Origin of the Ponzi Scheme

The idea of a Ponzi scheme is simple; attract as many investors as possible to a bogus business opportunity that seems too good to be true and use the cash of new investors to pay out returns to earlier investors. Obviously, this type of scam cant never last forever because of the constant need to recruit new investors, which becomes difficult as returns to earlier investors begin to dwindle when new investors can no longer be found. As early investors begin emptying their accounts and cashing out, the Ponzi operator is left with huge debts and no way to pay them off, resulting in the full and usually devastating collapse of the entire Ponzi operation.

Before the 1920s, a Ponzi scheme was simply known as borrowing from Peter to pay Paul, but that soon changed when Charles Ponzi arrived in Boston in 1920. Charles Ponzi was described by many as the "miracle man of Boston's Hanover Street" for his amazing ability to provide 50% profits in 45 days to anybody who invested in his foreign reply coupon trading scam. At one point Mr. Ponzi was so popular with the citizens of New England, especially within the Italian-American communities, that he was hailed as a hero and sometimes even required the assistance of mounted police to control the crowds of cash hungry investors that would arrive at his offices ready to hand over their cash.

The money collected by Ponzi was used to buy low cost International Reply Coupons (IRC). An IRC is a coupon for the cost of postage that is sent to the recipient of mail in a foreign country. It is the equivalent of sending a self addressed stamped envelope to a mail recipient in the same country as the sender when the sender expects a reply. Due to the high costs that can be required to send mail internationally, sending an IRC to a correspondent is considered mostly a courtesy. The weakness in the system that allowed Ponzi to rip off unsuspecting investors was that IRCs purchased from foreign countries could be redeemed for stamps within the United States. When there was a price difference between foreign postage and U.S. postage, the difference could be converted into cash through the sale of the stamps received after redeeming the IRC. After World War I, inflation caused the cost of IRCs in many parts of the world to fall, which could then be purchased for little money and sold for huge profits, according to Ponzi. Unfortunately, the cost of actually shipping the low cost IRCs to the United States and the bureaucratic red tape that surrounds such an endeavor would have outweighed the benefits of running the operation legitimately, which led Ponzi to start a scam that would eventually become his namesake.

Ponzi initially recruited family members in Italy to send him low cost IRCs, which were used to show potential investors, who at first were mostly his friends, how easy the opportunity was. His first few investors actually received their money back with the promised interest, which only added legitimacy to the Ponzi system. Eventually, the popularity of Ponzi's system snowballed, and everybody wanted in. He became so inundated with requests to purchase foreign IRCs on behalf of unsuspecting investors that he had to hire a workforce of agents to handle the orders, which came in from all around the country. When it was revealed by the U.S. Post Office that there simply were not enough IRCs in circulation to justify the huge profits of Ponzi's system, investors, journalists, and investigators began to grow suspicious. Ponzi was eventually uncovered as a trickster and a fraud who never actually invested any significant percentage of money given to him by investors in foreign IRCs, and instead just shuffled money from the hands of one investor to another, always taking a bit off the top to fund his own lavish lifestyle. Many of Ponzi's investors were absolutely devastated by the demise of the IRC scam, especially those who had mortgaged their property and drained savings accounts just to invest in Ponzi.

Ponzi was charged with 86 counts of mail fraud but only pled guilty to a single count as part of a plea deal for a low jail term. After serving only three and a half years for his crimes, Ponzi was released back into society only to con again, this time by duping people with a land investment opportunity that was nowhere near as successful as his IRC scam. He was again jailed and eventually deported to Italy, leaving the country with a reported $2.50 to his name. He worked for a short time as a business manager for an Italian state run airline in Brazil but lost his job when Mussolini's government, which gave Ponzi the job, lost influence and crumbled after World War II.

He worked as a translator of less than modest income until his death in 1949 at the age of 66. The man who was once hailed as a financial genius by some and a hero by others died lonely, blind in one eye, and partially paralyzed in the ward of a charity hospital in Rio de Janeiro.

Sources:

The First Ponzi Scheme. The Washington Post. 2008.

Ponzi Payment. Time. 1931.

Take My Money. Time. 1949.