CINCINNATI BUSINESS COURIER
October 24-30, 1988

Investments
By Charles D. Vaughan

Ponzi’s Story and Why His Scheme Still Works

TRUE CLASSICS  the Pierce-Arrow, Duesenberg, Cord, Packard and Locomobile. These five vintage autos are currently being featured on a set of 25 cent stamps by the Postal Service.

In his heyday the infamous Charles Ponzi was seen motoring around Boston in his cream colored Locomobile, one classic deserves another. Few people would now recognize the name of the car, but his name attached to the word “scheme” will live in infamy. Virtually nobody could tell you when Ponzi was active or what exactly was his famous scheme. I thought perhaps having a little knowledge of the original masterwork might be helpful in recognizing present and future copies.

Our anti-hero was born in Italy with the name Bianchi, emigrated to Canada and was first convicted of fraud there in 1907. Finding Canadian hospitality lacking, he moved to Boston and adopted his now famous name. Having mild success with a series of minor scams perpetrated on the immigrant population, he accidentally hit upon the motherlode. In a letter from a friend in Spain was an International Postal Reply Coupon, which I’ll call an IPRC for short.

He noticed that the coupon could be redeemed in stamps in the United States for six times what his friend had paid in pesetas in Spain. BINGO! The idea light went on in Ponzi’s mind.

The IPRCs were redeemable in stamps at exchange rates that were fixed by the governments of participating countries. Ponzi could see the possibilities of buying bales and bales of IPRCs in a country with a completely collapsed currency then taking them to a strong currency country to redeem them for stamps which would then be wholesaled. This could be done over and over indefinitely for huge profits.

He formed The Securities and Exchange Company in 1919 and began raising money among his fellow immigrants in Boston by promising to pay 40 percent interest for 90 day deposits. This was considered not too shabby compared with the 5 percent prevailing rate on bank deposits. In February of 1920, he raised his rates to 50 percent for 45 days and 100 percent for 90 days and he and his six clerks could not handle the deluge of cash that came in so fast they had to stack it to the ceiling in his office. He had no trouble paying off early investors with money received from newcomers. Naturally, as investors were paid off they promptly reinvested in the same profitable venture.

Ponzi made an opulent show in his Locomobile and bought interests in banks, steamships, movie houses and importexport businesses. He was philanthropist and role model for other immigrants until July when the Boston Post pointed out that there were not enough IPRCs sold in the whole world to support Ponzi’s enterprise. The ensuing, run was briefly stemmed when Ponzi sued the Post and declared another $100 million offering. But the coup de grace came when the Post ran Ponzi’s Canadian mug shot. He went back to prison and ultimately died in poverty and disgrace. Subsequent investigations showed that his International Postal Reply Coupon purchases totaled a whopping $30.

The Ponzi Scheme works over and over for several reasons. First, the scheme, whether it is rock concert tickets or construction loans, sounds feasible. Second, certain people are naturally greedy and want it to be true that they can make an instant fortune. Third, when early investors do get large payoffs, the word-of-mouth advertising causes the bandwagon psychology to set in. Finally, people are reluctant to challenge the enterprise because we all want to believe that “nothing succeeds like success.”

Con men rely on associating themselves with legitimacy. That is why many recent crooks have been found under the label “financial planners.” To date there are no absolute requirements for using this generic term. The Securities and Exchange Commission states that those using it to give investment advice must register, but enforcement is impossible. States are slowly getting into the act.

Ponzi Schemes rely on a steady flow of new investors to pay off old investors. Seldom can they stand up to close scrutiny. The first line of defense is to ask for a full disclosure of these facts and any conflicts of interest the principals may have. Legitimate operators treat these requests as routine: con men get offended.

The best defense may be to ask yourself this classic question, “If there is any loose money lying on the ground, why would somebody pick it up and put it in my pocket?”