By John F. Sase
Preluding courses that focus on Real Estate, Mortgages, and other related topics, was life around the dinner table at home. My father had entered the realm of Real Estate in the late 1920s/early 1930s. My stepmom had worked Burton Abstract and Title for decades. Before studying Real Estate Economics, I absorbed the knowledge that my parents shared with me.
Real Estate trends repeat themselves every couple of decades. Prices of homes and business buildings go up! Then, those prices go down. Eventually, the prices of homes and business buildings go back up as the cycle repeats itself. Most Real Estate brokers tend to remain honest and treat their clients with respect. These brokers value their clients in part because they may be their neighbors and repeat customers in the future.
However, some brokers and their sales staff remain unconcerned with current markets as they believe in a philosophy of “get rich quick” and then move on to other income generating shenanigans.
Whenever times get tough in this business, it seems that more and more con artists promising castles in the air emerge from the woodwork. Many of us citizens, looking for alternatives to the failed opportunities of “Flipping Real Estate,” along with other touts that populate late-night infomercials, have received e-mails tempting the market with both new and old schemes. Nowadays, we hit our Delete keys and move on.
However, the relevance of this e-mail was brought home to me (Dr. Sase) by Bryan Lagalo, a Doctoral Candidate in the Economics Department of Wayne State University. He shared a well-conceived presentation in my class on Financial Economics. He titled his PowerPoint presentation for this class, “Charles Ponzi: The Life of an Infamous Schemer.” Bryan informed a small group of academics about Ponzi, an Italian flimflam man who duped thousands of Americans during the early twentieth century in what now has become known as “the Ponzi Scheme.” Seeing Bryan’s presentation made me stop and think about the parallels that exist between the scams of yesteryear and those repeated today. So, when I read the Scam Mail quoted in Bryans paper, I thought to myself, “It’s the ghost of Ponzi!”
Before watching Bryan’s presentation, I knew as much about Ponzi as the average investor—virtually nothing more than I could express in a single paragraph. However, that has changed since watching Bryan’s PowerPoint show. His audience fought to hold back the laughter of disbelief over a con artist whom I can describe only as a completely amoral sociopath. With the assistance of Contributing Editor Gerard J. Senick and myself, Bryan chronicles Ponzi and his scheme, one which made the Ponzi name synonymous with fraudulent and unsustainable investment scams.
“Aaay! It’s the Ponz!”
(With Apologies to Arthur Herbert Fonzarelli, AKA “the Fonz”)
Over the years, the term “Ponzi Scheme” has evolved into our byword for any act in which financial-market manipulators swindle trusting investors out of billions of dollars in assorted (and sordid) pyramid schemes.
The term continues to appear regularly in the Wall Street Journal and related publications that circulate widely throughout the current political arena and the popular press. The name of Ponzi has spread so profusely that a Google search of the single word “Ponzi” generates over 203,000 hits this week. Our search provided us with the definition from the Securities and Exchange Commission (SEC). It states, “Decades later, the Ponzi scheme continues to work on the ‘rob-Peter-to-pay-Paul’ principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses.” (“Ponzi Schemes”, US Securities and Exchange Commission.
Born in Lugo, Italy, in 1882, Ponzi said that he came from an upper-class family, (though he had a propensity for changing the facts of his life). He attended the University of Rome La Sapienza, but dedicated his time mostly to bars, cafes, and the opera. At the age of twenty-seven, Ponzi immigrated to the United Sates.
Having gambled away his life savings during his passage to America, he arrived in Boston with little but his name. In the Smithsonian magazine, (“In Ponzi We Trust,” December 1998), Mary Darby quotes the “Ponz” as stating that he “landed in this United States with $2.50 in cash and $1 million in hopes, and those hopes never left me.”
Ponzi learned English while working at odd jobs along the Eastern Seaboard. However, after being fired as a waiter for stealing from and shortchanging customers, he decided to move to Montreal, Canada. There, Ponzi took a job as an assistant teller at the newly opened Banco Zarossi, (a bank started by Luigi Zarossi to accommodate the growing number of Italians who had immigrated to Canada). Zarossi offered 6% interest on deposits--doubling the average rate offered by competing banks at that time.
Eventually, Ponzi, who then managed the growing bank, discovered that Zarossi offered high rates simply to attract large deposits that he used to cover interest payments on poorly made Real-Estate Loans (sound familiar?) Fleeing to Mexico, Zarossi took much of the bank’s money with him.
On the plus side after the failure of Banco Zarossi, Ponzi lived at Zarossi’s home and tried to help his family. However, jobless and broke, Ponzi forged a check for $423.58 that he made out to himself, though from the director of a company who had banked with Zarossi. However, after presenting this check for payment, Montreal police arrested Ponzi. Serving three years while in a Quebec prison, Ponzi contrived a cover-up story in a letter to his mother, explaining that he was working as a “special assistant” to the prison warden. However, Mama Ponzi eventually discovered the truth.
Following his release in 1911, Ponzi returned to the United States. However, merely ten days after leaving the Canadian prison, Ponzi was arrested for smuggling Italian immigrants across the border from Canada. Ponzi then spent two more years of incarceration in the Atlanta Prison in Georgia where he worked as a translator for this warden, who was intercepting letters from Italian mobster Iganzio Saietta, known as “Lupo the Wolf.”
After serving his time, Ponzi moved to Boston. There, he met Rose Maria Gnecco, a stenographer. When Ponzi neglected to tell Gnecco about his time behind bars, Ponzi’s mother sent the young woman a letter describing the Ponzi matter in its entirety. Nevertheless, Gnecco married Ponzi in 1918 despite this shared information. Ponzi then worked at various jobs before developing an idea that resembled the present-day Yellow Pages. However, his company attempted to sell advertising space in a circulated catalog that listed various businesses--an idea did not catch on as the company failed soon after.
Prelude to the Famous Ponzi Scheme
In August 1919, Ponzi’s fortunes began to change when he received a letter from a company in Spain inquiring about his failed catalog idea. This letter contained an International Reply Coupon (IRC), a form that allows a person in one country to send prepaid postage for a reply to someone in another country.
Although Ponzi received an IRC priced in pesetas (the Spanish currency of the time), the U.S. Post Office exchanged IRCs for postage priced in stronger U.S. dollars. By the end of World War I, more than sixty countries accepted IRCs and agreed upon regulated postage-exchange rates that reflected the current rate of currency exchange. However, many European countries experienced high levels of inflation at the turn of the decade.
As a result, currencies from countries like Spain and Italy suffered significant devaluation relative to the dollar, though the IRC postage-exchange rates remained the same.
Furthermore, the IRC discrepancy provided Ponzi with an opportunity for arbitrage. Therefore, he developed his simple plan: He enlisted family and friends in Italy to buy the cheap IRCs and send them to him in the United States. Here, he would convert and redeem them to US dollars, a post-war currency of significantly higher value. In turn, Ponzi boasted that his net returns easily exceeded 400%, even after transaction costs.
Nothing in his plan was illegal, at least not technically.
Next, Ponzi borrowed money and sent it to his relatives in Italy, whom he asked to send back in the form of as many IRCs possible. Subsequently, Ponzi sold his arbitrage idea to several friends in Boston, promising that he would provide a 100% return in only ninety days. Ponzi used the funds that he collected to start a company that he registered as the Securities Exchange Company (SEC). (Ironically, his company shared its acronym with the Securities and Exchange Commission founded by the Federal Government a decade and a half later).
Originally, Ponzi limited his issue to notes bearing small principal amounts such as $50, $100, and $1000. However, once his business accelerated, he left a blank line on these notes to allow investors to enter whatever amount they wanted to invest. Through this new company, Ponzi offered investors a 50% return after forty-five days or a 100% return after ninety days on virtually any principal amount.
This offer encouraged a Federal postal inspector to visit Ponzi at his business. The inspector voiced the concern that selling millions of IRCs was not legal. In retort, Ponzi explained that the IRC coupons always could be exchanged in other countries outside of the jurisdiction of the US Post Office.
Though it looked great on the surface, Ponzi’s initial investment scheme did contain substantial holes. For example, in 1920, the nations that accepted IRCs announced new postal exchange rates reflecting a large devaluation in their currencies. Furthermore, the U.S. Post Office limited its issues of IRCs to ten per visit.
Due to the immense volume of IRCs needed per transaction to ensure a profit, the transaction costs eliminated any significant arbitrage profit. Because of these impediments, Ponzi would likely have realized that transporting, unloading, and redeeming the needed volume of IRCs at a post office would prove to be prohibitive. Furthermore, his confiscated business records indicate that he purchased only a small number of these IRCs.
Fortunately for Ponzi, most people had not used an IRC or knew much about them. This public ignorance masked the fundamental problems involved with IRC arbitrage. Therefore, investors quickly flocked into Ponzi’s office.
————————
Dr. John F. Sase teaches Economics at Wayne State University and has practiced Forensic and Investigative Economics for twenty years. He earned a combined M.A. in Economics and an MBA at the University of Detroit, followed by a Ph.D. in Economics from Wayne State University. He is a graduate of the University of Detroit Jesuit High School (www.saseassociates.com).
Preluding courses that focus on Real Estate, Mortgages, and other related topics, was life around the dinner table at home. My father had entered the realm of Real Estate in the late 1920s/early 1930s. My stepmom had worked Burton Abstract and Title for decades. Before studying Real Estate Economics, I absorbed the knowledge that my parents shared with me.
Real Estate trends repeat themselves every couple of decades. Prices of homes and business buildings go up! Then, those prices go down. Eventually, the prices of homes and business buildings go back up as the cycle repeats itself. Most Real Estate brokers tend to remain honest and treat their clients with respect. These brokers value their clients in part because they may be their neighbors and repeat customers in the future.
However, some brokers and their sales staff remain unconcerned with current markets as they believe in a philosophy of “get rich quick” and then move on to other income generating shenanigans.
Whenever times get tough in this business, it seems that more and more con artists promising castles in the air emerge from the woodwork. Many of us citizens, looking for alternatives to the failed opportunities of “Flipping Real Estate,” along with other touts that populate late-night infomercials, have received e-mails tempting the market with both new and old schemes. Nowadays, we hit our Delete keys and move on.
However, the relevance of this e-mail was brought home to me (Dr. Sase) by Bryan Lagalo, a Doctoral Candidate in the Economics Department of Wayne State University. He shared a well-conceived presentation in my class on Financial Economics. He titled his PowerPoint presentation for this class, “Charles Ponzi: The Life of an Infamous Schemer.” Bryan informed a small group of academics about Ponzi, an Italian flimflam man who duped thousands of Americans during the early twentieth century in what now has become known as “the Ponzi Scheme.” Seeing Bryan’s presentation made me stop and think about the parallels that exist between the scams of yesteryear and those repeated today. So, when I read the Scam Mail quoted in Bryans paper, I thought to myself, “It’s the ghost of Ponzi!”
Before watching Bryan’s presentation, I knew as much about Ponzi as the average investor—virtually nothing more than I could express in a single paragraph. However, that has changed since watching Bryan’s PowerPoint show. His audience fought to hold back the laughter of disbelief over a con artist whom I can describe only as a completely amoral sociopath. With the assistance of Contributing Editor Gerard J. Senick and myself, Bryan chronicles Ponzi and his scheme, one which made the Ponzi name synonymous with fraudulent and unsustainable investment scams.
“Aaay! It’s the Ponz!”
(With Apologies to Arthur Herbert Fonzarelli, AKA “the Fonz”)
Over the years, the term “Ponzi Scheme” has evolved into our byword for any act in which financial-market manipulators swindle trusting investors out of billions of dollars in assorted (and sordid) pyramid schemes.
The term continues to appear regularly in the Wall Street Journal and related publications that circulate widely throughout the current political arena and the popular press. The name of Ponzi has spread so profusely that a Google search of the single word “Ponzi” generates over 203,000 hits this week. Our search provided us with the definition from the Securities and Exchange Commission (SEC). It states, “Decades later, the Ponzi scheme continues to work on the ‘rob-Peter-to-pay-Paul’ principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses.” (“Ponzi Schemes”, US Securities and Exchange Commission.
Born in Lugo, Italy, in 1882, Ponzi said that he came from an upper-class family, (though he had a propensity for changing the facts of his life). He attended the University of Rome La Sapienza, but dedicated his time mostly to bars, cafes, and the opera. At the age of twenty-seven, Ponzi immigrated to the United Sates.
Having gambled away his life savings during his passage to America, he arrived in Boston with little but his name. In the Smithsonian magazine, (“In Ponzi We Trust,” December 1998), Mary Darby quotes the “Ponz” as stating that he “landed in this United States with $2.50 in cash and $1 million in hopes, and those hopes never left me.”
Ponzi learned English while working at odd jobs along the Eastern Seaboard. However, after being fired as a waiter for stealing from and shortchanging customers, he decided to move to Montreal, Canada. There, Ponzi took a job as an assistant teller at the newly opened Banco Zarossi, (a bank started by Luigi Zarossi to accommodate the growing number of Italians who had immigrated to Canada). Zarossi offered 6% interest on deposits--doubling the average rate offered by competing banks at that time.
Eventually, Ponzi, who then managed the growing bank, discovered that Zarossi offered high rates simply to attract large deposits that he used to cover interest payments on poorly made Real-Estate Loans (sound familiar?) Fleeing to Mexico, Zarossi took much of the bank’s money with him.
On the plus side after the failure of Banco Zarossi, Ponzi lived at Zarossi’s home and tried to help his family. However, jobless and broke, Ponzi forged a check for $423.58 that he made out to himself, though from the director of a company who had banked with Zarossi. However, after presenting this check for payment, Montreal police arrested Ponzi. Serving three years while in a Quebec prison, Ponzi contrived a cover-up story in a letter to his mother, explaining that he was working as a “special assistant” to the prison warden. However, Mama Ponzi eventually discovered the truth.
Following his release in 1911, Ponzi returned to the United States. However, merely ten days after leaving the Canadian prison, Ponzi was arrested for smuggling Italian immigrants across the border from Canada. Ponzi then spent two more years of incarceration in the Atlanta Prison in Georgia where he worked as a translator for this warden, who was intercepting letters from Italian mobster Iganzio Saietta, known as “Lupo the Wolf.”
After serving his time, Ponzi moved to Boston. There, he met Rose Maria Gnecco, a stenographer. When Ponzi neglected to tell Gnecco about his time behind bars, Ponzi’s mother sent the young woman a letter describing the Ponzi matter in its entirety. Nevertheless, Gnecco married Ponzi in 1918 despite this shared information. Ponzi then worked at various jobs before developing an idea that resembled the present-day Yellow Pages. However, his company attempted to sell advertising space in a circulated catalog that listed various businesses--an idea did not catch on as the company failed soon after.
Prelude to the Famous Ponzi Scheme
In August 1919, Ponzi’s fortunes began to change when he received a letter from a company in Spain inquiring about his failed catalog idea. This letter contained an International Reply Coupon (IRC), a form that allows a person in one country to send prepaid postage for a reply to someone in another country.
Although Ponzi received an IRC priced in pesetas (the Spanish currency of the time), the U.S. Post Office exchanged IRCs for postage priced in stronger U.S. dollars. By the end of World War I, more than sixty countries accepted IRCs and agreed upon regulated postage-exchange rates that reflected the current rate of currency exchange. However, many European countries experienced high levels of inflation at the turn of the decade.
As a result, currencies from countries like Spain and Italy suffered significant devaluation relative to the dollar, though the IRC postage-exchange rates remained the same.
Furthermore, the IRC discrepancy provided Ponzi with an opportunity for arbitrage. Therefore, he developed his simple plan: He enlisted family and friends in Italy to buy the cheap IRCs and send them to him in the United States. Here, he would convert and redeem them to US dollars, a post-war currency of significantly higher value. In turn, Ponzi boasted that his net returns easily exceeded 400%, even after transaction costs.
Nothing in his plan was illegal, at least not technically.
Next, Ponzi borrowed money and sent it to his relatives in Italy, whom he asked to send back in the form of as many IRCs possible. Subsequently, Ponzi sold his arbitrage idea to several friends in Boston, promising that he would provide a 100% return in only ninety days. Ponzi used the funds that he collected to start a company that he registered as the Securities Exchange Company (SEC). (Ironically, his company shared its acronym with the Securities and Exchange Commission founded by the Federal Government a decade and a half later).
Originally, Ponzi limited his issue to notes bearing small principal amounts such as $50, $100, and $1000. However, once his business accelerated, he left a blank line on these notes to allow investors to enter whatever amount they wanted to invest. Through this new company, Ponzi offered investors a 50% return after forty-five days or a 100% return after ninety days on virtually any principal amount.
This offer encouraged a Federal postal inspector to visit Ponzi at his business. The inspector voiced the concern that selling millions of IRCs was not legal. In retort, Ponzi explained that the IRC coupons always could be exchanged in other countries outside of the jurisdiction of the US Post Office.
Though it looked great on the surface, Ponzi’s initial investment scheme did contain substantial holes. For example, in 1920, the nations that accepted IRCs announced new postal exchange rates reflecting a large devaluation in their currencies. Furthermore, the U.S. Post Office limited its issues of IRCs to ten per visit.
Due to the immense volume of IRCs needed per transaction to ensure a profit, the transaction costs eliminated any significant arbitrage profit. Because of these impediments, Ponzi would likely have realized that transporting, unloading, and redeeming the needed volume of IRCs at a post office would prove to be prohibitive. Furthermore, his confiscated business records indicate that he purchased only a small number of these IRCs.
Fortunately for Ponzi, most people had not used an IRC or knew much about them. This public ignorance masked the fundamental problems involved with IRC arbitrage. Therefore, investors quickly flocked into Ponzi’s office.
————————
Dr. John F. Sase teaches Economics at Wayne State University and has practiced Forensic and Investigative Economics for twenty years. He earned a combined M.A. in Economics and an MBA at the University of Detroit, followed by a Ph.D. in Economics from Wayne State University. He is a graduate of the University of Detroit Jesuit High School (www.saseassociates.com).
