In the wake of the Madoff and Stanford scams, “Ponzi Scheme” is a term that gets thrown around a lot.  A Ponzi Scheme is a fraud in which one set of investors is paid off with money collected from the next set of investors.  In other words, I take $10 from Amos on Monday.  I take $10 from Bob and Barb on Tuesday and use this money to pay interest to Amos.  I take $10 from Chris, Casey, and Clara and Wednesday and use this money to pay interest to Bob and Barb.  Everything works very nicely as long as each successive group of investors is larger than the next (or until the authorities figure out what is going on).  Ponzi schemes can expand more rapidly when investors reinvest their profits rather than collecting them in cash.

The Ponzi Scheme  is named after its most famous perpetrator, Charles Ponzi.  Today, I’ll tell you a bit about Charles Ponzi.  However, the accuracy of the information is questionable, mostly because Charles Ponzi deviated from the truth quite often, and it could be difficult to separate his lies from the truth.

Ponzi was born in Italy in 1882 and immigrated to the United States in 1903.  When the ship arrived in Boston, he had just $2.50 in his pocket.  You shouldn’t feel sorry for young Mr. Ponzi, though – the reason why he had so little money is because he had gambled away the rest of his savings during the journey across the ocean.

Ponzi worked odd jobs, eventually landing a job as a dishwasher in a restaurant.  Ponzi worked his way up to being a waiter, and things were beginning to look up for him.  Unfortunately, Ponzi was supplementing his income by short-changing the customers and stealing from the restaurant.  His employer was not pleased with this behavior, and Ponzi was jobless.

Ponzi moved to Canada and became an assistant bank teller at a bank in Montreal.  The smooth talking Ponzi worked himself up to bank manager.  Unfortunately, this job ended when the bank went belly up and the bank’s owner fled to Mexico with the remainder of the bank’s assets.

Ponzi was nothing if not resourceful, though.  He wrote himself a check from the checkbook of a former customer of the bank and quickly found himself behind bars.

After getting out of prison in 1911, Ponzi moved back to the United States, where he was soon arrested for his involvement in a plan to smuggle illegal Italian immigrants into the country.  (Hey, is anyone else noticing that Ponzi is building a rather lengthy rap sheet?)

Interestingly, Ponzi’s trademark criminal endeavor had its roots in one of the few legal ideas Ponzi ever had.

Ponzi became aware of an International Reply Coupon.  These don’t exist any more, but I’ll try to explain them.  Basically, if you were in the United States and wanted to send a letter to Italy, you might purchase an International Reply Coupon (IRC) to include with your letter.  Your Italian recipient would use the IRC as postage.  Essentially, this was courtesy similar to sending a self addressed stamped envelope today.

The aspect that interested Ponzi is that IRCs were purchased at the postage rate in the purchaser’s country, but could be used for postage in any country, even if the postage rate in that country was higher.  For example, let’s say that postage in Italy was 25 cents and postage in the US was 50 cents.  Someone in Italy could buy an IRC for 25 cents and include it in a letter to the US.  The US recipient could then use the IRC for postage, even though US postage was 50 cents.

Ponzi’s plan was to purchase IRC in countries where they were priced low and sell them in countries where they were priced high.  For example, purchase 1000 IRCs in Italy at 25 cents each ($250) and sell them in the US for 50 cents each ($500) – a tidy profit on your investment.  This is a concept called arbitrage and it is perfectly legal.  (For the Seinfeld fans among you, this may conjur memories of Kramer and Newman making a run to Michigan with a mail truck full of aluminum cans).

Ponzi had his relatives in Italy purchase IRCs.  Ponzi ran into difficulties attempting to redeem the coupons, and eventually stopped handling the coupons at all.  However, he told everyone that his company was indeed buying and selling the international reply coupons and making a sizeable profit – but the redemption method was a secret.  Ponzi would make you 50% profit in 45 days or 100% in 90 days.  The early investors reaped big profits and told their friends, those friends told others, and the scheme was off and running.  At its peak, the scheme was taking in $250,000 per day – in 1920 dollars!

Were some folks skeptical of Ponzi’s promises?  Yes, of course.  When a writer claimed that such returns could not possibly be achieved from legal activities, Ponzi sued him for libel – and won a $500,000 judgment! 

Eventually, all good things must come to an end.  The Boston Post hired Charles Barron (the man whose name adorns a financial magazine to this day) to investigate Ponzi.  Barron’s findings?  That 160 million IRC must be in circulation in order for Ponzi’s claims to be mathematically possible.  Unfortunately, only 27,000 actually were in circulation – and the US government indicated that there was no unusual activity with IRCs.  Clearly, Ponzi was not telling the truth.  The Post won a Pulitzer Prize for exposing Ponzi’s scheme.

When Ponzi’s scheme eventually imploded, he took down six banks.

Ponzi was sentenced to five years on federal charges of mail fraud (for sending information to investors through the mail) and served three and a half years.  He then faced state charges in Massachusetts for larceny.  The slick talking (and broke) Ponzi acted as his own attorney.  In his first trial, he won an acquittal on ten charges.  A subsequent trial resulted in a conviction on five other charges, and Ponzi was sentenced to serve between seven and nine years.

While on bail, Ponzi attempted to sell Florida swamp land to investors.  He jumped bail on that charge and attempted to flee to US by ship.  He was captured in New Orleans and was sent back to Massachusetts to serve out his prison term of seven years – interestingly, with no additional prison time for jumping bail.

After Ponzi was released in 1934, the US government had him deported to Italy as an undesirable alien – it turns out that Ponzi had never actually become a citizen.  Benito Mussolini gave Ponzi a job in the finance section of the government.  (Seriously, Mussolini – are you reading the papers?)  Ponzi eventually (gasp!) fled the country with money from the Italian treasury.

Ponzi died in poverty and poor health in Rio de Janeiro in 1949.

Wikipedia was a source for this article.