In late 1919, Charles Ponzi was a poor but ambitious man. Less than a year later, he was worth millions. Then his ill-gotten wealth vanished in an epic collapse that brought down six banks and ruined thousands of investors. What was Charles Ponzi’s scheme?
Who was Charles Ponzi?
In August 1919, Charles Ponzi became fascinated with International Reply Coupons, or IRCs. An IRC was prepaid reply postage for international mail. They were usually bought in one country and then exchanged for stamps in another country.
Charles Ponzi thought he saw an arbitrage opportunity. He could buy large amounts of IRCs in countries with weaker currencies and redeem them in countries with stronger currencies. According to his autobiography, The Rise of Mr. Ponzi, he stood to gain an entirely legal net profit of 230% by exploiting the difference between the Italian and American exchange rates.
Ponzi established the Securities Exchange Company and set out looking for investors. He “claimed to have elaborate networks of agents throughout Europe who were making bulk purchases of postal reply coupons on his behalf.” Investors egaerly jumped aboard, intrigued by the generous terms of his promissory notes, which offered an eye-popping 50% interest rate payable in 90 days. For later notes, the term changed to 45 days.
Happy investors poured money back into the company and convinced their friends and relatives to do the same. By February 1920, Ponzi had recorded $5,000 in profits. By March, he was up to $30,000. By May, Charles Ponzi’s total profits reached a whopping $420,000. By June, Ponzi was a millionaire and the majority owner of The Hanover Trust Bank of Boston. He spent lavishly, acquiring a 12-room mansion among other things.
Ponzi was triumphant. Yet, dark clouds filled the horizon. Joseph Daniels, who’d never been paid for furniture he’d sold to Ponzi, sued for $1 million. The size of the lawsuit raised a troubling question among the public…how had Charles Ponzi gotten rich so quickly?
Charles Ponzi & his Ponzi Scheme?
On July 24, the Boston Post published a favorable article on Ponzi and reported his newly-acquired fortune at $8.5 million. But the newspaper’s acting publisher and city editor remained suspicious. They hired Clarence Barron (the man behind Barron’s), to investigate Ponzi.
Two days later, the Boston Post began a series of articles questioning Ponzi and his company. Barron played a key role, uncovering several unsettling pieces of information. For instance, Ponzi was not investing his own money in his company. Also, a whopping 160 million IRCs were needed to cover Ponzi’s purported investments, yet only 27,000 were in circulation. Last but not least, the U.S. Post Office reported that IRCs were not being bought in quantity anywhere in the world.
On August 2, Ponzi’s former publicity agent, William McMasters, wrote his own story for the Post. He claimed that Ponzi was over $4.5 million in debt, including the interest on outstanding loans. Investors clamored for their money back. Ponzi obliged, temporarily quelling fears.
On August 11, approximately one year after he started his business, Ponzi’s scheme ran out of steam. The Boston Post published an article detailing Ponzi’s criminal past. Meanwhile, Hanover Trust was seized by the Bank Commissioner, thwarting Ponzi’s plans to use its deposits to cover his debts.
How did the Ponzi Scheme Work?
It turned out that Ponzi never made investments of any sort. In its final audit, his company was found to own just $61 of IRCs. Instead, he paid off earlier investors with money obtained from later investors. While he didn’t invent the “Ponzi Scheme,” he made it famous.
Ponzi was arrested by federal authorities on August 12. He was charged with 86 counts of mail fraud and served three and a half years in prison. In 1925, he was charged with 22 counts of larceny by the state of Massachusetts and given an additional nine-year sentence.
Guerrilla Explorer’s Analysis
“Even if they never got anything for it, it was cheap at that price. Without malice aforethought I had given them the best show that was ever staged in their territory since the landing of the Pilgrims! It was easily worth fifteen million bucks to watch me put the thing over.” ~ Charles Ponzi
While Charles Ponzi is nearly forgotten, his legacy lives on in the scheme that bears his name. So, beware the siren’s song of easy money and guaranteed profits. In the end, it never turns out well.