How the Ponzi Scheme got its name - a short version of Charles Ponzi's story.
Charles Ponzi Was A Real Person
In the field of investment or securities fraud, the phrase "Ponzi scheme" is often heard.
According to the short article "'Ponzi' Schemes" on the website of the United States Securities and Exchange Commission, Charles Ponzi raised over a million dollars in three hours in 1921. People thought he was selling them an investment that would give a 50 percent return in 90 days. It sounds too good to be true today, and it was too good to be true then.
By the time the court caught up with him, Ponzi admitted to taking $10 million from investors, many of whom were neither wealthy nor sophisticated. The actual amount could have been $15 million or more. He returned $8 million before his trial.
The Promotion Behind the Original Ponzi Scheme
Ponzi was a convicted criminal before he concocted his most famous scheme. Many would say he had no intention of ever making an effort to actually run the supposedly honest business that he was promoting. Writer Mark C. Knutson has taken a close look at the scheme and concluded it would be impossible to run it at any scale, and certainly not at the scale Ponzi proposed. Knutson's website, "The Remarkable Criminal Financial Career of Charles K. Ponzi" presents a very detailed recounting of the facts and an analysis of the Ponzi story and is recommended to anyone interested in learning more about Charles Ponzi.
What Charles Ponzi told investors was this. He could buy International Postal Reply Coupons cheaply abroad and then turn them into American postage stamps. Then he would sell the postage stamps and get lots more money than what they had cost him to buy. This was because of an apparent arbitrage opportunity arising from foreign exchange rates. An American dollar could buy more coupons in Bulgaria (for example) than in the U.S., because the value of the coupon was set in local currency, regardless of the prevailing exchange rate. However, no matter where the coupons were purchased, they could be exchanged in the U.S. for the same thing, a U.S. postage stamp.
What Mark C. Knutson points out is that Ponzi would have needed armies of wheelbarrow-pushers just to carry the tens of millions of coupons he pretended to have bought. Turning the coupons into cash would also have been problematic, but not for Ponzi. He may have begun with the intention of working the arbitrage as described, but those intentions seem to have quickly evaporated. No matter what Ponzi told investors, he did not use their money to buy coupons.
What is a Ponzi Scheme?
Charles Ponzi's modus operandi was not new, but now bears his name as some kind of tribute to the vast scale with which he performed it.
Very simply, a Ponzi scheme is one where the promoter "robs Peter to pay Paul". The actual venture, whether it's postal coupons, real estate, racehorses, or anything else, does not make enough money to pay back the investors and give them the big profits they are expecting. The promoter, desperate to keep the scheme going, uses the money from new investors to pay the old ones. The most successful schemes go on for a long time by keeping investors just happy enough not to complain, and to never ask for their money back. When the investment comes due, a Ponzi scheme promoter will try very hard to get the investor to reinvest their money.
Even if the promoter of a Ponzi scheme doesn't keep any money for himself (and that would be unheard of), the scheme will collapse as soon as the payments going out exceed the money coming in. Since the whole point of the Ponzi scheme is to make money for the promoter, typically a large portion is spent or hidden early on. Charles Ponzi lived a lavish life for a little while, enjoying the fruits of his criminal ingenuity.
People were more than eager to give him their money.
A Ponzi Scheme is Not an Investment
Arguably, a payment to someone running a Ponzi scheme is not an investment at all. It's a gift. The money will not be paid back, and the promoter will disappear like Santa Claus on Boxing Day.
Charles Ponzi's End
Ponzi himself was found out by the investigative journalism of the Boston Post, and the whole scheme quickly tumbled down. The Boston Post won the 1921 Pulitzer Prize for Journalism: Public Service, "For its exposure of the operations of Charles Ponzi by a series of articles which finally led to his arrest." (From the "1921 Winners" page, on The Pulitzer Prizes website)
Ponzi was convicted of mail fraud, sentenced to jail for five years, and eventually deported from the United States. He died alone and apparently poor in Brazil in 1949. His name lives on infamously.
Notes
This article was edited on June 25, 2009, in response to a reader's comment that the sources should have been cited better. The website of Mark C. Knutson (link in the body of the article, above) is particularly informative. To verify some of the biographical information, the author referred to genealogical records using the facilities of Ancestry.com.
The copyright of the article The Original Ponzi Scheme in Crime is owned by Jill Browne. Permission to republish The Original Ponzi Scheme in print or online must be granted by the author in writing.
So, based on the definition of the scheme, the greatest Ponzi Scheme ever
is Social Security. They take from us today, claiming it to be an
investment in our future, and pay the amounts promised to our parents with
it. But as it always happens the jig is about to be up!!
Jun 24, 2009 8:54 AM
Guest :
I, like the other poster thought the same thing. Social Security is the
biggest Ponzi scheme going today? The government takes the money from the
young working people and pays the older retired workers. But now there is
more money going out than there is coming in. Ontop of that the government
took a big slice for theirselves off the top and keep taking off the top.
A modern day Ponzi scheme being purpatrated by the government
on the American people. The worst part to the governments ponzi scheme is
that they made it a law we have to pay into their scheme even though we
know it will collapse. I will admit that sometimes I get confused when it
comes to social security. I'm not sure if it's a ponzi scheme of the
governments slush fund. I would have to say both!
Jun 24, 2009 10:34 AM
Guest :
Social Security is a ponzi, unlike an annuity, which actually does
something over time with what you trickle in.
Jun 24, 2009 11:31 AM
Guest :
Soc Sec isn't a Ponzi scheme. The amount collected has always been vastly
more than necessary to meet all future commitments. A Ponzi scheme does NOT
raise enough revenues to meet future commitments. Soc Sec does collect
enough to meet future payments.
The problem with SS is not the
amount collected, nor is it false promises. The problem of SS has always
been that the money collected is pooled into the general budget fund where
it is used for whatever...military spending, bridges to nowhere, road
projects, health benefits, the annoying commercials that kept us informed
of the pending switch the digital TV, important studies that tell us if you
eat too many Big Macs you'll get fat. Congress spends the money and then
gives the taxpayers an IOU. It's the IOU's that are worthless, not the
general concept of SS. The IOU's are worthless because the government
continues (and we allow it) to spend more money than it brings in.
It will never happen because no politician is willing to take SS revenues
out of the general budget. But in theory it is ridiculously easy to solve
the "problem" of social security...SAVE the money! If the
government kept SS dollars out of the general budget pool, those dollars at
even a minimal interest rate growth would be far more than adequate to
assure continued payments.
That will never happen though because
if SS collections were taken out of the general budget, those revenues
would either have to be made up through new taxation, or heaven forbid,
congress would actually have to make radical spending cuts. We the people
don't want any further taxation, they (the idiots WE continue to elect)
don't have the courage to cut the programs that we already have.
And truthfully folks, the bottom lines is that "the government"
isn't a "them" Somehow standing against we the people. We elect
"the government." And we continue to elect spineless politicians
who won't force us to face the economic realities of spending gone wild.
For the record, I'm neither a Reagan Conservative, nor an LBJ liberal. The
current situation is not a Democrats vs. Republicans issue. They are both
equally guilty of overspending. They just overspend on different pet
projects. In the long term,unless some major shift in voter attitudes
occurs, America is going to suffer no matter which of the current parties
holds the majority.
Jun 24, 2009 11:38 AM
Guest :
There is one greater Ponzi Schemer now siting in the White House. Currently
the government is robbing from Peter to pay Paul, and the whole house of
cards will fall on the latter day baby boomers and their children. It is a
fact proven time and time again throughout history that you can't spend
your way out or debt. Someone has to eventually pay, and in this case it
will be in inflationary terms that could very likely bring down the form of
government that our forefathers have fought and died for.
Jun 24, 2009 3:21 PM
Guest :
social security isn't a ponzi scheme.....this contributer is right on!
Kudos to you.
Jun 24, 2009 4:03 PM
Guest :
Believe it or not, Ponzi was not the first to do this. I think there is a
Charles Dickens story that had a concept like this going on.
Jun 24, 2009 8:30 PM
Guest :
Many comments here about SS. The info about the general budget is
absolutely correct. Another HUGE point, when SS was voted in, what was the
male mortality age? NOT 65 but 62. Now it's somewhere around 72, about 18%
increase. SO the same fund that was meant to pay out from age 65 to NOTHING
(due to the mortality age) is expected to pay our longer life expectencies.
Until relatively recently ( 20 years or so ) SS was awash in funds. The
problem has many facets; being raped by every pork lover in Washington (and
small town America), Life expectancy dramatic increases combined with fewer
and fewer payees for every payor, everyone wanting more social services
combined with fewer taxes. WAKE UP! There is no free lunch. You think taxes
have been lowered but you don't pay attention to increased taxation on
gasoline, services, "luxury" items, sales taxes etc. You want
more tax deductions to lower your AGI, but where do your SS dollars get
paid from? You only get out what you put in. It's much easier to criticize
the White House than to look in the mirror and admit that we all have our
hands out. Remember, when you point your finger to focus blame, there are 3
finmgers pointing back at you.
Jun 25, 2009 3:44 PM
Guest :
1 There are no citations for your piece or the photo. When you fail to
provide citations that underscore your points, the "facts" seem
to be taken from thin air. I'm sure that's not your intent, so please use
citations, references, foot-notes - whatever is appropriate for each
point.
2 Social Security has been bungled over many
administrations, but it's not a Ponzi scheme.
Jun 27, 2009 11:41 AM
Guest :
Responding to a couple of things here...
I don't think SS has
ever really been "bungled" in the sense that it was changed
somehow and it got worse. SS was never a "savings" plan as such;
funds were always put into the general budget. But no one in 1936 foresaw
the huge deficit spending that came later. If it was bungled, it was
bungled in the beginning. They should have created a true trust fund for
this money assuring that it could not be spent for other purposes.
The life expectancy changes do have an impact, but in the beginning and
through the 1970s there was SO much money coming in that the program should
have been fine despite the rising life expectancy. But no program requiring
money in the future can be effective if all of the money (and then some) is
spent in the present!
The "no citations"
comment...seriously dude, get a life! The Ponzi story is well known. If for
some reason you NEEDED to verify the info on this particular web page, you
could accomplish that in about five seconds with 2 or 3 keystrokes to peer
reviewed historical journals.
Jun 29, 2009 3:15 PM
Guest :
Get bent guest 9. Why are there so many nitpicking people like you out
there?
