Ponzi Schemes

A Ponzi scheme is today known as an investment in a system that promises high credit ratings but in order to give these high claims, new investors are the ones paying the interests of the former investors. The system continues to operate while the flow of new investors continues to increase. At a time the flow of investors decreases the scheme can not afford the initial interest or the return of the money invested so the scheme collapses. Charles Ponzi, who is the innovator of the Ponzi scheme was born born in Parma, Italy in 1877 and migrated to Boston when he was 21 years in 1903 only to end up dying in a charity hospital in Rio de Janeiro, Brazil in 1949 in total poverty. This curious character is identified with a financial procedure which is called the Ponzi “scheme”.

How it started; When Ponzi noticed that the ticket he had received from Italy to travel to the US had been purchased in Spain he realized that the reason for this was that the price in Spain was exceptionally low due to the weaker currency at the time. The operation of arbitration offered a special benefit to Ponzi who soon was convinced that he could become a millionaire. He started spreading his discovery among his friends who he asked to participate in the business. With this single argument of business and an extraordinary power of persuasion, he convinced his friends to invest their money with him the promise of restoring their investment within 90 days with a direct interest of 45% on capital. In a few weeks a long line of people were wanting to invest in “Ponzi’s business” as they did not want the shame of being fools in the neighborhood who had not invested in a safe business.

He lived a few months of unbridled luxury, until inflows stopped covering the commitments made, and ended up in jail. He promised clients a 50% profit within 45 days, or 100% profit within 90 days, by buying discounted postal reply coupons in other countries and redeeming them at face value in the United States as a form of arbitrage. Ponzi started living in luxury and spending people’s money while he presented himself as a high profile business man that had a great idea. As long as the flow of new investors was positive his scheme operated normally but when the flow of new fools came to a pause, the problem arised; as the flow of money to cover yesterdays investors was not available. Ponzi was spending more than he was earning with hope that new investors would find interest in placing money with him and his scheme, but only to realize that paybals were soon exceeding receivables. 1970 Nobel Prize winner Paul Samuelson, had written a book about the Ponzi scheme correlating it with how the social security is bulit to work; in reality if you think about it; a ponzi scheme does not have much difference from the way modern social security systems work.