ECONOMIC ANALYSIS:

Thinking About Ponzi

I’ve been thinking about Ponzi. Actually I’ve been thinking about schemes/pyramids, the press, governmental investigations, the past, and our present dilemmas. As the summer of 2008 progresses, there is a growing undercurrent of concern gnawing at the very foundations of our financial/economic systems. Page one news stories talk of losses and write-offs in the mega BILLIONS. The investors of the planet played fast and loose with money they had (or money they leveraged). Their judgment was clouded by visions of easy money and big returns. Now they see mountains of losses, not profits. They are wary of being bitten or taken twice. Such hard-learned caution will prove a major obstacle to any long-term recovery or any quick turnaround.

You see, Charles (Carlo) Ponzi (1882-1949) is forever identified with the pyramiding scam which bears his name. Ponzi was a wheeler-dealer from the moment he got off the boat from Italy in 1903. He soon relocated to Canada, where he worked as a teller at a bank that was growing by leaps and bounds because it paid more money in interest than its competition. He saw that the “premium” being paid was financed by new deposits, not from operational profits. The game worked only as long as a steady stream of new money and customers underwrote any would-be withdrawals of the earlier deposits. Rollovers and continued cash infusions were essential. The bank eventually failed, and Ponzi’s boss fled Canada with the remaining funds. Ponzi was apprehended and ended up doing time for an unrelated check fraud rap. Still... he had learned much from his former employer!

After his release, Ponzi relocated to the US, where he was soon arrested for smuggling in illegal immigrants, and he served two more years. Upon his release, he settled in Boston, where he came up with a money-raising scheme involving international postage reply coupons—effectively selling “prepaid return postage stamps.” He promised a 50% return on a 45-day investment, paying lucrative commissions to his sales force for every friend and family member they enticed into investing. He started his own company, the Securities Exchange Company (the SEC!) to promote the scheme. (Has a nice “ring” to it, don’t you think?)

His take in Feb. 1920 was $5,000, by March it was $ 30,000, by May it was $420,000—and by July his take was in the MILLIONS; by then he was raking in $250,000 a day!

An alert local press and government began to question (and investigate) his money-making model. On Aug. 10, the Feds shut down Ponzi’s “SEC,” and on Aug. 13 he was arrested and charged with 86 counts of fraud. He pled guilty to mail fraud on Nov. 1 and was sentenced to five years in prison. He served three and a half years, only to be sentenced to nine more years on state charges. He was ultimately deported in 1934.

Ponzi’s flash-in-the-pan pyramid scheme pales in comparison to the complexity and sums of money involved in the financial shenanigans that are unwinding/unraveling before our eyes some 80 years later. His mess was local to New England. Our messes are nationwide and global. Still... there are similarities—and differences—to the Hell Ponzi had wrought, and the looming crises “we” face.

In substance over form, both scenarios necessitate an ongoing and increasing influx of new money and investor/lenders to keep the “engines” chugging away. This is far more critical than the greed-driven quest for easy money and a fast buck. To present and future would-be investors, loss of large returns today is not as devastating as the fear of losing principal (or investment basis).

How is the housing crisis to be solved without new buyers armed with fresh borrowings? How can GDP consumption continue (much less grow) based solely on earned incomes? How will retirees draw on promised retirement benefits without the ongoing influx of future workers’ tax withholdings? How will retired autoworkers draw their pensions without profits from future car sales? How will Uncle $ugar re-finance any weekly redemptions and additional borrowings from our national debt without the continued/expanded largesse of foreign creditors? Ditto for our ballooning trade deficits.

Ponzi’s victims had to eat their losses, but at least he did time for his crimes. Has anyone this time around really been indicted yet?

I’m Fred Cederholm and I’ve been thinking. You should be thinking, too.

Copyright 2008 Questions, Inc. All rights reserved. Fred Cederholm is a CPA/CFE, a forensic accountant, and writer. He is a graduate of the University of Illinois (B.A., M.A. and M.A.S.). He can be reached at asklet@rochelle.net.