International Law

Pigeon King and Testimonials

Over the last two days, we have discussed Arlan Galbraith's Pigeon King scheme, amid the allegations from the Iowa Attorney General that Arlan is running a Ponzi scheme.

We have talked about two of the essential elements in a Ponzi scheme: return of capital masquerading as income and magical thinking.

First, it is very difficult for the ordinary person looking only at the returns to discover whether a scheme is essentially a Ponzi device, the return of capital masquerading as a return on investment. I can take $100 from you, and promise you a 2% monthly return and "achieve" this by simply returning $2 of your $100 to you for 50 months. After the first year, you would be convinced I was a financial re-invest your "winnings".

Only by accessing Arlan's bank account could one determine in advance whether PKI is a Ponzi scheme. Therefore, you have to focus on the reality of the end market.

Arlan, according to the CBC report on PKI, he faces two problems. First, the pigeons have no pedigree as racers and so cannot be used for breeding purposes. Second, even Arlan admits that there is no current market for the pigeons as squabs. (In January 2008, Arlan started the registration process with respect to trademarking the name and design "Hinterland Squabs")

The second element necessary for a Ponzi scheme is a suitable crowd for your pitch. It was not accident that Charles Ponzi sold his securities to working class Italians in Boston.

What is Arlan's pitch? "I believe we can save the family farm with pigeons." This is a very attractive pitch to farmers who face a Hobson's dilemma: there doesn't seem any good way to make money, so why not take a chance on Arlan's scheme? The crowd must be disposed on this occasion to magical thinking.

Today, I want to discuss the third element necessary for a Ponzi - the use of both paid and unpaid testimonials or shills.

How can a con work if so many bad things are said about it public? (This is the challenge all fraud reporting sites face.)

The answer lies in Leon Festinger's concept of cognitive dissonance. Roughly, we can expect social proof -usually in the form of cheering, emotional testimonial revivals to overwhelm an individual's gut feeling of wrongness, when:

1. The individual has committed irrevocable actions consistent with his/her belief in the pyramid scheme. The more irrevocable, the deeper the commitment.

2. The individual perceives and is aware of real world events which disconfirm his/her belief. This induces uncertainty in the individual.

3. The individuals in the scheme deal with the dissonance produced by real world events by trying to rally more people to their side, since as Cialdini put it, "The principle of social proof says: The greater the number of people who find any idea correct, the more the idea will be correct." If the facts on the ground cannot be ignored, then look to facts in the air.

Now you can see how the three elements, when combined together, have what Charlie Munger calls a lollapalooza result. A farmer who is first skeptical of Arlan's scheme, invests a little bit of money to "try it out." Unable to distinguish between a partial return of capital and real income, the farmer enthusiastically embraces Arlan's salvation. He or she is already primed to accept magical thinking. Finally, amid the cheerleaders but real uncertainty, the farmer clings desperately to Arlan's pigeon breeding scheme.

Tomorrow, we will talk about how it ends: in fire or ice. And on Friday, we talk about potential remedies or what you can do about it.

Related posts: What is New in Family Farming? and Why Being a Sucker Feels So Right.

Full post as published by Misleading Advertising Law on April 16, 2008 (boomark / email).