Sept 26, 2008 (LBO) - Protests erupted against authorities in a sleepy Sri Lankan fishing village which can almost lay claim to be the Ponzi capital of the world, after a financier in the area was blacklisted as running an illegal business, police and residents said.

The Central Bank of Sri Lanka named Piyadasa Ratnayake, a financier in Hungama in Southern Sri Lanka popularly known by the alias Danduwam Mudalali or the 'punishment businessman.'

Residents say he had acquired the name in his school-going days when the naughty young Ratnayake was repeatedly punished by his teachers.

'Danduwam Mudalali' had originally started lending money to small fish retailers at high interest rates, charging daily interest rates to become prosperous.

Danduwam Benchmark

Later on, he had started getting money from others and re-lending, paying 7 percent a month 'interest' for his 'depositors'. By this time nobody knew where his money was being 'invested' to pay such a high return.

But people were coming from all parts of the island and giving him money to get 7 percent interest which is annualized at around 90 percent.

Along with Ratnayake, the Central Bank also named five other businesses as carrying on illegal finance businesses. One of them - ' Sakwithi House Constructions' - had already collapsed, leaving thousands penniless.

Such operations are known as Ponzi scams, named after Charles Ponzi, an Italian who lived in the US city of Boston in the early part of the last century.

Ponzi claimed to run a business arbitraging on the price differential of international postal reply coupons between the US and Italy.

But a typical Ponzi scam operates by paying off earlier depositors with the money coming from later ones, until the business collapses.

In Hunguma, on Friday, about 300 people had come to Danduwam Mudalali's house demanding their money back. Police said a mobile patrol was sent to the place and officers had observed the financier starting to re-pay depositors.

Residents say announcements were made by loudspeaker as each depositor was re-paid, in a bid to instill confidence.

When he ran out of cash, post-dated cheques were given, police said.

Residents say a group of people had then protested against the central bank saying they wanted to protect Danduwam Mudalali.

Danduwam Mudalali had, by this time, spawned several copycat 'financiers' who were attracted to the business by the apparently easy manner in which the 'financier' was getting 'deposits'.

A former associate of Danduwam Mudalali had set himself up as Dedi Danduwam meaning 'greater punishment.' He gave an interest rate of 100 basis points above the benchmark 'Danduwam' rate.

Dedi Danduwam alias 'Saman' was now locked up on a drugs charge, police said.

Residents say some law enforcement officers who deposited money with Danduwam Mudalali was also given the Dedi Danduwam rate of return.

In Sri Lanka authorities kept interest rates far below inflation for almost four years, printing money to finance budget deficits.

State banks in particular kept savings rates around 5.0 percent while inflation raged above 20 percent.

Negative real rates, or even low nominal rates amid low inflation, can make ordinary people easy prey to scammers.

Meanwhile, just off Hungama yet another person had set himself up as 'Maraneeya Danduwam or deadly punishment. The 'deadly' rate of return was 200 basis points above the Danduwam benchmark.

Yet another group had started collecting money paying a lower rate of return. They were known as Lihil Danduwam or light punishment firms. They offered rates about 300 or 400 basis points below the benchmark Danduwam rate.

The 'lihil' rate artists were reputed to be 'depositing' their money with the Danduwam and Dedi Danduwam operators after keeping a large profit.

They were acting in much the same way as the likes of Lehman Brothers, Merrill Lynch, Bear Stearns and Goldman Sachs, who happily parked high yield 'sub-prime' securities with each other to boost returns, as the Fed cut rates as low as one percent, while fiscal deficits widened.

'Agents' who brought money to the larger Danduwam operators were also paid a 100 basis point commission - much like an arranger's fee in Wall Street.

The musical chairs in global financial capitals, powered by unceasing money printing by the Fed in particular and reserve currency central banks in general, collapsed in August 2007.

In Hungama it is just starting. But there is no Ben Bernanke to create paper money out of thin air and bail them out.