The term "Ponzi Scheme" has come up in the news a lot lately, primarily in describing $50 billion in investment securities fraud Bernard Madoff is accused of perpetrating. Not often explained is what a Ponzi Scheme is, and how it works.

Named for Charles Ponzi, an Italian immigrant and con man around the turn of the 20th Century, the con is sometimes also referred to as a "pyramid scheme" wherein early investors are paid from the deposits of a widening base of new investors. As long as new people continue to buy into a growing ponzi scheme, money continues to flow upward to the pyramid of investors. These schemes inevitably collapse when the pool of new investors pumping new money in can’t grow fast enough to support the payments to earlier investors, because actual investment earnings, if any, are not sufficient to cover promised returns.

Even though Ponzi schemes always collapse, getting in early ("on the ground floor") can yield tremendous returns. It’s the people who come in towards the end of the scheme that lose big, since their money hasn’t actually been invested, but merely passed up to the personal accounts of the creator of the scheme and earlier investors.

One year after Charles Ponzi was released from prison for fleecing unsuspecting investors out of $7 million, President Franklin D. Roosevelt concluded that the federal government could get away with such a scheme. Social Security was signed into law as part of the "New Deal" in 1935.

Social Security is now the largest government enterprise in the entire world and combined with Medicare/Medicaid accounts for over 40% of all U. S. federal government spending.

Social Security is a mandatory retirement investment, deducted each pay period from every employee’s wages, with the promise that these investments will be repaid with interest by the federal government upon retirement, but like most Ponzi Schemes, the money isn’t actually invested in any conventional sense. In fact, current social security deposits are not only used to cover current transfers to retirees, but also part of the federal deficit. The government can get away with this for the time being because Social Security deposits are currently in excess of payments, but the number of retirees is now growing faster than the workforce. Unless changes are made in the way Social Security functions, it will collapse like all Ponzi Schemes do, when the pool of new investors isn’t contributing enough money to support payments promised to beneficiaries further up the pyramid. Eventually, a whole generation of investors into this scheme is going to get burned. Since the largest generation, the "baby boomers" are beginning to retire, with a smaller generation coming up to support them, that day of reckoning is likely coming sooner rather than later.