Where Did Ponzi Schemes Get Their Name?
It can be an honor to be named after something you created or popularized. The Greek mathematician Pythagoras created his own theorem to easily calculate measurements. The Hungarian inventor Ernő Rubik is best known for his architecturally puzzling Rubik’s Cube. But what happens when your name is attached to the worst crime you’ve ever committed?
That’s precisely the case with the Italian-American swindler Charles Ponzi. Originally born Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi, Ponzi’s name lives on anytime someone engages in a money-making scheme that pays profits to early investors with funds from more recent investors. Ponzi certainly wasn’t the first person to trick his investors out of millions, but his criminal history was so outrageous that his biggest scheme was immortalized in his honor.
Did Ponzi Always Have a Taste for Crime?
Ponzi may not have always had a thirst for swindling others, but he was always hungry for money. It’s what drove him to leave his native Italy after his family lost their ancestral fortune and his unfinished college training prepared him for nothing. Legend has it Ponzi arrived in America with only $2.50 after gambling the rest away on his overseas voyage. That desperation to keep himself afloat and bring wealth back to his family fed his hunger to get money by any means necessary.
After picking up the English language with ease, Ponzi worked his way up from a dishwasher job to a head server position at a restaurant in Boston. He was quickly fired for shortchanging his customers. It was the first of several money-making plots that failed before Ponzi’s big scheme.
Countless failed attempts at making money later, Ponzi became an assistant bank teller in Montreal, serving an ever-growing population of Italian immigrants. The bank’s founder was a crook who funded interest payments with money deposited in newly opened accounts instead of profits from investments. That’s where Ponzi first learned about “Robbing Peter to pay Paul,” the phrase that was soon replaced with “Ponzi scheme.” More on that later.
When the bank shut down, Ponzi needed funds to get back to America because he was penniless once again. While looking for work, he found himself in a warehouse that kept its money in his old bank. Knowing the name of the warehouse director, he forged a signature on a check worth $423.58. He spent three years in jail for his crime, and upon his release, he spent an additional two years for illegally smuggling immigrants into the country. At this point in his life, crime was second nature to Ponzi, which explains how he became one of the most legendary crooks of all time.
The Original Ponzi Scheme
By 1919, Ponzi had tried to launch several businesses to no avail. He couldn’t even keep his new wife’s family fruit business from failing. Things were looking pretty grim until he set up an office in Boston where he mailed random business to his connections in Europe. He didn’t get any investments in his ideas, but a response note from Spain included an international reply coupon (IRC). IRCs allowed someone in one country who received correspondence from another country to respond to the original messenger free of charge.
Ponzi learned that IRCs purchased in poorer countries like Italy could be used to buy stamps in America at a discounted rate. This is what’s known as arbitrage, and it was the driving force in Ponzi’s big scheme.
Ponzi quickly connected with investors and friends from Boston and promised them he could double their investments based on his stamp-selling business model. In January of 1920, Ponzi’s company had 18 investors and a total of $1,800 in investments. By July, Ponzi was raking in a million dollars a week. Investors were making off like gangbusters, but Ponzi could never sell enough stamps to generate legitimate profits. So he took the money from new investors and used it to cover earlier investors’ interest payments. People were flooding his offices and personal homes in hopes of investing, so Ponzi thought the system could continue without fault.
Ponzi was wrong.
The Ponzi Scheme Fallout
Reporters questioned Ponzi’s investment operation, but he reacted with successful libel lawsuits against the journalists. His lawsuit trigger finger held off additional journalists’ investigations until Clarence Barron, owner of The Wall Street Journal, realized Ponzi’s IRC scheme could never make enough revenue. There were only 27,000 IRCs in the world, but Ponzi would have to move 160 million coupons to keep his business afloat. In addition, Ponzi revealed he invested his money in real estate, stocks and bonds and not in his own company.
Barron ran a front-page expose on The Boston Post in July 1920, which led to a raid of Ponzi’s office. Officials only found a very small number of IRCs and not nearly enough documentation of his company’s finances.
Ponzi’s game was over. The government brought 86 charges against him in two separate indictments. After pleading guilty, Ponzi first received a light sentence of five years but only served three and a half. Then he served an additional nine years after facing state charges. Upon completing the full sentence, Ponzi was deported back to Italy, where he lived in poverty until his death in 1949. Little did he know that his biggest scandal would live in infamy any time someone cheated their investors.