A Ponzi scheme is a particular kind of pyramid scam. It's really a process for running a scam. The way that it works is that you create some kind of "investment fund". You promise some kind of great payoff, and convince people to invest. As you get new investors, you use their investments to pay off the previous investors, skimming off a layer from the top to enrich yourself. The whole pyramid - the layers of investors paying off investors - is really just a front for what's really going off - which is the manager of the Ponzo scheme stealing money.

For example, you could start a Ponzi scheme by selling an "investment" with a promised growth rate of 50%/year. Suppose you sold 10 $100,000 "shares" in your fund. At the end of the year, you need to be able to pay $150,000 to each of your original ten investors. So you get 20 people in invest - you've then taken in $2,000,000, and you've paid out $1,500,000, which means you got to pocket a cool half-million dollars. Of course, the next year, you need to enlist 30 new investors just to break even - so you'd get something like 40 - and pocket the money left after paying off the previous year's 20. And so on.

This works great for as long as you can rope in more investors. But eventually, you're going to get to the point where you can no longer bring in enough investors. And the whole mess collapses, because there was nothing really there. There was no business. There was no investment. There was just a scam to allow the people who started it to cheat a lot of people out of a lot of money.

The whole idea of a Ponzi scheme is that you've got that pyramid - the ever-growing pool of "investors" at the bottom, who are pouring money into the pool, and there's a small group of people at the top, who are stealing money from the pool, while doing the Ponzi payoff trick just to make the people at the bottom still keep pouring money in.

For those who haven't followed it, Bernie Madoff is a famous New York investment broker. He's the former president of NASDAQ. It turns out that his investment fund wasn't really an investment fund - it was just a Ponzi scheme. He managed to keep it going for an astonishingly long time. And it wasn't a well-hidden one - we was under suspicion for at least a decade, but no one really bothered to investigate, because despite the fact that it looked like a Ponzi scheme, acted like a Ponzi scheme, smelled like a Ponzi scheme, etc., no one could believe that a guy like Madoff would get involved in anything so crass.

Ok. So that's background. Now Bloomberg is coming along and saying that Madoff's Ponzi scheme - the largest one in history - is nothing, because social security is the same thing, but on a much bigger scale.

http://scienceblogs.com/goodmath/2009/01/social_security_vs_ponzi_schem.php