106
even stored in his wastebaskets.
Convinced of his genius, investors
mortgaged their homes and
invested their life savings with
Ponzi. Most did not take their
profits when offered, but instead
reinvested, trusting him to increase
their wealth even further. In
February 1920, Ponzi was
promising customers a 50 per cent
profit a mere 45 days after their
investment. Soon, that number was
raised to 100 per cent, sparking
even more investment.
Ponzi deposited the money in
Boston’s Hanover Trust Bank – in
which he also bought a controlling
stake. With the ever-increasing
influx of cash, Ponzi revelled in his
new life of luxury: he bought a
mansion with a heated pool in
Lexington, smoked cigars from
diamond holders, and bought
dozens of gold-handled canes for
parading around town.
CHARLES PONZI
Questions raised
While Ponzi was making money,
his operation was running at a
tremendous loss, using money
collected from new investors to pay
the promised returns to earlier
investors. This type of scheme,
which “borrows from Peter to pay
Paul”, eventually came to be named
after Charles Ponzi himself.
By the middle of 1920, Ponzi was
making about $250,000 (£1.9 million)
a day, but local newspapers began
to investigate when a furniture
dealer publicly claimed that Ponzi’s
cheques had bounced. The Boston
Post responded with a series of
articles asking hard questions about
Ponzi’s money machine, noting that
he himself was not investing with
his own company.
Around the same time, the
Commonwealth of Massachusetts
got involved. Although Ponzi was
questioned by state officials, he
steered them away from inspecting
his books – his helpful offer to
refuse new investments during
their investigation calmed their
suspicions. When the US Attorney
for Massachusetts did look at the
books, he just found a box of index
cards bearing investors’ names.
In July came another blow: the
US Post Office confirmed that Ponzi
could not be making the returns he
had claimed on the international
postal coupons – there were not
enough of them in circulation. The
Post reported this, too, and Ponzi
filed a suit against the newspaper,
before spinning a yarn about
purchasing coupons in Italy and
selling and reselling throughout
Europe. He convinced nobody.
On 2 August 1920, newspapers
declared Ponzi to be insolvent.
As investors pulled out, Ponzi
struggled to find the money to
pay them what they were owed.
A pyramid scheme promises high returns to
investors, who are paid back through the
investments of later investors. As with all
pyramid schemes, Charles Ponzi’s was
mathematically unsustainable because each
round needs to involve at least double the
number of investors as the previous round.
Four friends of
the first round
investors
The schemer
In the first round, the
schemer takes a $1,000
investment from two
investors, promising to
double their money.
In the second round, the schemer
finds four more investors and gets them
to invest $1,000 each. With this $4,000,
he pays back the first round investors.
In the third round, he needs $8,000 to
pay the second round investors, and finds
eight investors to invest $1,000 each. The
first round investors are pleased with the
results, reinvest, and tell their friends.
The scheme grows and the schemer is
able to make payments to himself.
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107
A large crowd gathers outside
Charles Ponzi’s Boston office in July
1920 after The Boston Post published
a number of articles questioning his
business practices.
WHITE COLLAR CRIMES
By 9 August, his main bank
account was overdrawn and the
district attorney froze it. Knowing
his arrest was imminent, Ponzi
surrendered to federal authorities
on 12 August 1920. He was charged
with 86 counts of mail fraud.
Final years
Ponzi had lost around $20 million
(£150 million) of investors’ money.
While some were paid, Ponzi was
short by $7 million (£53 million). His
arrest brought down six large state
banks, including the Hanover Trust.
Many investors were financially
crippled, receiving under 30 cents
for each dollar they were owed.
The impulsive Ponzi used his
bail release to flee to Florida, where
he launched the “Charpon Land
Syndicate,” another Ponzi scheme
selling swampland to investors
with the promise of substantial
returns on their money. Ponzi was
arrested for fraud and sentenced
to one year in prison, but he was
freed on appeal.
In New Orleans, he was caught
trying to flee to Italy by boat –
despite shaving his head and
growing a moustache to disguise
himself – and was sent back to
finish his original jail sentence in
Boston. Deported to Italy in 1934,
he tried a few more unsuccessful
schemes in Italy before moving to
Brazil, where he died, in 1948. ■
How Ponzi schemes
impact the economy
Ponzi schemes inflict severe
financial damage on investors
and the economy by diverting
money away from productive
and legitimate investments.
The bigger the scam, the more
damage it causes, particularly
once large banks become
involved. When the scheme
is revealed, investors can
lose confidence in those
institutions and are reluctant
to invest in them again.
Discovering and closing
down Ponzi schemes can be
difficult. Often, neither the
perpetrators nor the schemes
themselves are regulated. And
even in regulated institutions,
Ponzi schemes may use
technical language to hide
their true nature.
Ponzi schemes that violate
a number of financial laws
may be investigated
separately by more than one
regulator, which makes it hard
for the bigger picture to
emerge. The financial
significance of the institutions
that have invested in the
scheme can also make
regulators reluctant to
investigate, believing that the
institutions are too big to fail.
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