C.J. Marshall: Significa: Ponzi scheme -- Another way not to make money
Last week, I wrote about the pyramid scheme and how such a system cannot possible sustain itself as a money-making operation. Today, I'm going to talk about a similar system which is also illegal but has also proved to be popular with certain unfortunate folks who have been taken in by it -- the Ponzi scheme.
A Ponzi scheme is similar to a pyramid scam in that both use the money generated by the latest investors to pay off earlier participants to give the illusion of quick and easy profits. But both are always doomed to fail because each is based on a system involving geometric progression - a fatal flaw which can never be overcome when used in an attempt to generate money.
The Ponzi system was made "popular" by a gentlemen named Charles Ponzi, an Italian immigrant and con man who operated in the New England area as well as Canada in the early 1900s. Around 1920, Ponzi discovered that an international reply coupon - a coupon used to purchase mail services between nations - could be purchased for a penny in Europe and redeemed for 10 cents worth of stamps in the U.S. Ponzi hit upon the idea of having agents purchase postal coupons in Europe, then sent to America where they could be redeemed, and realize, in his words, a 400 percent profit margin.
Or at least that's what he claimed. In actual fact, when Ponzi attempted to redeem the coupons in the U.S., he ran into such a mountain of bureaucratic red tape that he found it impossible to make a profit.
By this time, though, Ponzi had attracted enough people to his scheme he could pay off the initial investors with the money given to him by newer participants. As a result, the initial investors quickly made a handsome profit - with some making $750 after 90 days on a $1,250 investment. This of course made the scheme even more attractive, with even more people seeking Ponzi out in the hopes of jumping on the gravy train.
Several months passed, with many mortgaging their homes and investing their life savings with Ponzi, then reinvesting their "profits" on the promise of an even greater financial return. However, this "success" also began to generate a great deal of suspicion from a number of news media as well as the authorities - namely, how could a penniless immigrant manage to make so much money so quickly that he could guarantee such generous quick returns on investments.
Ponzi kept on touting how he was using the price difference of international reply coupons to finance his financial empire, but subsequent investigation revealed that no significant increase in the purchase or redemption of such coupons was occurring - something which definitely would have shown up if Ponzi's claims were legitimate. When further investigation ultimately revealed that Ponzi was simply using new investments to pay off old ones, the system collapsed, and many participants were wiped out financially as a result. Ponzi would eventually be sentenced to both federal and state prisons for fraud, and after his release was deported to Italy.
Ponzi did not originate the scheme that bears his name today, but he made it so "popular" with investors that everyone associates it with him when it is described. As I explained earlier, the system involves the operator to pay off earlier investors with money coming in from newer accounts. As long as new money keeps on coming in, one can continue to keep the system operating. But the fatal flaw is the more you have, the more you need - this is where the geometric progression comes in. Ultimately, such a system is always doomed to collapse, leaving investors with little or nothing in return, and often losing all the money they invested as well. As the old saying goes, caveat emptor - let the buyer beware. If something looks too good to be true - in this case a fantastic show of profits with little or nothing to demonstrate how it is done - it probably is.
C.J. Marshall is a writer and columnist for The Daily Review. He can be reached at email@example.com.