2 – The Ponzi Scheme
Charles Ponzi earned his reputation as one of the greatest swindlers of all time. He was born in Italy in 1882 but moved to the United States in 1903. When he arrived in Boston, Ponzi had $2.51 in his pocket and spoke little or no English. Over the next few years, he became fluent in the language and worked as a dishwasher in a restaurant and slept on the floor. He eventually became a waiter at the eatery but was fired for theft and short-changing customers.
Ponzi moved to Montreal in 1907 and landed a job as an assistant teller at the Banco Zarossi. It was here where he first saw what would later become the Ponzi Scheme in action. The bank offered 6% interest on deposits which was double the normal rate. However, it was in serious trouble because of bad real estate loans and the founder of the bank funded the interest payments with customer deposits. Eventually, the bank fell, and Zarossi fled to Mexico with millions of dollars.
Ponzi was sentenced to three years in prison for forging a check followed by another spell in jail for smuggling illegal Italian immigrants across the border. In prison, he befriended con artist Charles W. Morse, a man who became a role model for the Italian. After several years where he tried and failed to make a success of legitimate businesses, Ponzi returned to his criminal roots with the scam that made him famous.
In 1919, he found a weakness in what was known as an International Reply Coupon (IRC). IRCs were designed to allow a person in one country to send it to someone in another country who would use the coupon to pay for the postage of a reply. Although IRCs were priced at the cost of postage in the country where it was purchased, you could exchange them for postage stamps in the country where it was redeemed. Profit was possible when there was a difference in these two prices.
Due to post-WWI inflation, the cost of postage in Italy in U.S. Dollars reduced drastically so Ponzi purchased cheap IRCs in Italy and exchanged them for stamps in the United States which were of a much higher value. Ponzi made a 400% profit and set up a stock company to raise money from the public to expand his scheme. He promised to double your investment in three months, and initially, investors benefitted from large profits.
In January 1920, he founded a legitimate firm called the Securities Exchange Company, and within five months, approximately $2.5 million had been invested. By the end of July 1920, Ponzi was making almost $250,000 a day! A lot of people reinvested instead of taking their money; this was a huge mistake as although the scheme was raking in tens of millions, basic financial analysis would have shown it was losing a lot of money. As long as cash came rolling in, Ponzi could pay investors with this new money, but just like the Zarossi scam, the Ponzi scheme was destined to crash.
The big issue was that Ponzi couldn’t change the IRC coupons into cash. He lived a luxurious life and attracted unwanted attention. A financial journalist named Clarence Barron pointed out that there would need to be 160 million IRCs in circulation to cover the investments made with Ponzi’s company. This news caused widespread panic, and while Ponzi bought some time by paying out $2 million, the Boston Post printed a story about his activities in Montreal, and the entire scheme collapsed bringing down six banks and wiping out his investors.
He only served a few years in prison but spent more time behind bars for perpetrating another fraud. Ponzi jumped from scheme to scheme without ever hitting the big time again, and he died in Brazil in 1949.