What is a Ponzi scheme?
A Ponzi scheme is a type of fraud. Investors are encouraged to hand over their money being told they will get fabulous returns. The problem is, that there is actually no company making money to back up the claims.
Charles Ponzi
This scheme is named after Italian Charles Ponzi and a business venture he started in America round about 1920. As you can see from his photograph on the left, he ended up in jail. Ponzi arrived in the United States from Italy in 1903 when he was twenty one.
He worked in various jobs – none very interesting or exciting – and in 1919 realised that there was a way he could make money that could be very profitable. Indeed, it was also legal.
International postal reply coupons came to his attention. These were a way for businesses or individuals to mail letters or parcels internationally at low cost to other countries. Because Italy’s currency was in a poor way against the dollar, he figured that he could buy coupons in Italy and redeem them in the United States for several times the original cost.
So far, so good.
He told potential investors that they would receive a 50% return every ninety days. People loved it. In just a few months, people were beating a path to his door. He opened an office in Boston and potential investors flocked there in their thousands. Many would take him their entire savings. There was so much, he hardly had the time to deposit it in the bank.
In just a few months after launching the scheme he had taken in over $6 million.
But there was a problem
The international postal coupons came in tiny denominations. In order to go ahead with his scheme he would have to buy and redeem HUGE quantities of coupons. Typically, the coupons were worth tiny sums – about five cents – so you can imagine the enormous quantities he would need.
So he didn’t. This is where the plan failed. It was much simpler to pay off his early investors with the money that kept flowing in from later ones. Unfortunately, he didn’t have the foresight to see that this couldn’t go on indefinitely. Unaware, he branched out and opened more offices. He was planning to buy a chain of movie theatres, a ship … and of course, his bankers loved him.
But of course, people started talking about him … and asking questions. A newspaperman asked the post office how they were coping with the huge (but imaginary) influx of international coupons. He discovered that there was no influx – Ponzi had only cashed in coupons to the value of $30. He had simply been making payments to investors using other investors’ money. His scheme lasted only eight months.
Unsurprisingly, Ponzi was tried, convicted and jailed. After three and a half years in jail he was released but had to face additional charges. It also comes as no surprise to know that he jumped bail and fled to Florida where the land boom was (temporarily) making ordinary people into millionaires.
He tried to set up a real estate company. This time, he was selling genuine land – the trouble was that he didn’t tell investors that it was mostly underwater swamp land.
Soon he was back in jail. It turned out that he never became a legal citizen or resident in the USA and he was deported.
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