Essay details:

  • Subject area(s): Marketing
  • Price: Free download
  • Published on: 14th September 2019
  • File format: Text
  • Number of pages: 2

Text preview of this essay:

This page is a preview - download the full version of this essay above.

The Ponzi scheme phenomenon or Pyramids known in Albania is very exceptional and dramatic case comparing to other cases known in the history of existence of Ponzi schemes. In Albania this schemes known in country as “pyramids” escalated to unprecedented and unpredicted consequences because it had economic, political and social profound. If you mention Pyramids to Albanians comes immediately in their mind the most devastated and chaotic period of the last 25 years or maybe of its history.  

The wide appeal of Albania's schemes can be attributed to several factors that come from the fact that Albania was a newly democratic country, coming out from the most isolated communist regime known in Europe. When Albania started the transition in 1991 after an era of central planned economy to an open market economy, it was the poorest country in Europe. Was also the most isolated country because for more than 45 years only the elite of the country could travel abroad, the other part was killed if tried to escape abroad. From 1945 to 1985, its isolation was compounded the communist dictator Enver Hoxha, which eliminated almost all forms of private property, freedom of speech, religion or moving among the country or abroad. When talking about communist countries in Europe or even in the world, the Albanian model is always an exception: more conservative system then China and SU. The economic or political relations with other countries were inexistent (after breaking up with ex-Soviet Union and China) because he wanted that the country would stay away of foreign influences and information! When transition began in 1991, the country had been reduced to poverty because the country was not producing, had a very limited banking system (only state bank) and the vast majority of its population was not familiar with banking institutions or market practices. Like most of the ex-communist countries Albania was facing with triple digits inflation, until 1995 when GDP started the growth and the inflation felt to single digit.

One of the most important causes of the growth of the pyramid scheme was the inadequacy of the formal financial system. There were three state banks which dominated the deposit market holding 90 percent of deposits and private banks were not interested in domestic deposits but mostly to trade financing.  The biggest problem with the banks was the payment and loan system. Time of proceeding payment transactions between accounts at different branches of the same state bank was 5-6 days, transaction between different banks exceed up to 15 days. As a result of those, people tended to keep cash money and the ratio of deposits was under 65 percent.  On the landing part, was nearly impossible to get a loan from the state banks if you didn't have any relationship with the bankers and after happened that almost 30 percent of loans were nonperforming (bad loans). This situation opened a new tendency in Albanian market, some private companies started their activity as “loan companies” legitimated by the authorities and foreign exchange dealers flourished the informal market. The first “loan firm” was VEFA holding, very popular among the population and authorities because it was a kind a salvation for everyone who wanted emerging loans. After them a lot of other companies started the illegal activity of taking deposits and giving private loans, mostly from migrant workers. Lending rates were quite high, around 10 percent per month in 1993 and 7 percent in 1995. As in many aspects of the economy, there are no clear records of deposit rates that these companies were offering at the beginning. The use of their funds was uncertain, some of them were engaged in productive investments and some other is believed to have used borrowing money for illegal/criminal activities. At that time those companies replaced perfectly the no completely functional bank system. It was difficult for the authorities and foreign agencies (IMF and World Bank) to distinguish between the informal credit market that existed in the country and the term pyramid schemes. The impact of informal credit market and companies which invested on them drew was around US$300 million a year (around 12 percent of GDP).

The first warning about the danger of pyramid scheme was in late 1994 from World Bank but still was unheard because the authorities treated the borrowing companies as a rare success story among Albanian businesses. The companies were licensed and operating under the Civil Code which permitted borrowing by companies, even that they were never audited by the authorities or paid profit taxes.  In February 1996 the parliament passed a new Law on the Banking system, which mentioned for the first time “pyramids” and that only the bank shall accept household deposits, demand deposits and deposits with initial maturity of 12 months or less. The Bank of Albania tried to stop the borrowing companies by informing them that they were violating the new law and that they will need a license to operate but the Governor of the Bank of Albania will not give to them. The new law was not implemented; the ministry of Justice and other authorities did nothing to close the borrowing companies as violator or the law. Although, it is not proved but strongly believed that the problem was not only legal but mostly of governance that the government was in some way supporting and taking benefits from these companies.  

b. Flourishing period '96-‘97

1996 was an election year, and some major “borrowing companies” made campaign contribution to Democratic Party, the wining and the governing party. Also during that year was happening something big, the suspicious trade of oil that Albania was doing with Yugoslavia which was under UN sanctions for oil and some other goods. The direct involvement of the companies cannot be proved but during the time that this trade stopped the borrowing companies raised their interest rate to attract more funds. During this year new pyramid schemes entered on the market, drawing more deposits and giving higher and higher interest rate per month. Interest rates in the formal financial sector also rose during this period the Bank of Albania raised the interest rate from 13.25 to 16 percent. Political uncertainty environment caused by pre-elections caused the Lek (national Albanian currency) to depreciate by 15 percent the first 5 month of 1996. The biggest companies were VEFA, the most liable, Gjallica, Kamberi, joined by Populli, Xhaferi which offered a 4-5 percent per month and after 6-10, Sude was the one who started escalating interest rate offering 12-19 percent per month in May 1996 and had no real investments. Xhaferi sponsored Lushnja football team and recruited the former captain of the 1978 World Cup wining Argentina team to coach it. This one was one of the first revealing pyramid scheme trying to cover the real intensions with feuding investments.

Everyone heard about how beneficial those companies were because the first people who got the first money back with high interest told to other and the “mouth to mouth” marketing method worked more than well. In the second half of 1996 were nearly 2 million of depositors in a country of 3 ½ million of people. “Pyramid mania” took everyone on board! Kamberi rose interest to 10 percent per month, followed by Populli who offered 30 percent per month and the “best” Sude, 44 per cent per month rate! By November the deposits in normal borrowing companies and pyramid scheme companies reached the total of USD $1,2 billion. In total they were 17 companies, some small and local some other very big. The crowd of people who was investing in those firms was not only the poor ones but also people who believed that the schemes had the government support or the rest who found themselves in the middle of madness and thought to try it also. People sold their houses, farms, cars, everything they could to invest more and more money so they could be rich! Again government was just a passive observer! The World Bank and IMF gave increasingly repeated warnings of what was happening. Only in October the Bank of Albania found out that VEFA's deposits in the banking system were US $120 million (5 percent of GDP) the problem became clear . Press, part of administrative government and people reacted negatively accusing IMF mission that was trying to close down “Albanians most successful business firms”.

c. The collapse of “pyramids”

The collapse started when one of the companies, Sude, collapsed. People started to listen to warning. Other companies attempt to convince depositors that their deposits were safe but that they need to reduce the interest rate to 5 percent per month.  The tactic did not succeed.  Gjallica, the one with real investments declared their bankruptcy. The remaining schemes ceased payments in the last attempt to survive. Government tried to take some measurements, took some actions against some of the companies frizzing the bank accounts of Xhaferi and Populli (US$250 million – 10 percent of GDP). The Bank of Albania, acting on its own initiative, began to limit daily withdrawals from bank accounts to 30 million Lek (then about US $300,000) to prevent other schemes from emptying their accounts.  These measures helped in some ways because Xhaferi and Populli returned money to some depositors, but it was only permanently. Government was still trying to find the way how to react and how to move, while they were still trying to maintain the distinction between the companies with real investments and the pure pyramid schemes. No success! By end of February, beginning of March Albania was on chaos, large number of people invaded the streets to protests and ask for their money, police was very violent to them. Anger was growing up. Government had no control anymore. Police and army deserted. Thousands furious people who lost everything run in the streets, armoires had been looted, mass emigration to Italy began throw the sea illegally. The government resigned. Everything was on chaos, angry people who lost everything started taking arms and using them against government building, against each other or public goods (hospitals, schools, factories, banks).  

d. Effects and stabilisation

1997 was the year were started a nearly civil war that caused death to more than 2000 people and entered in history of Albania as the most devastating year ever. Many industries temporarily (or permanently) ceased production, no trade with foreign countries; inflation was 28 percent on the first part of the year, Lek depreciated by 40% to USD$. In July was formed a transition government formed by five-party coalition headed by Socialist Party leader Fatos Nano. With the help of international authorities IMF, World Bank, EU and a multinational force led by Italy the order was restored, the capital city and some other cities got stabilized.  By early September, the government had an agreement with the IMF mission on an economic program. Major elements included an increase in the VAT rate from 12 ½ to 20 percent, strict monetary control, long-overdue reforms in the banking sector. The program was successful; the Lek appreciated by 20 percent, inflation during second half of the year felt to 11 percent (28 on first part of year) and budget deficit was brought under control for the first time since 1995.

The effects on the economy in 1997 from Ponzi scheme collapse are difficult to calculate because the collapse widespread civil disorder but it's sure that that year influenced badly the economic and political progress of Albania. On the monetary side the rise of Ponzi schemes did not produce an increase in velocity and prices. Possibly the main effects were on asset distribution. A few people got richer; some of them much richer, many more got poorer but the effects on the real wealth loss of the economy was very limited because of the small size of the country. Despite from the negative effects, the Albanian experience does suggest though that the macroeconomic effects of even very large Ponzi schemes are likely to be limited.

...(download the rest of the essay above)

About this essay:

This essay was submitted to us by a student in order to help you with your studies.

If you use part of this page in your own work, you need to provide a citation, as follows:

Essay Sauce, . Available from:< > [Accessed 06.06.20].