The Ethics of Winding Down a Ponzi Scheme

A while back one of my friends made the following argument on Facebook:

It’s easy to call all poor/working poor people “irresponsible”, but let’s be frank. My grandmother is a small business owner. She built her business from the ground up, was a single mom, and raised 4 children. She paid into SS and Medicare her whole life. She earned those benefits. To call her “irresponsible” is the height of irresponsibility.

My response to this argument follows:

The issue is not whether poor people or your grandma are irresponsible or not. The issue is whether other people, who may already be paying far larger tax bills, should pick up the tab for false promises made to people like your grandma.

Frankly, your grandma is a victim of a Ponzi scheme. Whether she wanted to or not, she was forced to invest in a scheme that promised her an imaginary return on her benefits. I don’t know for sure that she is getting back more than she invested in nominal or real terms, but this is likely based on the fact that she is probably near or past retirement age now.

When you invest in a Ponzi scheme, you get hurt. There is no fair way around this. Your grandmother isn’t entitled to get everything she was promised just because she was the first to invest in the Ponzi scheme, or because she is a nice lady, or even just because she is your grandma. Clearly the facts that she had four kids as a single mother and started a business are irrelevant; those are just choices she made, not something she deserves a reward for from society.

In a Ponzi scheme, more is promised than can be delivered. Some of the promises have to be broken. The law has evolved a set of actual principles to deal with Ponzi schemes: recover profits paid to investors as reasonably possible, and distribute the proceeds pro rata among the underpaid victims. See this treatment of the Bernie Madoff Ponzi scheme, for example.

Sure, your grandmother may have expectations. She expected to get the money she was promised. But everyone else has expectations too. They expect to not have to bail out your grandma once the Ponzi scheme explodes. Now, maybe we should think of these Ponzi schemes as something that we are all victims of. If that’s the case, then perhaps the pain should be shared between people paying more taxes than they expected to, and people getting less benefits than they expected too. But your grandma isn’t entitled to get off scot-free.

Eventually my generation will be expecting benefits from Social Security and Medicare. Perhaps, unlike past generations, we will expect back less from the program then we paid in. We’ll think this means that we are getting back “our” money and getting what we “deserve”. We’ll be just as wrong as my friend on Facebook. We weren’t paying for our benefits, we were paying for the grandparents or parents of someone working today. That’s how a Ponzi scheme works.

Entitlement Growth

This is one of my favorite Heritage charts:

The projections for the growth in these programs are pretty staggering – and worth taking a look into later.  Yesterday, Christina Romer (Chair of Obama’s Council of Economic Advisers) testified before the House Committee on the Budget.   She said that only a small part of the growth in Medicare spending was attributable to demographic people (more old people needing health care and living longer), and that most was due to the increased cost of health care (page 4 of this link).

The graph above seems to contradict that claim.  Why would Medicare grow so much faster than Medicaid if demographic changes were not a very large part of the cost increase?  I don’t know whether Ms. Romer is correct.  I’ll probably be rooting through the CBO’s website later this week to see how exactly they came up with their numbers.