Leaning Tower of Ponzi

Here’s a nice little history of Charles Ponzi and the original Ponzi scheme. This was plucked from an excellent post on thetrumpet.com. The very nature of our financial system is a Ponzi scheme.

In 1903, a destitute Charles Ponzi stumbled upon a way to make some quick cash by taking advantage of the postal system. When the postal service sent letters overseas, it was common for senders to include an international reply coupon. This coupon could be exchanged for postage back to the country from which the letter was sent. Charles found out that due to exchange rates, you could purchase postal reply coupons cheaply in some foreign countries, then send them back to the United States to swap them out for American stamps of higher value. Then you could sell the stamps.

For a while, Charles made a good living gaming the system at taxpayer expense. Because of the laws at the time, it was perfectly legal.

Then, Charles decided to recruit investors into his scheme with the promise of 50 percent returns. Investors would give him their cash, and sure enough, Ponzi would deliver on his promise.

Charles even signed up recruiters who brought in clients from around the country interested in taking advantage of his fool-proof investment strategy. People sent him millions—huge sums in those days. For him to receive more than $250,000 a day was not unusual.

But things went bad. Instead of working his “system” to make money for his investors, Charles instead began paying out the returns for old investors with the new money that kept coming in from new investors—as opposed to doing so with profits. This was the Ponzi scheme.

For a while, Charles kept up the appearance of a successful entrepreneur. If anyone became suspicious or uncomfortable with his investment, Ponzi immediately gave him his money back—thus keeping his reputation intact. At first, paying out money was not a problem. Eager new investors were sending him tons of it. As long as there was an ever-increasing supply of new suckers, new money could be used to pay profits to older investors. Anything left over went toward fancy clothes, gold-handled canes, and living the high life.

Problems arose when a newspaper reporter did the math. Charles Ponzi had to be moving more than 160 million postage tickets a year to pay back all his investors. But since there were only around 27,000 postal reply coupons in existence globally, the reporter knew the truth. Ponzi was running a scam.

But here is perhaps the most astounding part of the whole swindle.

Even after Ponzi was mathematically proven to be a fraud—on the front page of the Boston Post—many intelligent people refused to believe it. They still thought of him as a legitimate businessman. The morning the story broke, investors still lined up around the block from his office to give him more money. Mr. Ponzi boasted that the day the story ran, he took in a million dollars from investors. Their faith was unshakable.

Mr. Ponzi’s charisma and rock-solid reputation, combined with the fact that he was making so many of his early investors rich, blinded people to the clear fact that his whole system was not only an unsustainable fraud, but it was also on the verge of collapse.

New investors who actually did the math began to shy away. Investigators began poking around Ponzi’s “business.” Ponzi’s already shaky bulwark buckled. Then the whole tower of fraud collapsed in a heap of zero balances. People lost millions. And Charles Ponzi went to jail, and down in history as the father of the Ponzi scheme.

The hallmark of the Ponzi scheme, just like all pyramid schemes—was that it was predicated on ever-increasing amounts of new investment dollars from subsequent investors to pay the 50 percent returns promised to investors. Actual profits just weren’t there. As a mathematical probability it had to fail.

Unfortunately, 100 years later, investors are still seduced by this get-rich-quick scam.

One Bernard Madoff is just the most recent high-profile example of a con man who used his stellar reputation to steal billions. A Wall Street insider, Madoff founded and became chairman of the Nasdaq stock exchange. Victims recount Madoff’s ability to make people believe that he was doing them a favor by allowing them to be part of an exclusive investment community. The promise of apparently consistent market-beating returns did the rest. Madoff looked so good that he was able to dupe people—including multibillion-dollar professional investors and institutions—out of their money. He didn’t even advertise: People came to him.

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One Response to “Leaning Tower of Ponzi”

  1. Tom Humes said, on February 19th, 2009 at 8:10 am

    Nice Site layout for your blog. I am looking forward to reading more from you.

    Tom Humes

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