Ponzi

Carlo always felt as though he was destined for something bigger than this. He was born in the Kingdom of Italy, which had just become an independent nation, in 1882.

Carlo's family had once been wealthy, but by the time he was born, the good times were long gone. Still, he managed to attend university in Rome, but he probably spent more time partying than studying.

The United States looked like the land of milk and honey at the turn of the 20th century, and immigrants from all over Europe were making their way across the pond, emigrating in record numbers for the time. Carlo decided this adventure was for him, and he changed his first name to something more familiar to American ears: Charles.

Charles Ponzi arrived in the US in 1903, wandering from job to job to make ends meet. The evidence suggests that Charles’s work wasn’t entirely above-board. Eventually, he worked as a bank teller in Montreal, where the bank eventually failed. Did Charles have anything to do with it? Tough to say.

We do know for sure that he was caught forging a check and spent three years in a Canadian prison. We also know he moved to Atlanta, where he was caught in an operation that smuggled illegal Italian immigrants into the US. Charles served two more years in prison, this time in Atlanta.

Even after being thrown in prison twice, this life wasn’t good enough for Charles Ponzi. He wanted more.

Such lofty ambitions demanded an ambitious scheme, and some time around 1920, he found just the thing.

Ponzi had discovered International Reply Coupons, or IRCs for short. IRCs were like prepaid postage stamps for international mail. The idea was to eliminate the hassle of purchasing postage in different currencies when sending letters to other countries.

Person A would buy an IRC at their local post office, and insert the IRC with their letter. They’d buy a stamp for their letter and send it off to person B. Then, person B would be able to use the IRC at their local post office, essentially buying stamps so the cost to send the letter back was covered.

In essence, the IRC was currency fixed to the price of sending a letter overseas. Technically, that’s not 100% accurate since it was more like a fraction of a letter, but you’ll get the idea if you keep this in mind.

Imagine you’re in Ponzi’s shoes, and let's imagine you’re corresponding with a friend back home in Italy. Suppose the value of Italian currency drops to almost zero while the IRC is in the mail. So, you spent $1 on the IRC and want your friend to respond by letter. They could use the IRC and send it back, but perhaps now the IRC is worth much more than what the return postage is selling for. In that case, your friend could simply sell the IRC, use the proceeds to return the letter, and then pocket the difference.

This idea is called arbitrage—finding two markets where the same thing is selling at a different price and taking advantage of the situation quickly, before markets can adjust.

While this sounds good in theory, in actual practice, any profit margin from this sort of arbitrage is very likely to be fleeting. Currency exchanges aren’t usually that wild, particularly for the countries participating in the IRC network, and there were small transaction fees that eroded any remaining opportunity. Not to mention, as soon as an opportunity was discovered, the clock started ticking as other investors raced to pick up the pennies left on the trading floor.

So, no, this was no genuine get-rich-quick scheme. It simply wouldn’t work for long enough, and there were far too many competitors. Ponzi wasn’t about to be deterred by reality, though!

The scheme I described above is actually fairly complicated and difficult for the average individual to explain, particularly if the person explaining the scheme doesn’t really want you to understand how it works. Ponzi understood this element of human nature extremely well.

He had a real knack for selling pipe dreams! After explaining what he was doing in vague terms, he started taking money from investors. He promised returns that should have seemed too good to be true, but this is a common thread among most major scams: the folks willing to believe in his scheme would be exactly the ones who would give him money.

Those early investors got paid! Ponzi promised a 100% return within 90 days in order to keep the funds flowing, and sure enough, he was able to return those funds (and then some), thanks to the flood of new investors coming in, not from anything the IRC arbitrage strategy actually made.

This early success led to more investors beating down the doors, reminiscent of the earlier South Sea Bubble I wrote about, along with other infamous scams throughout history.

This pyramid scheme was doomed to fail eventually, but sometimes eventually is a long time. In Ponzi’s case, the run only lasted about a year, but that was enough time for him to have taken in around $15 million in 1920 dollars, or about $210 million in today’s value.

If this sounds like peanuts to you, that’s a fair take. Sam Bankman-Fried, today’s Ponzi-schemer du jour, was found guilty of taking investors for about $8 billion—40 times Ponzi’s take, even adjusted for inflation. Of course, Bernie Madoff is still the king of con, having committed about $65 billion worth of fraud.

Will anyone else’s scheme live on in the very name of the con itself, the way Ponzi scheme does today?

What’s your favorite story of a financial con? Let me know in the comments!

If you missed yesterday’s conversation about the Tulip Bubble, you might enjoy reading that next: