Wall Street History

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Wall Street History

07/16/2004

Charles Ponzi

Over four years ago I did a piece on Charles Ponzi but I recently
came across an article from a newspaper of his day that adds a
little more heft to my prior story. In addition, I found a mistake
in the research of a prime source in the earlier effort, that being
that Ponzi was 37-years-old when he began perpetrating his
fraud, not 42. [It’s the second error I’ve discovered by this well
known market historian in just the past few weeks. Alas, he’s
deceased, which doesn’t absolve me while I’m alive!]

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“Mundus vult decipi - ergo decapitur: The world wants to be
deceived, let it therefore be deceived.”
--Charles Kindleberger

Market history is full of ponzi schemes, from the South Sea
Company bubble to John Bennett''s New Era Philanthropy scam,
and Charles (Carlos) Ponzi is the man we can thank for the term.
In September 1919, Ponzi was a 37-year-old ex-vegetable dealer,
forger, and smuggler in Boston who decided he would become a
wealthy financier. Described as handsome and quick-witted, he
had only $150 in cash to his name and lacked any real
connections. But he had a scheme.

"Ponzi finance" is defined by one expert “as a type of financial
activity engaged in when interest charges of a business unit
exceed cash flows from operations.” Another explanation is
when “a borrower who has some control over the price in the
market in which he issues his own personal debt will want to
play the ‘ponzi game of financing,’ that is, the repayment of debt
with the issuance of new debt.” [Charles Kindleberger] And a
third definition is when a scheme “entices initial investors, after
they have made a lot of money, to tell their success stories to
another round of investors, who then invest even more in the
scheme, allowing the hoaxer to pay off the second round of
investors, whose success story entices an even larger round of
investors, and so on .The perpetrator may hope to exit, not
having paid off the last and largest round of investors, and then
hide from the law.” [Robert Shiller]

In Charles Ponzi’s case it was sort of like a chain letter in which
he would borrow money without collateral, promising to pay $15
for every $10 left with him for 90 days.

What Ponzi told his would be lenders (mostly Italian immigrants)
was that he would be buying International Postal Union reply
coupons overseas and then send them elsewhere to be redeemed.
As Robert Sobel writes in his book, “The Great Bull Market:
Wall Street in the 1920s,” “In this way, (Ponzi) could take
advantage of differences in currency quotations to make profits.”
At least that''s what he told his investors.

Ponzi was to purchase lire, francs, and drachmas at low market
prices and sell them at higher official prices (in theory). He
started a firm, The Old Colony Foreign Exchange Company,
where he took in the money and paid principal and interest
without fuss or bother. The newspapers in Boston picked up the
story and soon Ponzi was not only famous, but he was also
taking in about $1 million a week. He had grand expansion plans
and he talked of establishing a string of banks and brokerage
houses. Soon he was purchasing a controlling interest in the
Hanover Trust Co., naming himself president.

Sobel writes of these times that wherever Ponzi went, crowds
followed. “You''re the greatest Italian of them all!” Ponzi
protested, “No, no. Columbus and Marconi. Columbus
discovered America. Marconi discovered the wireless.”
“Yes,” came the response, “but you discovered money.”

The Boston district attorney began an investigation. Edward
Dunn of the Boston Post began one of his own. Dunn discovered
that less than $75,000 worth of reply coupons were printed in
most years and in 1919 only $58,560 was issued. Ponzi said he
took in millions and invested them in the coupons. Clearly, Dunn
reasoned, money had been used for other purposes.

Dunn was to find out during his investigation that Ponzi – using
the name Charles Bianchi - had been involved in a remittance
racket in Montreal back in 1907. The Post’s reporter Herbert L.
Baldwin was dispatched to Montreal and wrote the following
account in the summer of 1920.

“Charles Ponzi, Boston’s financial wizard, and Charles Ponsi,
alias Charles Bianchi, a convicted forger who spent two and a
half years behind the bars of one of the Canadian jails, were
pronounced one and the same man today.

“A rogues’ gallery expert, a police inspector who arrested
Charles Ponsi (Bianchi), the warden of the penitentiary at St.
Vincent de Paul; a clerk who worked in the same office where
the forgeries took place, and an Italian banker, one of the best
known in this city, were among those who saw photographs of
Charles Ponzi of Lexington, Mass., and with one accord told a
Post staff reporter:

“ ‘Why, that’s Bianch,’ or ‘That’s Ponsi,’ as happened to be the
name they knew him by....

“The offense that sent Charles Ponsi to prison here and the
methods of the banking office of J. Zarrossi, where the forgeries
were committed, were the end of the victimizing of scores –
some say hundreds of hard-working residents of Montreal and
vicinity by promising them ‘more percentage’ than any other
bank offers .

“Twelve years have passed since Zarrossi closed his banking
doors and fled to Mexico and Charles Ponsi went to jail for a
term of three years.”

Reporter Baldwin interviewed a number of those duped by Ponsi.

“Vitriolic epithets were poured into the Post man’s ears as Italian
residents of Montreal and a half dozen of its suburbs were
interviewed and gazed upon the photographs .

“The warden at the penitentiary smiled quietly as the Post man
once more produced his photographs .

“Ponsi was a model prisoner and attracted no unusual attention at
the penitentiary, so far as could be learned. Records there give
his height as 5 feet 2 inches and his age as 26 years in 1908 .

“Bianchi-Ponsi at the time of his arrest declared, according to
police officials here, that his mother and father were dead and
that he had no relatives anywhere. Officials read with interest
the details of his folks back in Parma, Italy, as supplied by Ponzi
in his life story to a Post man last Sunday, and as they perused it
they commented on the fact that he declared he was doing private
investigating during the years that Bianchi-Ponsi was doing time
in the big jail 25 miles from here .”

Confronted with the damning evidence, Ponzi had to act
fast to avoid a panic. He countered by promising to pay his
investors 50 percent interest on money left with him for 45 days,
rather than the initial 90 days previously required.

But Ponzi’s operations were finally closed pending a district
attorney''s investigation. Charles proclaimed his innocence and
lenders besieged his office. Somehow he managed to pay them
all off, though, without a single default.

Forced to go public more than he desired, he warned investors
not to dispose of their holdings and told them they had nothing to
fear. He also asserted at this point that he was worth at least $12
million. For a time, confidence returned and money began to
flow back in.

On August 2 the Boston Post had claimed that Ponzi was
insolvent, but even this did not prevent the positive flows.
Finally, the end came on August 11 when all of his companies
and offices were closed, never to reopen. Robert Sobel writes.

“In the days that followed it was learned that the dapper financier
had purchased a few reply coupons, but used most of the money
he received to pay those who presented 90-day notes. In effect,
he was taking in money with one hand and paying out more with
the other. Such a scheme could not last for long, unless
increasing amounts continued to arrive. Ponzi was bound to
collapse when the money ran out.”

On August 16, Boston and the nation learned the Old Colony
Foreign Exchange Company had no assets and liabilities of
$2,121,895. The search for Ponzi''s money extended into
October and little was ever found. Ponzi himself was declared
insolvent on October 15. The presiding judge, James Olmstead,
commented.

“While Mr. Ponzi is not to be classed in the same category with
robbers and burglars, he was undoubtedly a clever manipulator
who took advantage of the credulity of the investing public,
which in this instance is the usurer. The investors who loaned
their money for a return of the principal and 50% interest would
seem themselves guilty of usury if such existed.”

It was finally resolved that Charles Ponzi had taken in some $15
million in 8 months, and that his books showed a deficit of $5
million; less than $200,000 was eventually recovered from his
holdings.

While out on bail pending appeal, Ponzi decided he had to scam
some other innocent fools so he sold underwater lots in Florida to
the unsuspecting, thereby making another small fortune. [Ponzi
was one of many crooked real estate agents selling useless land
in Florida''s mosquito-ridden interior during the 1920s.]
Nonetheless, his appeal denied, Ponzi went to prison until 1934.
Upon his release he was deported to Italy where he immediately
joined the fascists and gained positions in the government.
Later, he was sent to Rio de Janeiro by his employer, LATI
Airlines, where he became a fixture in the social set. He died of
natural causes in 1949.

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As I alluded to earlier, I initially did the bulk of the above in
March 2000, right at the top of the equity market. Just as in the
1920s, the stock market in the spring of 2000 was another ponzi
scheme. As Robert Sobel wrote of 1920 and the era that
followed, “The cult of the stock market was, in the end, the
greatest fantasy in an age filled with illusion.” But each
generation or two needs to be taught this painful lesson all over
again.

Sources:

Charles Geisst. “Wall Street: A History”
Charles P. Kindleberger. “Manias, Panics, and Crashes”
Judith and William Serrin, editors. “Muckraking! The Journalism
That Changed America”
Robert Shiller. “Irrational Exuberance”
Robert Sobel. “The Great Bull Market: Wall Street in the 1920s”

Wall Street History will return July 23.

Brian Trumbore

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