Monday, February 15, 2016

Ponzi Scheme in China: $7.6 Billion Lost

A recent article in The Economist elaborates on a massive Ponzi scheme that recently collapsed in China and caused 900,000 investors to lose about $7.6 billion.

Ponzi schemes are not new in China. In fact, China’s current lack of regulation in the peer-to-peer lending industry has created an environment ripe for fraud. This article points out how the lack of government regulation can lead to an economic environment where investors find it nearly impossible to distinguish between fraud schemes and legitimate businesses. We can also learn a few additional things from this Ponzi scheme that might help investors identify when something really is too good to be true.

The article mentions that “instead of paying investors out of revenues from business projects,” Ezubao was “paying long-standing investors with money deposited by new ones,” a structure that can’t last and is the key feature of a Ponzi scheme. Additionally, the founder of Ezubao spent millions of dollars on advertising, instructed employees to live lavish lifestyles, and even appeared on the government’s web portal during interviews. One fundamental principal that is true in nearly every fraud is that the fraudster generally does not quietly save their fraudulent earnings. Instead they live extravagant lifestyles, own nice cars, jewelry, and other luxurious items.

Every fraud eventually collapses, despite fraudsters’ best efforts to keep the details concealed. In the case of Ezubao, managers buried their accounting records underground, but after 20 hours of excavating, police were still able to retrieve the evidence.

As investors and consumers trying to not lose money in a fraudulent investment, it is important to understand how the company makes money, how lavish the lifestyles of management personnel are, and what fraud prevention regulations are in place (or lacking).

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