“Mundus vult decipi – ergo decapitur: The world wants to be
deceived, let it therefore be deceived.”
–Charles Kindleberger
It only seems fitting these days to discuss the origination of the
term “Ponzi scheme.” While not all would agree that current
market conditions warrant using such a harsh term, your author
thinks certain segments, particularly in the IPO area where
insiders are selling their interests at record rates, are worthy of
it. And market history is full of ponzi schemes, from the South Sea
Company bubble to John Bennett”s New Era Philanthropy scam.
Charles (Carlos) Ponzi is the man we can thank for the term. In
the Boston of September 1919, Ponzi was a 42-year-old ex-
vegetable dealer, forger, and smuggler, who decided he would
become a wealthy financier. Described as handsome and quick-
witted, he had only $150 in cash to his name and lacked any real
connections. But he had a scheme.
“Ponzi finance” is defined by one expert “as a type of financial
activity engaged in when interest charges of a business unit
exceed cash flows from operations.” Another explanation is
when “a borrower who has some control over the price in the
market in which he issues his own personal debt will want to
play the ”ponzi game of financing,” that is, the repayment of debt
with the issuance of new debt.” [Source: Charles Kindleberger]
In Charles Ponzi”s case it was sort of like a chain letter in which
he would borrow money without collateral, promising to pay $15
for every $10 left with him for 90 days.
What Ponzi told his would be lenders (mostly Italian immigrants)
was that he would be buying International Postal Union reply
coupons overseas, and then send them elsewhere to be redeemed.
As Sobel writes in his book, “The Great Bull Market: Wall Street
in the 1920s,” “In this way, (Ponzi) could take advantage of
differences in currency quotations to make profits.” At least
that”s what he told his investors.
Ponzi was to purchase lire, francs, and drachmas at low market
prices and sell them at higher official prices (in theory). He
started a firm, The Old Colony Foreign Exchange Company,
where he took in the money and paid principal and interest
without fuss or bother. The newspapers in Boston picked up the
story and soon Ponzi was not only famous, but he was also
taking in about $1 million a week. He had grand expansion plans
and he talked of establishing a string of banks and brokerage
houses. Soon he was purchasing a controlling interest in the
Hanover Trust Co., and made himself its president.
Sobel writes of these times that wherever Ponzi went, crowds
followed. “You”re the greatest Italian of them all!” Ponzi
protested, “No, no. Columbus and Marconi. Columbus
discovered America. Marconi discovered the wireless.”
“Yes,” came the response, “but you discovered money.”
The Boston district attorney began an investigation. Edward
Dunn of the Boston Post also began an inquiry. Dunn discovered
that less than $75,000 worth of reply coupons were printed in
most years, and in 1919 there were only $58,560 worth issued.
Ponzi said he took in millions and invested them in the coupons.
Clearly, Dunn reasoned, money had been used for other
purposes.
Dunn was to find out during his investigation that Ponzi – using
the name Charles Bianchi – had been involved in a remittance
racket in Montreal back in 1907. Confronted with the evidence,
Ponzi denied all. The story was printed and Charles had to act
fast to avoid a panic. He countered by promising to pay his
investors 50 percent interest on money left with him for 45 days,
rather than the initial 90 days previously required.
But Ponzi”s operations were closed down on July 26, pending the
district attorney”s investigation. Charles proclaimed his
innocence and lenders besieged his office. Somehow he
managed to pay them all off, though, without a single default.
Forced to go public more than he desired, he warned investors
not to dispose of their holdings and told them they had nothing to
fear. He also asserted at this point that he was worth at least $12
million. For a time, confidence returned and money began to
flow back in.
On August 2 the Boston Post had claimed that Ponzi was
insolvent, but even this did not prevent the positive flows.
Finally, the end came on August 11 when all of his companies
and offices were closed, never to reopen. Sobel writes.
“In the days that followed it was learned that the dapper financier
had purchased a few reply coupons, but used most of the money
he received to pay those who presented 90-day notes. In effect,
he was taking in money with one hand and paying out more with
the other. Such a scheme could not last for long, unless
increasing amounts continued to arrive. Ponzi was bound to
collapse when the money ran out.”
On August 16, Boston and the nation learned the Old Colony
Foreign Exchange Company had no assets and liabilities of
$2,121,895. The search for Ponzi”s money extended into
October and little was ever found. Ponzi himself was declared
insolvent on October 15. The presiding judge, James Olmstead,
commented.
“While Mr. Ponzi is not to be classed in the same category with
robbers and burglars, he was undoubtedly a clever manipulator
who took advantage of the credulity of the investing public,
which in this instance is the usurer. The investors who loaned
their money for a return of the principal and 50% interest would
seem themselves guilty of usury if such existed.”
It was finally resolved that Charles Ponzi had taken in some $15
million in 8 months, and that his books showed a deficit of $5
million; less than $200,000 was eventually recovered from his
holdings.
While out on bail pending appeal, Ponzi decided he had to scam
some other innocent fools so he sold underwater lots in Florida to
the unsuspecting, thereby making another small fortune. [Ponzi
was one of many crooked real estate agents selling useless land
in Florida”s mosquito-ridden interior during the 1920s.]
Nonetheless, his appeal denied, Ponzi went to prison until 1934.
Upon his release he was deported to Italy where he immediately
joined the fascists and gained positions in the government.
Later, he was sent to Rio de Janeiro by his employer, LATI
Airlines, where he became a fixture in the social set. He died of
natural causes in 1949.
*In doing the research for this piece, I came across a quote from
Robert Sobel, the applicability of which to today”s environment
is scary. While Ponzi was well known, there were countless
other schemes which didn”t catch the nation”s attention. But this
was 1920 and Sobel writes of what followed:
“Wall Street happenings would be followed assiduously by
millions who in 1920 cared little about the stock markets. Many
who had never before purchased securities would ”take a flyer”
on one stock or another. The Ponzi scheme affected less than
50,000 unsophisticated people. Millions were involved – some
directly but most indirectly – in the stock market by the end of
the decade. Among their number were highly shrewd,
knowledgeable speculators who brought years of experience to
the market. At first it seemed as though the market rise was a
once-in-a-lifetime chance to make money with little or no risk.
But as stock market prices continued to rise, many began to
believe that the rise would be permanent, that the growth curve
would be unending. In prospect, this conclusion was reasonable,
for the nation was engaged in a great expansion, profits were
rising, and conditions seemed sound. In retrospect, we can see
the flaws in the argument, the contradictions in the economy
which eventually were reflected on Wall Street. The cult of the
stock market was, in the end, the greatest fantasy in an age filled
with illusion.”
Sources: “The Great Bull Market: Wall Street in the 1920s,”
Robert Sobel
“Manias, Panics, and Crashes,” Charles Kindleberger
“Wall Street: A History,” Charles Geisst
Brian Trumbore
