Charles Ponzi was born in Italy in 1882 and emigrated to the US in 1903. For the next 16 years he held various menial jobs, and served time for various crimes, including fraud. In 1919 he set up a business to exploit the difference in price between international postal coupons by buying them in Europe where they were cheap and redeeming them in the US. He raised money from the public by promising them he would double their money within 90 days (quickly changed to a 50% return in 45 days).
How did the fraud work?
Ponzi quickly realised that, although the arbitrage opportunity was real, delivering the expected returns was a practical impossibility since it would involve buying more coupons than could be transported. Even satisfying the original 18 investors would have required him to buy and exchange 53,000 coupons. Indeed, there is no evidence of him exchanging any coupons. But rather than wind up the scheme, he decided to raise more money from new investors, using their subscriptions to pay off the old investors. Initially, this worked well as the original investors spread news of the scheme.
What happened next?
Within months Ponzi was receiving huge amounts of money from across the US. As well as hiring more agents to solicit investors, Ponzi tried to keep the scheme afloat by taking control of a local bank. By the summer of 1920 he was living a luxury lifestyle in a large mansion. Then an article in a local newspaper prompted an investigation and investors demanded their money back. In August Ponzi was declared bankrupt. By November 1920 he was jailed for fraud. He died in poverty in 1949.
Lessons for investors
In the end Ponzi’s victims ended up getting back only 30% of the value of their initial investments, with millions still unaccounted for to this day. Ponzi’s fraud became so notorious that similar ploys are now known as “Ponzi schemes”. However, investors should have realised the promised returns were unsustainable, especially at a time when local banks offered only 5% a year. The financial journalist Chris Barron pointed out that, even if legitimate, the original scheme was itself unethical as it essentially involved taking advantage of the American taxpayer, who owned the US Postal Service.