Perhaps the oldest fraud in the financial system is the Pyramid scheme, a fraudulent operation that pays returns to investors out of the money paid by subsequent investors rather than from profit. In America, the Pyramid is known a the Ponzi scheme, after the name of one high profile fraudster of the 1920s.
The principle is simple: the scheme usually offers abnormally high returns in order to entice new investors. The perpetuation of the high returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors in order to keep the scheme going. Yet the system is destined to collapse because the earnings, are less than the payments. Normally the authorities intervene, although in the case of the latest pyramid scandal- that of the "funds" run by Bernard Madoff - the scale of the losses is truly vast: an estimated $ 36 billion.
Yet, despite the scale of Mr. Madoff's alleged crimes, there is an even bigger Ponzi scheme, much closer to home, and one that is actually run by the British State. There are over 6 million people employed by the British State and the vast majority are entitled to receive pensions that they have not contributed to. Neither the state as employer, nor the employees have paid for the lucrative pension rights that are on offer, and the vast majority of these pensions are thus paid from the general pool of current taxation. MPs. judges, civil servants, all are entitled to receive large pension rights upon retirement.
Meanwhile, those in the private sector who have contributed to the National Insurance fund for there own pension have found that the fund was never created- that too went into the general pool of taxation. Those who, under the terms of the legislation of the 1980s and 1990s, opted to create private pension funds have found that after Gordon Brown began to tax such funds, over £4 billion a year is paid into the general taxation pool. All in all, more than a third of the general taxation pool is now being used to pay unfunded public sector pension liabilities.
2008 was a year of brutal financial turmoil. The fall of major investment houses lead to the gridlock of the whole financial system. Despite the dramatic cuts in nominal interest rates, the availability of credit in the market has shrunk dramatically, and where such credit is even available, the effective cost has risen substantially. It is clear that 2009 will see a punishing recession, but no one knows how deep or how long the economic plunge will last. The effect on private sector pensions, based on investing in different securities has been appalling. The pension fund deficit of the British Airways employees is so large that it is stopping the firm itself from proceeding with any of its hoped for merger plans with other Airlines.
The British government, however, has taken on some massive liabilities. The nationalisation of much of the banking system is increasing the liabilities owed from general taxation, and the markets are already concluding that British government debt levels are too high.
In Estonia health care is paid for from a genuine insurance fund, as is social welfare payments. Deficits are not permitted, and the overall level of state debt is exceptionally low- in good years the state even records a surplus. Despite he rapid growth of private debt in Estonia over the past five years, the levels of debt are still less than 40% of those of the UK. There is a higher level of net saving, which is the result of a fully funded pension system.
Unless the political class in Britain (which is the greatest beneficiary of the public sector pension scheme) can reduce the burden it imposes on the general pool of taxation, Britain faces a bleak financial future of high tax and rotting public infrastructure leading to declining competitiveness, social discord and increasing international irrelevance.
2009 will be a year of recession.
We do not know how long this will be nor how deep it will be. However, a root and branch reform of public sector finance is critical. Irrespective of party, the need for leadership is clear. Any figure brave enough to articulate the need for revolutionary change will demonstrate their fitness to lead. Yet are there any in what Peter Oborne calls the narrow self serving political elite who have the vision, the will or the courage to end the British Ponzi scheme and return the UK to financial honesty?
At the turn of the year a hope so, but I am not encouraged by what I see.