The Pyramids of Putumayo
By Ibsen Martinez
Having witnessed the apocalyptic end of Soviet-era socialism I think I can skip the final days of capitalism. That would be a collapse too many witnessed in a lifetime. But I’ll be happy if ever I see the final day of human malevolence and gullibility such as pyramid schemes, for instance.
“He was thought of as a great philanthropist, a pillar of the community, the chairman of Nasdaq—all of that stuff,” reportedly said one hedge fund executive who knew Mr. Bernard Madoff, the notorious founder of Bernard L. Madoff Investment Securities LLC—ever since the days he was a lifeguard in Long Island, long before he became a sprinkler installer in Queens.
Mr. Madoff’s major achievement as a financier amounts to the first worldwide Ponzi scheme, something The New York Times pronounced to be ” a fraud that lasted longer, reached wider and cut deeper than any similar scheme in history.”
The scale of the fraud has not been fully verified, but Mr. Madoff himself estimates the losses at $50 billion. Mr. Madoff is certainly a remarkable man who allegedly became so popular with investors that he often turned away their money. As in any other Ponzi scheme, the returns he paid came not from real investment gains but from inflows from new clients. It might still have been going on, were it not for the global financial crisis.
Harassed by the credit crunch, investors eventually decided to reach for their money and started asking for it faster than Mr. Madoff could bring in fresh cash. That his scam came to be detected only amidst a global financial crunch and that his wily ruse rippled outward into Europe are probably the most distinctive features of Mr. Madoff’s exploits.
But Madoff’s crafty subterfuge was in no way the only Ponzi scheme worthy of note in the recent past. In fact, enticing investors by offering abnormally high short-term returns has proved to be the fraudulent investment operation favored by the truly daring ever since the eponymous scheme orchestrated by the infamous Charles Ponzi back in the 1920’s.
One of the more notorious pyramid scams in the U.S. was the 1980s scandal involving the La Jolla-based J. David & Co. investment house, in which Jerry Dominelli was convicted of defrauding hundreds of well-heeled clients out of millions.
While Mr.Madoff was being arrested by federal agents who accused him of running the largest fraud scheme in Wall Street’s history, a get-rich-quick scheme that left more than a thousand victims in Florida was unveiled.
As of mid-December local police had not been able to fully identify the man who during last year preyed upon religious, ethnic and elderly groups, and particularly targeting Haitian immigrants. “They don’t have any piece of paper from the guy. There is no evidence that they gave him money. That’s the challenge,” a police spokesman said. The victims invested anywhere from $3,000 to $20,000. The man promised returns of 90 percent to 100 percent on their investments within 90 days. Authorities are still investigating the allegations and no one has been charged.1
This case is an example of what experts call “affinity schemes”. Typically, affinity schemes involve pyramid operations in which fraudsters take advantage of the fellowship ties that flourish in immigrant neighborhoods. It appears that investment clubs have been a staple in Florida’s Haitian community for years.
In the mid-1990s, Albania was transitioning into a liberalized market economy after years under a State-controlled economy. The rudimentary financial system became dominated by pyramid schemes. To worsen things, government officials tacitly endorsed a series of pyramid investment funds.
Approximately two-thirds of the Albanian population invested in them.
Finally, in 1997, Albanians—who in total had lost $1.2 billion—finally took their protest to the streets. Relentless rioting led to the toppling of the government. Neighboring governments intervened militarily to protect their own investments. In the process, some 2,000 people were killed.
In the face of many similar scams registered all over the world in modern times, one question arises: How may intelligent and educated people, some of them naive about finance and others quite knowledgeable, be ruined by schemes that in all appearance are highly dubious? What explains the everlasting recurrence of these scams?
It is a well known fact that when dealing with matters they don’t fully understand humans tend to model their actions on the behavior of other humans. This mechanism has been termed “irrational exuberance,” a phrase sometimes attributed to former Fed Chairman Alan Greenspan, but actually coined by another economist, Robert J. Shiller in a book with that title.
Shiller employs a social psychological explanation that he terms the “feedback loop theory of investor bubbles.” Simply stated, when many people seem to be making big profits on the investment, and telling others about their good fortune, it only makes the investment seem safe and too good to pass up. In Schiller’s words, “the fact that others have made a lot of money appears to many people as the most persuasive evidence in support of the investment story associated with the Ponzi scheme—evidence that outweighs even the most carefully reasoned argument against the story.”2
For a podcast with Robert Shiller, see Shiller on Housing and Bubbles with host Russ Roberts on EconTalk.
In Shiller’s view, all investment crazes, even those that are not fraudulent, can be explained by this theory. How does the irrational exuberance theory play in Latin America when considering recent investment scams?
Consider Colombia, where pyramid schemes are utterly epidemic. Last November, Colombian government officials declared a state of emergency in order to deal with multimillion-dollar investment scams that targeted mostly poor investors.
Panic had spread among investors across Colombia after one suspect financial agency halted payments. Disturbances broke out in 12 states and investors stormed offices in the southwestern cities of Pasto and Popayan, threatening to lynch the managers. Twelve people died in the riots before authorities could restore order.
One collapsed investment house, known by the initials DRFE, for “Dinero Rápido y Fácil en Efectivo” (Spanish for “Fast Easy Cash Money”) promised profits of up to 150% per month before its founder, a former parking lot attendant, fled the country. Police said $270 million was believed to have been lost in a scheme run by the DRFE agency across its 240 offices.
DRFE was only one of more than 200 Colombian firms suspected of taking deposits illegally from investors, offering interest rates of up to 300% over just six months. Others, such as DMG, after the initials of its founder, David Murcia Guzmán, are more sophisticated affairs that pose as normal companies selling merchandise, but pay their clients in “points” redeemable in cash after six months. So far, 92.4 billion pesos ($42m) has been seized from DRFE offices, though officials believe the company may have taken as much as $200m in deposits.
Much of the alleged pyramid investment activity was concentrated in the southwestern state of Nariño, where rampant drug trafficking has generated a steady flow of disposable cash. The operations were not clandestine; long lines regularly formed outside some of the investment shops in the southern city of Popayan.
Colombia also boasts a young, somewhat smaller schemer than Mr. Madoff but who, unlike the former, is also a popular hero: el señor David Murcia Guzmán.
One the most important weekly magazines in Colombia, Semana, portrays Mr. Murcia as a self-avowed Robin Hood: “Not since the time of Pablo Escobar, when he acted like a philanthropist and won popular acclaim with his program ‘Medellín sin Tugurios’ (‘Medellín without Shantytowns’), has Colombia seen such an enigmatic and controversial figure such as David Murcia Guzmán.”
Indeed, Mr. Murcia (28) has had a meteoric career. He left his birthplace, the town of Ubaté in the Cundinamarca department, very early on. With only a high school degree he received in Bogotá, he travelled from city to city dedicated to earning a living as a travelling salesman making $130 a month. In 2003 he arrived in La Hormiga, in the state of Putumayo, and he didn’t have enough money to even pay for a room for himself in the town’s hotel. But that didn’t last long.
In 2005, with an initial investment of 100 million pesos ($43,000 USD), believed to be drug trafficker’s money, he founded the group DMG in Bogotá. Today, he already has an emporium with more than 200,000 clients, branches in seven countries and partners to open new offices in 99 other countries, according to what Murcia told a radio journalist.
None of the pyramid schemes that collapsed in November belonged to DMG. But the eyes of the government and of justice are focused on DMG because it has been the source of inspiration of the nearly 250 pyramid schemes that the government has identified nationwide.
With its philosophy of multiplying money and thus feeding a mafia-like culture of easy money, DMG gained the confidence of its clients. It also showed the way for many other unscrupulous types who found a market willing to bet on this risky business.
According to the Attorney General’s office perhaps as many as 4 million people in a country of 44 million lost money, an estimated $1 billion, in four hard-hit southern states alone. Some analysts assert that the extraordinary success of pyramid schemes in this country draws from widespread public disappointment at a banking system unattainable to the poor.
Commercial banks tend to offer low interest rates and charge exorbitant fees. To be true, Colombian President Alvaro Uribe has sought to defend the country’s financial system, but at the same time he has urged banks to make services more easily available to poorer Colombians.
Inside his gigantic organization, Murcia built a cult of personality based on an image of himself as a redeemer for marginalized social classes, who have been abandoned by the state and stepped on by the banks.
Indeed, not all Colombians are opposed to the investment firms. While some have looted the companies who scammed them, others have organized marches in support of what they call “the banks of the poor”. They chant DMG’s motto: “Crea en Dios y en David Murcia” (“Believe in God and David Murcia”).
Perhaps that is the reason why many pro-DMG demonstrators fiercely demanded that government’s hands remain off their rags-to-riches folly.
C. Ron Allen, “Florida’s Haitians lose cash in get-rich-quick scheme”. South Florida Sun-Sentinel, December 20, 2008.
Schiller, R. J. Irrational Exuberance. Princeton, NJ: Princeton University Press, 2000, p. 66.
For more articles by Ibsen Martinez, see the Archive.