Pyramid schemes or Ponzi schemes as they are often called have been around in the market economy for quite some time now. They have even wrecked significant havoc and always end up being part of some form of crisis or another. Even in 2008, the Bernie Madoff scandal caused chaos on Wall Street as a pyramid scheme had been used to siphon off $50 billion from under the nose of the world’s most competent regulators. Pyramid schemes have therefore always been regarded as dangerous, to say the least.
However, none of the pyramid schemes had brought about a revolution and engineered the fall of a government or bankrupted an entire nation. This distinction belongs to the Albanian pyramid schemes that mushroomed in the early 1990’s and plunged an entire nation into economic turmoil in 1997. In this article, we will learn more about the economic insanity that gripped Albania in the 1990’s.
Albania had been a strictly communist country till the late 80’s. It was ruled by a dictator who believed in self-sufficiency. This meant that Albania was not trading with other countries of the world back then. Also, there was no concept of private ownership for over a generation. It is for this reason that the entire population of Albania was unaware of even the basics of investing in financial markets. Also, there were no channels that provided information to the Albanians. Hence, decades of isolation had created a country that was rife with financial scandals.
State Banks were Incompetent in Albania
To further complicate the problems, the banks owned by the Albanian state were outright incompetent. They were not able to even perform the basic functions of banking efficiently. For instance, it would take 5 to 6 days if money had to be transferred from one account of the same state-owned bank to another! If more than one bank was involved in the transactions, the payment process would take at least 15 days.
Also, the Albanian banks were not very good at making loans. They always had a large number of nonperforming assets on their books. This made the investors worry about the safety of their investments, thereby limiting the deposits in these banks. The Albanian population had a distrust of banks and preferred to hold large amounts of cash. This is why the informal credit system was able to gain a foothold in Albania.
Informal Credit System
The shortcomings of the Albanian banking system created opportunities for other unscrupulous and fly-by-night operators to undertake activities in the financial sector. A lot of these organizations started mushrooming. They offered interest rates of close to 4% per month to their investors! These interest rates were obviously not sustainable until the economy was in hyperinflation. The IMF was worried about the legitimacy of these operations. A lot of these companies were not banks at all. They were simply borrowing money from the Albanian public on their own account.
Some of these businesses were alleged to be laundering money for the Italian mafia. Some others were alleged to be indulging in smuggling goods past the Albanian border to the neighboring country of Yugoslavia which was facing sanctions from the United Nations. However, the naive Albanian public was totally unaware of the risks. They kept investing money in these operations and the amount of funds being managed by the informal credit system swelled up to $1.2 billion dollars.
The informal credit system may have been engaged in illegal operation. However, they were engaged in some kind of operation. Seeing the success of these companies, many pure- play Ponzi operators stepped into the market. These operators kept bidding interest rates higher against each other and finally some operators were claiming to offer as much as 40% interest per month!
Anybody with even the slightest knowledge of finance can say with certainty that such schemes are simply not possible however the Albanian public brought into these schemes. Farmers sold their lands and livestock and handed money over to the Ponzi operators. There were queues outside the offices of these companies to deposit money.
The Albanian government is also suspected to be hand in glove with these operators. This is because, despite the increasing volume of insanity in the markets, they took no action at all. Most of these operators were running unlicensed businesses which were outright illegal. Also, neither the businesses nor the investors were paying any taxes. However, the government ignored the activities of the marketplace and let the bubble mushroom.
As the bubble grew large enough, these Ponzi schemes had money that was equivalent to over 10% of the GDP of Albania! Every Albanian citizen had invested in these schemes in one form or another.
The Market Goes Bust
The Ponzi schemes had reached their pinnacle. Once almost everybody had invested in these schemes, there was no more room to go forward. Hence, there were no investors whose money could be taken and given out as interest to the earlier investors. This is when the fly-by-night operators started fleeing and the entire Albanian economy went into crisis.
Riots broke out on the street, and hundreds of people died. A civil revolution took place as military and police deserted the government fearing angry mobs. A new government was elected, and the old one was replaced. However, even the new government took a firm stand. The investors were not compensated for their losses. Some of the Ponzi schemes which still had money were liquidated, and money was paid out to investors.
The Albanian pyramid scheme crisis remains the only case when pyramid schemes caused an economic collapse and civil revolution in an entire country!