Tuesday, January 26, 2010

Charles Ponzi, from riches to ruination

After years in the United States and a series of dashed dreams Charles Ponzi hit upon a foreign exchange scheme, the international reply coupon. In my next post I’ll describe how it worked in more detail. For now let’s get on with the biographical story.

Ponzi, as usual, needed money, about $50, to fund his reply coupon business, so he created yet another firm with the imposing name Securities Exchange Company. (Presumably he didn’t refer to it as the SEC; the U.S. Securities and Exchange Commission was created by congressional act in 1934, fifteen years after Ponzi’s business. As became evident with the Madoff scam, it might have profited from studying a little more closely the Securities Exchange Company.) Ponzi launched the business with a promissory note to the creditor who had been hounding him to pay on his office furniture. And then he borrowed from the public at large in amounts starting at $10 against the promissory notes of the Securities Exchange Company. The idea was that he would use the proceeds to buy coupons. In 45 days he would repay the notes at 50% interest.

At the beginning of 1920 Ponzi had 18 investors for a total of $1,770. When he paid his early investors $2,478 on their original investment, word of this get-rich-quick scheme spread quickly. By the end of July there were 30,219 investors holding notes of the Securities Exchange Company for nearly $15 million.

Soon enough Ponzi decided that “it had gotten to be sort of monotonous to watch my clerks fill the waste baskets with green-backs after the cash drawers were full.” (p. 140) He set his sights on acquiring banks. His first target was Hanover Trust, the bank that had refused his loan request for $2,000. His strategy was to maintain a large “dormant” account (somewhere in the neighborhood of $500,000), surreptitiously buy up small lots of stock by paying a few dollars over market, and elicit support from the Italian stockholders who had a large minority stake in the bank. Then he confronted the officers of the bank, asking to buy enough shares to control the bank. They naturally refused. So he pulled out his big gun and started to write out a check for his balance. The bankers said that they weren’t that liquid, that they would have to dispose of some securities, probably at a loss, to honor Ponzi’s check. Finally they reached a compromise, offering to sell Ponzi 1,500 shares. They counted on the Italian shareholders to support them, as they always had. But now they were pledged to Ponzi. “Half an hour later,” Ponzi wrote, “I left the Hanover Trust. . . . The bank was mine!” (p. 146)

Ponzi went on a shopping spree, buying real estate, mortgages, interests in banks and a construction company; he even bought the Napoli Macaroni Company. He had a sardine factory in Maine and a meat packing plant in Kansas City. And he offered $200 million for 1,800 ships from the government’s merchant fleet, saying that he would pay cash within 30 days of acceptance of his bid.

The problem—and Ponzi always had monumental problems—was that he wasn’t getting any coupons. “In fact, he confessed, “after the first lot, I had not been able to buy any more. Except in small quantities. For no other reason than the existing supply was not sufficient to meet the increased demand. They had to be ordered from the Universal Postal Union. But the moment the postal administrations of the various countries concerned began to notice an unusual activity in coupons, the cat was out of the bag. One by one they took steps to suspend the sale of coupons.” (p. 153)

Ponzi was spending as if his company were debt free. And he was tap dancing to buy time. He faced law suits, he survived a run, but finally he became the target of federal and state law officials. Soon enough the jig was up. An official audit showed that Ponzi was about $4 million short and he was placed under arrest.

He pled guilty to federal charges and was sentenced to five years in the Plymouth County Jail. Two years later the state trial began in which Ponzi was charged with 12 counts of larceny; the jury acquitted him. He earned early release from jail in 1924 only to face a second round of state charges; the trial resulted in a hung jury. The third time around, in 1925, the state brought four more counts of larceny against Ponzi, and this time he was not so lucky. The jury convicted him and the judge handed down a sentence of up to nine years. Ponzi was, however, free on appeal.

So what did Ponzi do? He got into the Florida real estate development business, but that didn’t go well. His reputation, it seems, had preceded him. The state of Florida brought charges against him for failing to file some mandatory state papers; he was tried and sentenced to a year of hard labor. Ponzi, getting ever more desperate, faked his suicide; the result was another jail term in Texas, then extradition to Boston to face his sentence of seven to nine years. Seven years later, in 1934, he was freed only to be rearrested by immigration officials and promptly deported to Italy. He died in Rio de Janeiro in 1949.

(After a brief hiatus to pursue a couple of other topics, I will return to Ponzi’s foray into the world of foreign exchange with a postscript on his idea for bank reform.)


  1. Hi Brenda,

    You describe yourself as a trader -- along with all the rest. Does that mean that you are good enough to support yourself trading?

    Just curious.

  2. Blue,

    I'm sorry, but I don't feel comfortable answering your question. This blog is about ideas, and I believe I have the credentials to write about ideas. It is not about me (except peripherally), my trades, or my investments. Just consider: if I said I made $5 million a year trading I would be deluged with requests for my secret; no one would ever believe that reading had anything to do with it. If I said I lost $10,000 a year trading, the response would be “Aha! I always knew that readers could never be successful traders.” In either case I would undermine the premise of this blog. I trust you understand.


  3. Blue,

    As I was ducking your question I should have added another metric. Let’s assume that I need $100,000 to support myself. If my trading account is $5 million I can succeed with only minimal risk management skills. If, on the other hand, my trading account is $20,000, I have to outperform the likes of Renaissance Technologies.


  4. I like your second answer better.

    My question wasn't about how much money you make. It was more to get a sense of who you are: is trading your primary occupation, or is it a hobby.

    Neither answer is better. It's just a matter of creating a mental image I can refer to when reading your blog.

  5. Blue,

    For me trading is a business, not a hobby.