The allegations surrounding Bernard Madoff read almost like a fictional super villain’s tale, though instead of holding the world hostage for “one billion dollars,” he swindled many sophisticated investors and financial institutions out of around 50 billion over several decades in an elaborate Ponzi scheme. So what exactly is a Ponzi scheme? A Ponzi scheme is a type of pyramid scheme, where early investors are paid with later investors funds. In other words, it involves shuffling money from current investors to folks who got in on the ground floor, “earning” early investors and the scheme operator a handsome “return”. The fraud is usually concealed through many bogus transactions and will continue as long as more and more suckers invest to keep paying the unusually high returns on initial investments.

Anthony Randazzo has a tells us how the scheme got its name over at Reason:

In 1920, former banker Charles Ponzi started a scam that offered investors a 50 percent return on their money within 45 days. Within just a few months he was pulling in $250,000 a day, paying off the first investors with money from later investors, planning to run with the money once he had what he wanted. The scheme fell apart before the year was over and Ponzi got five years in prison.

Go here for a detailed history of the fraudster and his fraud.

Sound familiar? It should. Government programs, especially Social Security, operate similarly to a Ponzi scheme. Here’s MIT-trained economist Arnold Kling over at EconLog:

Meanwhile, I’ve been thinking that Madoff is a perfect analogy for the public sector. The government gives people money, which it expects to obtain by taking the money from people in the future.

Madoff took investors for a $50 billion ride. How many trillions of dollars would “come up missing” if taxpayers tried to cash out or stop paying into the current redistribution system? Taxpayers are the suckers in the ultimate Ponzi scheme: the idea that prosperity can be created simply by transferring money from one person to another by means of the state. If you think the current bailouts are costly wait until a massive program like Social Security becomes insolvent.

Even major media personalities admit that some government programs, like Social Security, are Ponzi schemes:

CNBC’s Jim Cramer:

In a Ponzi scheme, investors get the returns from the money paid in by subsequent investors and eventually the whole thing falls apart. The last people to invest get hosed. In Social Security, a program I love, workers pay for the benefits of current retirees and hope someday future workers will pay for their benefits – it’s all a Ponzi scheme.

Here are a few other comparisons of Madoff’s scheme and government programs, especially Social Security:

Jay Ambrose at the OC Register:

The pretense used to be that when you coughed up your payroll tax, you were actually putting money into a personal Social Security account for your own future benefit. What’s actually happened, of course, is that the taxpayer dollars go to pay the immediate benefits of today’s recipients, whose numbers are about to vastly increase, while the surplus magically disappears into the supposed trust fund.

Charles Murray has a post at the American Institute for Economic Research:

Likewise, Social Security should be considered “too good to be true.” It is an unsustainable pay-as-you-go system—i.e., a Ponzi scheme. Just as Mr. Ponzi’s and Mr. Madoff’s schemes collapsed, Social Security will become unsustainable when payroll taxes don’t cover program benefits. At that time, benefits will need to be cut, or more money raised, whether by higher payroll taxes, by higher general-revenue taxes, or by higher borrowing.

Peter Schiff weighs in here:

Unfortunately, the Ponzi economy doesn’t stop there. A chain letter is no more viable when run by governments than when run by private citizens. However, government orchestrated pyramids have the advantage of required participation. As a result, they can maintain the illusion of viability for several generations. But the longer such schemes operate the larger will be the losses when they ultimately collapse.

Here’s Ron Paul on why financial markets need fewer regulations not more. (video) Anthony Randazzo echoes this point in the piece mentioned above and also notes that economic downturns help to expose frauds.