In breaking news this morning, the government of Colombia has announced measures to help out poor investors who have lost money in pyramid schemes.

The Australian media have mostly ignored it, but Colombia has been torn by riots and protests over the last few days due to the collapse of dodgy financial operators, who have apparently been promising huge returns based on nothing more than paying out earlier investors from the money deposited by later investors. Great if you get in (and out) quickly, but a losing proposition for the vast majority.

This is not unprecedented: in Albania in 1997 a similar collapse led to nationwide chaos and the deaths of some 2,000 people. Colombia so far seems to have got off lightly.

After the rogues had absconded, Colombians demanded that the government step in to guarantee their “investments” in the schemes. According to this morning’s report, “President Alvaro Uribe vowed to help poor investors regain their savings, but said Saturday that wealthier clients should have known better and will ‘have to take some blows to the chest.'”

Before we indulge too much in a feeling of developed-world superiority here, it’s worth reflecting on the similarity of Australia’s experience. When the Rudd government responded to the world financial crisis by formally guaranteeing bank deposits, many investors were evidently shocked to discover that it did not extend to all investments, and demanded government help in getting their money out of such things as mortgage-backed property trusts.

Property trusts are not pyramid schemes, but they both lie on a continuum: once government guarantees start, it’s not obvious where to draw the line. Both here and in Colombia, there seems to have been a failure of education about risk — also evident, of course, in our periodic moral panic about poker machines.

The natural desire to help people who may have lost their life savings needs to be balanced against the fact of moral hazard: that by decreasing the cost of foolishness, you will increase its supply. As Colombia’s vice-president pointed out, “When someone promises to double your money in six months they are trying to trick you. Nothing is free in this world and that is not going to change.”

But everyone likes to think we can create a world without losers.

Witness investors in the Australian car industry — surely as bad a long-term proposition as any pyramid scheme. The money keeps rolling in, and punters sleep easy in the knowledge that the taxpayers will always be there at the end to pick up the tab.

Peter Fray

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