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**Karl** · October 21, 2007, 10:35 PM

Pyramid scheme or genuine investment company?

cont:

Pyramid scheme or genuine investment company?
An online reader referred me to the crisis and chaos which occurred in Albania during and after a proliferation of 'investment schemes' which were in essence pyramid schemes.

At its simplest, a pyramid scheme is an arrangement where money is taken from Peter to pay Paul. Peter comes in at the bottom and the money he has 'invested' along with others who have been wooed is used to pay Peter who came in before.

If Peter carries with him Mary, the company may even pay Peter a special fee or commission for his action. For the sake of readers who have asked me to explain what a pyramid scheme is, I have borrowed freely from the website explaining an actual scheme which ended up in chaos not only for the depositors but the country also. The place was Albania, a poor and improperly managed eastern European country. The time is the 1990s.

Read on and digest.
"In a typical pyramid scheme, a fund or company attracts investors by offering them very high returns; these returns are paid to the first investors out of the funds received from those who invest later. The scheme is insolvent - liabilities exceed assets - from the day it opens for business. However, it flourishes initially, as news about the high returns spreads and more investors are drawn in.

"Encouraged by the high payouts, and, in some cases, by showcase investments and ostentatious spending by the operators, still more people are drawn in, and the scheme grows until the interest and principal due to the early investors exceeds the money paid in by new investors. To attract new investors, a scheme may raise interest rates, but the larger interest payments soon force it to raise rates again. Eventually, the high rates begin to arouse suspicion or the scheme finds itself unable to make interest payments.

"When investors try to get their money out, they discover the truth about the scheme, whose demise is swift - and usually accompanied by acts of outright theft by the operators, if they are not caught first.
"Some of the Albanian companies met this definition exactly: they were pure pyramid schemes, with no real assets. Other cases are more ambiguous. Some of the largest of the companies... had substantial real investments. They were also widely believed to be engaged in criminal activities - including violating United Nations sanctions by smuggling goods into the former Yugoslavia - that were thought to be the source of the high returns they paid.

"And they had been in business for a long time, in some cases since 1992. However, even if they had not been pyramid schemes from the outset, at some point, probably during early 1996, these companies too became pyramid schemes. When they collapsed, it was clear that their liabilities massively exceeded their assets.

Mania: The events of 1996
Two events set the stage for the pyramid-scheme mania of late 1996. First, at the end of 1995, United Nations sanctions against the Federal Republic of Yugoslavia were suspended, eliminating an important source of income (smuggling) for the companies. In January 1996, the leading companies increased their interest rates from four/five per cent a month to six per cent a month, or almost 100 per cent annually in real terms. (Annual inflation in Albania was five percent in 1995 and 17 per cent in 1996.) Second, the uncertainty created by approaching parliamentary elections, which were to be held in May, prompted the companies to raise their rates again, this time to eight per cent a month, or a real annual rate of well over 100 per cent.

"During the same period, new schemes entered the market, offering even higher rates. In early 1996, two new pyramid schemes...were created, and an already existing scheme that had no real investments...stepped up its activities, offering interest rates of 12-19 per cent a month.

"The proliferation of schemes had baleful effects. First, more depositors were drawn in. Although ... had the largest liabilities, it had only 85,000 depositors. ... and ... between them attracted nearly two million depositors-in a country with a population of 3.5 million - within a few months.

"Second, the investment funds felt pressured to compete and began to offer higher interest rates on deposits. In July, one company raised its monthly interest rate to 10 per cent.

"In September, another began offering more than 30 per cent a month. In November, yet still another offered to treble depositors' money in three months; the first company responded with an offer to double principal in two months. By November, the face value of the schemes' liabilities totalled US$1.2 billion.

"Albanians sold their houses to invest in the schemes; farmers sold their livestock. The mood is vividly captured by a resident who said that, in the fall of 1996, Tirana smelled and sounded like a slaughterhouse, as farmers drove their animals to market to invest the proceeds in the pyramid schemes.

"Throughout the year, the government was a passive spectator to the unfolding crisis. Although the enormity of the problem became clear when the Bank of Albania discovered that ... deposits in the banking system were equivalent to US$120 million (five per cent of GDP), and despite repeated warnings from the IMF and the World Bank, the finance ministry did not warn the public about the schemes until October. Even then, however, it drew a false and misleading distinction between companies with real investments, which were believed to be solvent, and "pure pyramid schemes".

"When it was suggested that some companies might be surviving by laundering money, President Sali Berisha came to their defence. Press and public reaction was mostly negative: the IMF was accused of trying to close down Albania's most successful firms. In November, in response to outside pressure, the government set up a committee to investigate the schemes. The committee never met.
"On November 19, one of the main players defaulted on its payments, and the collapse began.

Collapse
"The largest company's collapse shook the public's confidence in all of the companies and new deposits dried up. An attempt by four other companies, VEFA, Kamberi, Silva, and Cenaj to convince depositors of their soundness by lowering monthly interest rates to five per cent failed. In January 1997, two companies declared bankruptcy, triggering riots. The other schemes soon also ceased to make payments.

"The government belatedly took some useful steps. First, it refused to compensate depositors for their losses, which made achieving economic stabilisation after the crisis much easier than it would otherwise have been. Second, it began to move against some of the companies. In January 1997, it froze the bank accounts of two other companies Xhafferi and Populli, which amounted to US$250 million (10 per cent of GDP).

"The Bank of Albania, on its own initiative, began to limit daily withdrawals from bank accounts to prevent other schemes from emptying their accounts. In February, parliament passed a law banning pyramid schemes (but not defining them). However, the government continued to differentiate between companies with real investments and pure pyramid schemes and did not move against the largest companies.

"By March 1997, Albania was in chaos. The government had lost control of the south. Many in the army and police force had deserted, and one million weapons had been looted from the armouries. Evacuation of foreign nationals and mass emigration of Albanians began. The government was forced to resign. President Berisha agreed to hold new parliamentary elections before the end of June, and an interim coalition government was appointed.

"The interim government inherited a desperate situation. Some 2,000 people had been killed in the violence that followed the pyramid schemes' collapse. Large parts of the country were no longer within the government's control. Government revenues collapsed as customs posts and tax offices were burned. By the end of June, the Lek had depreciated against the dollar by 40 per cent; prices increased by 28 per cent in the first half of 1997. Many industries temporarily ceased production, and trade was interrupted. Meanwhile, the major pyramid schemes continued to hang on to their assets, proclaim their solvency, and resist closure.

Winding up the schemes
"Despite the many obstacles it faced, the interim government, aided by the international community, made impressive progress in restoring order and stabilising the economy. Winding up the pyramid schemes proved to be more difficult. The government encountered resistance from both the operators and the outgoing parliamentarians, many of whom were reported to have invested in the schemes.

"Thus, it was not until July that the newly elected parliament passed a law, drafted with assistance from the IMF and the World Bank, mandating the appointment of foreign administrators from international accounting firms to liquidate the schemes.

"The administrators appointed under the new law were required to report regularly to the government but otherwise had complete independence. They were given broad powers to carry on the companies' businesses, pay their debts, sell their assets, fire staff and managers, seize the assets of individuals connected with the schemes, and hire experts to trace assets abroad.

"However, by November 1997, when the administrators took up their duties, the schemes' liquid assets had shrunk considerably. The schemes' owners challenged the new law in the courts and tried to intimidate the administrators with threats of violence. It took several months to dislodge the owners, partly because the administrators needed their cooperation in finding the companies' assets. The administrators did not gain full control of all of the companies until March 1998.

"Owners who had not fled were jailed, and whatever assets remained were prepared for sale. But much had been lost already."

Be careful with your money
There is a basic law to life. All adults must take responsibility for their actions. Even if a grown person is led to a door by another grown person, the first person still has the responsibility to admit or to deny himself entry through that door.

Earned income is a precious commodity and the person with funds gained from this income is always torn between enjoying it immediately, that is spending it immediately, or 'saving' it in some institution which pays us (interest) to do so.

If Paul has money, the only way Peter can get it from him is to either offer Paul a service or a good that he needs, Paul can volunteer to give the money to Peter (unlikely), Peter can offer Paul an inducement (interest) to secure the money, or Peter can stick a gun in Paul's nose and say, 'Gi mi di money or a shot yu!'

There are always inventive ways to induce people to part with their money simply because there is not much utility value in stealing it, especially if one is law-abiding. Prison is hell. But there are also inventive ways of deferring the date of the 'stick-up.'

It is the responsibility of investors to educate themselves. If one investment club promises me a high rate of return and it can give me a step-by-step account of how the money earns its interest, I would be more inclined to go that route. If another company simply makes magic and also makes it too good to be true, then if I should put my money there it should come as no surprise when my dark day of reckoning arrives.

observemark@gmail.com

**Karl** · October 21, 2007, 10:43 PM

Originally posted by Karl View Post

cont:

Pyramid scheme or genuine investment company?

An online reader referred me to the crisis and chaos which occurred in Albania during and after a proliferation of 'investment schemes' which were in essence pyramid schemes.

At its simplest, a pyramid scheme is an arrangement where money is taken from Peter to pay Paul. Peter comes in at the bottom and the money he has 'invested' along with others who have been wooed is used to pay Peter who came in before.

etc., etc., etc...

Be careful with your money
There is a basic law to life. All adults must take responsibility for their actions. Even if a grown person is led to a door by another grown person, the first person still has the responsibility to admit or to deny himself entry through that door.

observemark@gmail.com

Forgive for asking; ...but, is this the same person who while lamblasting the PNP in essense said that the PNP Omar Davies and others who would not give licenses to operators of such schemes where 'silly', 'badminded', and where mismanaging the country or worse against such type schemes because of possible 'unworthy motives'?

Now the JLP is in office he has suddenly done an about face and is now agreeing the position of the Omar Davies and PNP spokespersons?

Perhaps, I misunderstood, honest, "tell it like it is"..."no anti-PNP sentiment"...purely working "for the people" Mark?

**Muadib** · October 22, 2007, 10:02 AM

Which Schemes have been indentified as Pyramid in nature ?

Careful yuh not accused of lying.

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