The Ponzi Scheme at 6:38 PM

This is a report I wrote yesterday for school about Charles Ponzi and his famous 1918 pyramid scheme and I thought y’all might like it. Enjoy!

 

The Idea

Named after Charles Ponzi's 1918 plan to sell International Reply Coupons on debt, Ponzi Schemes are basically a form of pyramid scheme, with the first investors being paid by the investment money from later investors. The so called Ponzi Scheme has been slightly altered or copied by many swindlers after the inventor's death in 1949. The most well known use of Ponzi's idea is that of the Social Security program put in place by the Franklin D Roosevelt administration in the 1930s. This system was supposed to help US citizens who did not have the means to support themselves; namely the elderly, the poor, widows, and fatherless children. This seemed like a good idea at the time because it was supposed to encourage the elderly to retire, creating openings for younger workers and then lowering unemployment as a whole. However, this did not work over a long period of time as soon the entire population had social security numbers and there were no longer any more “investors” to support the retirees.

 

The Original Ponzi

The idea for Charles Ponzi's first large scale scheme came to him when he received a letter from a company in Spain asking him about an advertising business that had failed just a few weeks before. Inside the envelope was an International Reply Coupon, which is basically to allow someone in one country to send a letter with an IRC to a correspondent in another country, who could use it to pay the postage of a reply. IRCs were priced at the cost of postage in the country of purchase, but could be exchanged for stamps to cover the cost of postage in the country where redeemed; if these values were different, there was a potential profit. In post-WWI Italy, the inflation was astronomical and IRCs could be purchased extremely cheaply then sold in America for a much higher price. This was merely a form of arbitrage; buying low an selling high, which is not illegal. Ponzi soon realized the potential of this idea, so he took out a loan and sent the money to relatives in Italy to purchase some of the coupons and send them back to him. However, when he went to sell the coupons, he ran into a mass of red tape. So to bypass this, he convinced investors in Boston to make an investment of $1,250 for a return of their money and an extra $750 within 90 days. He delivered as promised, and started the “Securities Exchange Company”. Huge profits rewarded him, and by January 1920, he brought in $5000 (approx. $54,000 in 2008 dollars). By march, that total was up to $30,000 ($328,000), then in June his numbers reached $420,000 ($4.59 million today), but the peak came in July when his total take was millions of dollars. People were mortgaging their homes to invest in this up and coming new company. By now, Ponzi was through with the stamps and just started taking in investments and giving out returns. This only worked because of the frenzy he had created; most people didn't take their profits, they just reinvested it... then told their friends to do so also.

 

First Suspicions

Naturally, his sudden wealth was not unscrutinized. A Boston financial writer did a little digging and wrote an article about Ponzi's scheme and how it could not possibly pay out full returns in such a short period of time. Ponzi sued for libel and won $500,000. It seemed at the time like Ponzi's golden empire would never crumble. But several popular papers sent investigative reporters to look into the Securities Exchange Company and the Commonwealth of Massachusetts was also threatening to investigate the company's books. Ponzi was able to slightly divert their suspicion temporarily and he started to look for a way out of the scheme. But time ran out, and Ponzi's publicity agent, William McMasters went to the Boston Post with several incriminating documents saying Ponzi was $2 million in debt, almost 4.5 with interest factored in.

 

The Scheme's Downfall

After McMaster's article was published, a massive crowd raided Ponzi's office and he had to pay out $15 million. He had taken in over $20 million, but he had lost over $2 million gambling, and the rest wasn't there just from the nature of the scheme and from Ponzi's luxurious living.

Charles Ponzi was arrested by federal agents on August 12, 1920. That same day, auditors stated that he was over $3 million in debt. His investors were devastated, receiving less than 30 cents on the dollar.

Charged with 86 counts of mail fraud, Ponzi was sentenced for 5 years in a federal prison, but was released after 3 and a half years. He then had to face 22 Massachusetts state charges of larceny and was sentenced to 9 years in a state prison as a common and notorious thief.

 

 

Resources, images, quotes, as well as a further reading list about the Ponzi Scheme and also the rest of Charles Ponzi's life available at http://en.wikipedia.org/wiki/Ponzi