the women empowering women snowball had started to flatten much poorer women. Women who would struggle to pick themselves up

after the snowball had rolled on. Key sources for this episode include Julia Stevenson's article Broken Hearts Club, Daniel Davis' book Lying for Money, and for the astonishing story of Sam Israel, Guy Larson's book, Octopus. This live edition of Cautionary Tales was written by me, Tim Harford, with Andrew Wright. Tonight, you heard the voice talents of Sarah Jopp and Stuart McLaughlin. CHEERING AND APPLAUSE The original music is the work of Pascale Wise.

Our BSL interpreter was Catherine Moxham. The show was produced by Alice Fiennes, Marilyn Rust and Ryan Dilling. Sarah Knicks edited the script. Our sound engineer was Andrew Bayless. The thanks to Zoe Stedman-Milm and the team at the British Festival of Economics. Porchland Tales is a production of Pushkin Industries. If you like the show, please remember to rate, share and review. If you want to hear the show at three sign up for pushkin plus on the show page of

apple podcasts at pushkin fm slash plus thank you that was fun Thank you so much guys. The Trump impression was okay, wasn't it? If you've enjoyed this special live episode about pyramid and Ponzi schemes, don't go away. I sat down with one of the smartest people I know in financial journalism, my Financial Times colleague, Rob Armstrong, one of the hosts of the Unhedged podcast. And we asked, what if everything is a Ponzi scheme? We'll be back with that

in a moment. In the 1980s and 90s, New York City needed a tough cop like Detective Louis Scarcella. Putting bad guys away, there's no feeling like it in the world. He was the guy who made sure the worst killers were brought to justice. That's one version. This guy is a piece of s***. Derek Hamilton was put away for murder by Detective Scarcella. In prison, Derrick turned himself into the best jailhouse lawyer of his generation.

The law was my girlfriend. This is my only way to freedom. Derrick and other convicted murderers started a law firm behind bars. We never knew we had the same cop in the case. Scarcella. We gotta show that he's a corrupt cop. They can go f*** themselves. I'm C. Fishman. And I'm Dax Devlin-Ross. And this is The Burden. Listen to new episodes of The Burden on the iHeartRadio app, Apple Podcasts, or wherever you get your podcasts. And to hear episodes one week early and ad-free with We're back and I've been talking to my Financial Times colleague, Rob Armstrong, about all things Ponzi for his podcast Unhedged. Pushkin.

I love a good Ponzi scheme. From Charles Ponzi himself to Bernie Madoff. I both admire the wicked intelligence of the puppet masters and I'm fascinated by the persistent credulity of the people who fall for Ponzi schemes. Here today to discuss Ponzis and pyramids and everything in between with me is Tim Parford, my fellow FT columnist and master of his own podcast, Cautionary Tales. Tim, how are you? I'm great, Robin. Pleasure to finally get, how are you? I'm great, Rob. Pleasure to finally get on Unhedged. I'm a loyal listener.

Although I always feel terribly badly dressed whenever I even think of you, Rob, whenever I read one of your wonderful columns about sartorial elegance. The subtext is, this column is written at you, Harford, you slob. And so I just feel slightly guilty about the whole thing.

You'll be glad to know I'm sitting in my bedroom in a t-shirt and a pair of jeans. So I hope that puts you at ease. Okay. Yeah. I feel better now. Thank you, Rob. I was fascinated to listen to the most recent episode of Cautionary Tales. It gave a lot of terrific examples, starting with the immortal Sarah Howe of Ponzi schemers. Tell us what a Ponzi scheme fundamentally is and what you discovered about them doing that episode. Yeah, we had lots of fun.

Caution Details is a podcast about things going wrong and what we can learn. This particular episode is about Ponzi schemes and pyramid schemes, which are obviously always a terrible idea, but they have a lot of lessons for us. And Sarah Howe invented the Ponzi scheme and can you believe that it isn't called a Howe scheme? It's outrageous. Outrageous. Another woman forgotten by history, unfairly forgotten by history, all the credit taken by Ponzi. Yeah. She was even operating in the same city in Boston, Massachusetts. Sarah Howell set up the ladies deposit company and basically offered to pay ladies 8% a month, which is

basically doubling your money in a year. And of course, there's no way of actually making that return. And so as with all Ponzi schemes, people investing in this opportunity, if they decide they want to withdraw their money, then Sarah Howe just paid them out of incoming money from other people who were eager to invest. And that's the fundamental of a Ponzi scheme. Early investors who are trying to cash out get paid not out of the productive return from the productive activity because there is no productive activity. They get paid because other people are also pouring money in. That's the basic genius of the idea.

And Cautionary Tales talks about Sarah Howe, who did this three times, talks about pyramid schemes and also talks about this insane Ponzi scheme run by a gentleman called Sam Israel, which is described in Guy Lawson's book, The Octopus, which is absolutely bonkers because it just goes utterly down a whirlpool of conspiracy theories and so on. So it's great fun. I want listeners to know that this is not a palanquial phenomenon of my home city, Boston. I have a good friend, and this connects nicely actually to the Sarah Howe angle. I have a good friend who, about 10 years ago in Brooklyn,

was, she's quite an entrepreneurial person, and was invited by another quite entrepreneurial person to a meeting of other women, and they were gonna talk about investment opportunity and so forth. And as it turned out, what this meeting of 10 or 12 women was, was, you know, I have this project that I'm working on. I need seed money for this endeavor.

And you know, each of you are going to contribute X amount to my endeavor. And then in the next round, each of you will become a receiver of funds from other people in the ladies' empowerment club of Brooklyn or whatever. And my friend, who has her head screwed quite tightly onto her shoulders, looked around at these well-meaning kind of semi-Bohemian, semi-business class Brooklyn ladies and said, you're all going to jail if you do this. This is a Ponzi scheme. And they all looked at her aghast like they had no idea that they were engaged in something

untoward or possibly illegal. Yeah, part of the issue is that it is not always straightforward to figure out whether something is a Ponzi scheme or not because superficially, I mean, there's an awful lot of stuff in a capitalist economy that involves where you invest some capital and you take a risk and if things go well, you get paid back 10x in the phrase that everyone likes to use. Exactly right. And this was the question listening to your episode, I most wanted to put to you, how is a market in its bubble phase, not exactly like a Ponzi scheme snowballing in size? Oh, I love it. So it's like a decentralized Ponzi scheme, right? It's a naturally occurring decentralized organic Ponzi scheme, where, you know, something,

the Magnets and 7 Tech stocks start to go bananas. And rather than a central schemer, a Ponzi or a Howe figure, we all do our little part. Journalists like you and I, Tim, we hype things up by constantly discussing one way or the other, the different stocks. Brokers have their role to play, investor, chat boards do the job. And so we all kind of ponzi each other until we're out of the next person to draw in to the market bubble, at which point the bubble collapses in an exact reversal of the social structure that built it. So I love this idea. So let's use 2020 hindsight. Let's go back and let's think about Amazon idea. So let's use 2020 hindsight. Let's go back and let's think about Amazon 25 years ago. And I think a little bit of hindsight clarifies things. So what distinguishes Amazon from a Ponzi

scheme? Because if you think about it, this is an organization which in the 1990s and the early 2000s was not making money, losing a lot of money. But it's raising money from investors. So, investors are putting money in and if they wanted to get their money out again, they could. No problem. How do they get paid? Well, because other investors are putting money in. So, there's a way to get paid and more and more money gets poured into this thing. And the reason it's not a Ponzi scheme, well, there's two things. One is there's no fraud, right? Because Amazon was perfectly honest about the accounts and perfectly honest that it was losing money. And so there's no deception, there's no fraud. So that's one reason it's not a Ponzi scheme.

The second reason it's not a Ponzi scheme is in the end, it all comes good. All of that investment does turn into something productive and everybody can get paid back. So the first part of that, them being honest, okay, that's important. But the second part could not be guaranteed. There's no way of guaranteeing that Amazon would ever make money and indeed lots of those dot com stocks in the 1990s never did. People could make a lot of money as long as they got out in time. And that's very Ponzi-ish. And what is so important about the Amazon example is that the kind of faith, or if you prefer, kind of credulity of Amazon's early investors is exactly what allowed Amazon to become such a great business eventually. In other words, because the investors didn't insist on being paid out of the company's

profits, Amazon was able to have this wonderful cycle where it just reinvested all of its capital in itself and built this incredibly strong, deep-moded, indestructible business, because it wasn't paying money to investors. It was reinvesting in itself because the investors had that faith. So, I think we now have a typology. So, if you're putting money in and early investors get repaid from later investors and the accounts are a sham, that's a Ponzi scheme and someone's going to jail. If the early investors get repaid by the late investors putting money in, but there's no accounting fraud, people are just over exuberant and the whole thing all collapses and it's pets.com, then no one goes to jail.

That's not a Ponzi scheme, that's a bubble. And if in the end it turns into a wonderfully productive investment such as Amazon, it's neither a Ponzi scheme nor a bubble, it's the genius of capitalism. I would argue that the Ponzi scheme and the bubble case are actually very close together. They're almost indistinguishably close because, other than the absence of the central figure pulling all the strings, simply because at some point in a bubble, the people involved in markets actually acknowledge that prices are no longer connected to economic fundamentals or the productivity of the companies involved.

They start using words like momentum. And they say, you can't get in front of momentum. The market is pushing upwards. If you get out now, you're going to regret it. It's fear of missing out. And to me, that moment, you are living Ponzi logic in that moment. There will be another person who will come along and pay me more, and I will be out of this game and somebody else will be left to hold the bag. There's always a story about where the money comes from, right? And I suppose the thing

about bubbly markets is the stories get less and less rigorous. People don't need a particularly strong data-driven, compelling story. They're just like, any story will do. I'm greedy now. And a lot of the Ponzi stories... Charles Ponzi's original story was something to do with arbitrage of international postal reply coupons. Really? That's going to work? But people believed it. There's another question I wanted to ask you, which is all of the Ponzi's you talked about in your podcast, and indeed all the ones I know of, and I'm thinking here of course of Bernie Madoff, the most famous of the recent

Ponzies, these all turn out very poorly for the puppet masters. Very poorly. So there's a question, there's a question about why us suckers fall for them. But there's a way in which the puppet master is the ultimate sucker. They've somehow believed their own Ponzi scheme in some way and they end up in jail or disgraced or why do they do it? I really am not sure why they do it. I suppose you could say, well, if the Ponzi schemes do somehow work out, if the international postal reply coupon arbitrage works, then everyone gets paid back in the end. I guess Sam Israel,

who ran the Beyu Capital Ponzi scheme, maybe he would have gotten away with it if one of his attempts to swing for the fences had paid off. But ultimately, there's a really interesting idea which I was introduced to by the writer Dan Davis, who wrote this terrific book about fraud called Lying for Money. He basically points out that if you take a typical Ponzi scheme, so let's say you're promising to double people's money every year. Okay, so you take $100 from a little old lady and you steal it. Okay, now in a year you need to pay her $200. That's okay. So you find two other little old ladies, you steal their money and you pay the first little old lady. Now, of course, in a year's time, you've got to do

it all again. Each year, you're earning twice as much money and you need to defraud twice as many little old ladies to pay the previous little old ladies. That's all kind of obvious and it's obvious that that can't keep going forever. That's an exponential process that's all going to come unraveled. But what Dan Davis pointed out is, what is easy to miss is that can balloon into thousands and thousands and thousands of dollars based on the original $100 theft. The fraudster only stole $100 and somehow now they're responsible for maintaining this enormous fraud. And no wonder so many of them end up crying with relief when they're finally arrested. Like, thank goodness, I don't have to do

this anymore. So I don't know why people do this. It's the magician's apprentice story. You cast the spell and all of a sudden it's much bigger than you are. And I think there is a general point about fraudsters that clearly applies to some Ponzi fraudsters is that they do get into it by mistake. You start a fund, you're struggling to be a legitimate investor, something goes slightly wrong and, okay, just one month I'm going to fudge the number so I can pitch to one more investor and then that takes on a life of its own. You get into it incrementally by small steps and suddenly the thing grows by leaps and bounds. And I think there's a way to read the Bernie Madoff scheme as having some of that character. And you can read Madoff's actions late in the scheme, as desperately trying to keep the thing under

control, turning investors away, as it were, because he couldn't handle it. And it just gets so huge that in the end, the gap between the underlying reality of the investments, about how much money you are really generating in a postal reply coupon arbitrage, and the fiction, what you're telling people you are making, that gap eventually becomes impossible to bridge. A lot of Ponzi schemes, I think it's ambiguous at the start. Did they mean it to be a Ponzi scheme or did they actually think they were investment geniuses and that everyone would get paid back? There is often an ambiguity at the start. But unless you're able to close that fraudulent gap early, it

becomes so unbridgeable. You don't have a chance. Tim, if you give me $100, I have a brilliant idea. I'm all ears. This is a long short. That portion of the show where we go long something we like or short something we don't like. Tim, are you long or short something? Can I go for a paired trade? Please do.

Excellent. Great. So I'm going to go short Ponzi and long pyramid schemes. So we should probably very briefly explain the difference. So a Ponzi scheme, someone's running a Ponzi scheme. They're lying. They're paying out earlier investors using money from later investors. Pyramid scheme works in a similar way, but it's decentralized. You basically get the later investors to send money to the early investors and then the later investors then have to recruit even later investors to pay them. And it's more transparent, but

more to the point. There's nobody actually running a thing. And what that means is that the person who sets up each individual pyramid scheme can cash out and walk away. And in fact, the pyramid scheme I described in the cautionary tale, we have no idea who set it up. She seems to have got fairly rich and just walked away and she never went to jail and we don't know who she was. You say she, Tim. You say she, but I think we're talking about you, Tim, aren't we? I couldn't possibly comment. Couldn't possibly comment. Rob, okay, I'm short Ponzi, long pyramid. Do you have a long or short for us? Well, let me ask you a question. Is Bitcoin a Ponzi or a pyramid? Or neither?

Or neither. I mean, I think it's more bubbly than either, but it's not a Ponzi scheme because there's nobody in charge. That's the whole point of Bitcoin, right? Nobody is in charge. So if it's anything, it's closer to a pyramid scheme where transparently, if you want to get paid for investing in Bitcoin, you get paid by other people coming in and buying your Bitcoin. So it's closer to a pyramid scheme. I'm going to be short Bitcoin just because I'm a coward. Well, I think that that's your inalienable right, Rob. And I think I might join you in your cowardice.

Thanks for being on the show. Oh, that's a real pleasure. Thank you, Rob. I loved it. Listeners, if you like Unhedge, you will love Conscienary Tales, Tim's podcast. Unhedged will be back in your feed before you know it. Thanks for listening. Unhedged is produced by Jake Harper and edited by Brian Ernstapp. Our executive producer is Jacob Goldstein. We have additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alastair Mackey, Greta Cohn, Marilyn Rust, Kira Posey, and Natalie Sadler. FT Premium subscribers can get the Unhitched newsletter

for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhitched offer. I'm Rob Armstrong. Thanks for listening. That was a special episode of the Unhedged Podcast. If you liked what you heard, you know where to find Unhedged. The same place you find all good podcasts. Cautionary Tales will be back in this feed soon.