Question & Answer

Question: In one of your seminars you mentioned a "Ponzi" scheme. Can you tell us what that is?

Answer: "Ponzi" is to pyramid schemes what "Kleenex" is to tissues. It comes from the original perpetrator of an investment scheme by the name of Charles Ponzi.

He had a job in an import-export brokerage house. A correspondent sent him an Italian postal reply coupon. This coupon, purchased in Italy for one cent, could be exchanged in the U.S. for five cents. Ponzi figured if he could get an accomplice to buy postal coupons in Italy and send them to him, he could make a 500% profit, and get rich quickly.

He went home and explained the plan to his neighbors, some of whom gave him $50, with the understanding that in three months they would get $75 back. He was a very smooth talker, and a heck of a salesman. Unfortunately, about this time, he found out he couldn't obtain the Italian coupons, as only a certain number were issued each year-not nearly enough to finance the investment he had in mind. In the meantime, the three months was up for the original investors. Ponzi took the money he was currently collecting and paid off his original investors. But instead of giving them 25% interest, he gave them 50% interest, and the opportunity to reinvest. Of course, they jumped at the chance. Imagine investing your money at 50% interest! At this point, he was literally "borrowing from Peter to pay Paul," reimbursing earlier investors with funds taken from later investors.

By the end of a year Charles and his wife, Rose had rented a large office and hired clerks, who kept the records. He was careful to continue paying off investors. In the year's time he took in over $10 million.

The press was the game spoiler. They gave him a great deal of publicity, and finally the state attorney general came in to audit Ponzi's records. Unable to sign on new investors while he was under investigation, he "borrowed" from Hanover Trust, leaving IOUs for millions of dollars, and attempted to compound his money by gambling. He lost it all, and went to jail.

In 1934 he was deported to Italy, where he managed to make money by blackmailing officials in Boston with threats to publish damaging information about them in his autobiography. He then worked for Mussolini, and after his defeat in World War II, Ponzi lost everything. He died at the age of 67 in a charity ward in Italy.

Since that time, any scheme that uses the theory of a pyramid is known as a "Ponzi" scheme. One of the more common ones are the chain-mail letters you may receive.

You can learn all about other "Ponzi" schemes in a book called "The Flim-Flam Man-How Con Games Work", Paladin Press, (800) 392-2400, $19.95 plus shipping and handling.

Copyright © 1994 Bankers' Hotline. Originally appeared in Bankers' Hotline, Vol. 5, No. 1, 8/94