Ponzi Scheme Defined

Dec 12, 2008 1:58pm

ABC News’ Stu Schutzman reports: "Giant Ponzi Scheme" was splashed across headlines today, referring to the arrest of a New York Banker accused of bilking investors to the tune of $50 billion dollars. That’s serious bilking, which would no doubt make Carlo Ponzi proud (more on him in a moment). A "Ponzi Scheme," says the Securities and Exchange Commission, operates on the "rob-Peter-to-pay-Paul principle." Usually the scam is generated by a less than scrupulous individual who offers investors enormous return, in very little time and with very little risk. Too good to pass up, huh? Those who do invest early actually can make gobs of money; think of them as the skinny, pointy top of a pyramid. The money paid to them comes from the next rung of investors, a slightly fatter part of the pyramid. They generally come in after the word is out that big bucks are being made. As more investors come in and the pyramid gets fatter, there is more cash for pay offs. But towards the bottom, as the pyramid gets really fat, with no product to be sold or service to be rendered, there are simply too many people to pay off and eventually the entire pyramid collapses. By then, the progenitor of all this often is long gone to some tropical paradise having skimmed his fortune off the top. Carlo Ponzi, namesake of these schemes, was by all accounts a born liar and swindler. He came to America from Italy in the early 1900s with $2.50 in his pocket having gambled away his life savings crossing the Atlantic. Now "Charles" Ponzi, he was short in stature but long on money-making ideas. After a series of low paying odd jobs, Ponzi began seeking more lucrative employment; like writing bad checks or illegally smuggling immigrants into the country. After his release from prison, Ponzi actually started a legitimate advertising business. The venture failed but his idea eventually became the "Yellow Pages." Even that would have been small potatoes for Ponzi who was looking to make millions — enter the original Ponzi Scheme. By 1920, Ponzi had it figured out. Convince wealthy people to invest in his idea to buy and sell postage stamps on the international market. Careful exploitation of exchange rates would result in enormous profits. Investors could make 50 percent profit in less than 2 months. They came running. The money was coming in faster than he could count it. In February 1920, Ponzi made $5,000; By July he was making $250,000 a day. Overnight he became one of the richest men in America. Mansions, fancy cars, he even brought his family over from Italy. But alas, his hubris and a very dogged investigative reporter for the Boston Post ultimately brought Ponzi down. Stories that Ponzi’s investment scheme was a fraud created a run on his company. Angry investors stormed the front door. Ponzi paid many of them off from out of pocket. Eventually he was convicted of mail fraud and sent to prison. His dream, he once said, was to make enough money to buy a Navy Warship and create the world’s first floating international shopping mall. Such is the stuff of dreamers…and schemers.

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