Albania's Pyramid Schemes Case Study Example | Topics and Well Written Essays - 2250 words

Albania's Pyramid Schemes - Case Study Example The private sector contributed about two third of the GDP, and the rising remittances from the Albanians working Greece and Italy increase the disposable incomes. The improved economic environment increased consumer imports, and investments in the emerging pyramid schemes. Lack of proper financial institution and securities markets encouraged the Albanians to look for alternative investment opportunities such as the pyramid schemes. This paper examines the effects of the pyramid scheme on the local economy. 2. Background As suggested by Dirk pyramid schemes operate on a simple principle whereby, money paid by the later investors is used pay artificially high returns to earlier investors (78). At first, early investors are promised high returns to woo potential investors. As the word spreads, many people are pulled into the scheme to benefit from the huge capital gains. As Jarvis observes during the early phases, the whole process seems to work, but with time the interest and principa l owed to the old investors exceed the money that the scheme has (5). As a result, investors are forced to cut short the payments and investors start panicking. Some of the players that were involved in the pyramid scheme include VEFA which was formed in 1992 by Vehbi Alimuca, and took in at least $700 million in deposits. The institution started as a trading company and is accused of promising customers unsupportable rates. The second major player is Xhafferi which was formed by Rrapush Xhafferi and at the time of its collapse it had taken $250 in deposits. Another key player in the pyramid scheme was Gjallica which was formed in 1991 and took in an estimated $850 million in deposits. Sude on the other hand, offered lottery services but thereafter started taking deposits from the customers. At the time of its collapse, the company had $90 million in liabilities and no assets. Just like Sude, Populli offered to pay its customers two times principal invested after 3 months. The compa ny worked closely with the Albanian opposition parties, and at the time of its collapse its liabilities were over $150 million. 3. Events leading to the crisis As Chris Jarvis, an IMF economist observes in the article titled, the rise and the fall of pyramid schemes Albania, the origin of the pyramid schemes can be traced to the decline of the smuggling market. According to Jarvis the smuggling of oil products through Albania ended with the suspension of the UN sanctions against Yugoslavia (10). As a result, the pyramid period schemes were forced to look for alternatives sources of income. One of the viable ways at the time was to increase the interests so as to attract capital from potential investors. Within a short time the deposit-taking market grew tremendously, and by the mid-1996, the deposit-taking companies were offering interest rates as high as 19%. In the first few months, the companies had attracted two million depositors, and the number continued to grow in the second half of 1996. The players in the informal sector competed by offering attractive rates and just to illustrate, in the September 1996 Populli offered a monthly interest are of 30% which Xhafferi countered with a 44% rate while Sude offered to double the principal in two months. To capitalize on these opportunities some of the investors sold their property while other sold their animals, and then put the proceeds in the pyramid schemes. Worried about the integrity of the schemes, the Governor of Bank of Albania issued the first warning, and then followed by the Minister of Finance. The government formed a committee to investigate the schemes but