Ponzi scheme: what is it – Dictionary of Economics

Ponzi Scheme Definition

The Ponzi scheme is a fraudulent investment operation that involves paying interest to investors on their own invested money or the money of new investors. This scam consists of a process in which the profits obtained by the first investors are generated thanks to the money contributed by themselves or by other new investors who are deceived by the promises of obtaining, in some cases, great profits. The system works only if the number of new victims grows.

Ponzi History

Although similar systems had been created before, the name of this scheme comes from the Italian Carlo Ponzi and the scam he carried out in 1920.

Carlo Ponzi was an Italian émigré who came to the US in the 1920s. Shortly after being in his new country, he discovered, thanks to an email he received from Italy, that international postal reply coupons could be sold in the United States more expensive than abroad, so the exchange rate would end up produce profit. As the rumor spread, many decided not to stay out of business and supported Ponzi with capital.

But even though Ponzi was collecting staggering sums of money and people were queuing up to trust him with their savings, Carlo Ponzi wasn’t really buying the coupons; he was paying profits of up to 100% in three months using the capital of successive new investors.

Ponzi convinced friends and associates to support his system initially, offering a 50% return on investment in 45 days. Some people invested and then got what was promised within the agreed time frame. The news began to spread, and the investment average began to grow. Ponzi hired agents and paid generous commissions for every dollar they could bring in. In February 1920, Ponzi made about $5,000, equivalent to $58,000 today.

In March he already had about 30,000 dollars. Mass hysteria was building and Ponzi began to spread to New England and New Jersey. In his time those who invested obtained great benefits, and these investors spread the word and motivated others to invest.

By May 1920, he had raised some $420,000. Ponzi began depositing his money at the Hanover Trust Bank of Boston (a small Italian-American bank on Hanover Street and mostly north of Italian Street), hoping that over time he might become president. of the bank or could impose its decisions on it; he actually managed to control the bank by buying his shares.

In July 1920 he already had millions. Many people sold or mortgaged their homes in the hope of earning high interest rates. On the 26th of that month, a large part of the plan began to sink after the Boston Post questioned the practices of the Ponzi company. Finally, the company was intervened by the State, which stopped all the new fundraising. Many of the investors angrily demanded the money from him, at which point Ponzi returned their capital to those who requested it, causing a considerable increase in popular support for him: many proposed that he enter politics. Ponzi’s emporium and dreams grew even more because he even planned to run a new type of bank, in which profits would be shared equally between shareholders and those who deposited money in the bank. He even planned to reopen his company under a new name “Charles Ponzi Company”, whose main objective was to invest in companies around the world.1

Thanks to this scheme, Ponzi began to live a life full of luxury: he bought a mansion with air conditioning and a heater for his pool, and also brought his mother from Italy in first class. Very soon this low-income immigrant obtained not only a great deal of money, but he also showered himself with the most extravagant luxuries for his wife and himself.

In August 1920 the banks and media declared Ponzi bankrupt. He himself later confessed that in 1908 he had been a party to a very similar swindle in Canada, offering investors huge profits.

The federal government of the United States finally intervened Ponzi and, his scam discovered, he was sent to jail but had to be released since he paid his bail in two different prisons and decided to continue with his system, convinced that he could sustain it. Very soon the system fell and the savers lost their money. Most people did not get the benefits, many of whom reinvested their money in the scam. Ponzi, even though he was sent back to Italy and even though the scam was discovered on him, was hailed by many as a benefactor.