Beware of the Ponzi

The pleas of guilty of American financier Bernard Madoff to running a $50 billion fraud offering to pay suspiciously high interest in good and bad times has had everyone nodding their heads wisely saying, ‘Oh, yes, a Ponzi’. But what is a Ponzi, who was he and how does a Ponzi work?

In fact the scheme—basically robbing Peter to pay Paul —had been in operation long before Italian born Charles Ponzi. A Ponzi should really be called a Miller because it was William Miller, born in 1874, who was the man credited—if that is the right word—with the first modern version of scheme. And now as then it is all about greed — the greed of the unfortunate investors who think they are getting more than other people and, at the bottom, end up losing their savings for what often amounts to a potential gain of the price of a pint of beer a week.


First, Miller developed a credit rating by repaying his debts and then set himself up as an investment adviser in Brooklyn, New York. He was also helped by the fact he taught a bible class and persuaded his flock that he could obtain them ten per cent interest on their investments. When they replied incredulously that this was four times what banks paid, he announced that he was offering ten per cent per week - or 520 per cent per annum.

He set up the Franklin Syndicate, trading on the name of the late statesman, and the first investors were repaid their interest promptly. Now money poured in to an extent that he was making around $430,000 a month. There were, however, hiccups and to avoid being exposed he was obliged to pay protection money to an Edward Schlesinger. Then, when it was clear the scheme was running out of steam, he gave what he said was his entire remaining capital of $240,000 to lawyer Robert Ammon and, on the understanding Ammon would send him regular payments, he fled to Canada. The lawyer never did. Miller was retrieved in February 1900 and in June sentenced to ten years. The term was reduced when in 1907 he gave evidence against Ammon, who was also charged with fraud. Miller disappeared shortly afterwards with, it was suspected, money he had held back from Ammon.

Charles Ponzi, who went to America from Italy at the end of the 19th century, discovered he could buy international postal reply coupons in some countries at below face value. They could then be resold in the United States at a profit of up to 50 per cent. His first venture netted him $1,250.

Now, based on this scheme, he offered investors 50 per cent on their money, payable in three months which was later cut to 45 days. Once he started paying the interest, more money poured into his offices. He bought land and a brokerage company and, for himself, 200 suits, 24 diamond stick pins, 48 gold handled Malacca canes and a lifestyle to go with them. Then in 1920 the Boston Post printed an article that Ponzi had served time for cheque frauds in Canada and also for smuggling immigrants. The rot set in, particularly when it was shown there were not enough International Reply Coupons in the whole world to back his scheme. The default was reckoned to be somewhere between $5 million and $10 million, but it could have been more.

He was sentenced to five years and then a further conviction followed in Massachusetts. While on bail he absconded to Florida, where he began a land swindle. It was then on to Texas before he was sent back to Massachusetts. After he had served that seven-to-nine-year sentence he was deported to Italy where he is thought to have swindled the government. He made his way to Brazil where he worked for an airline, ran a hot dog stall and, before his death in a charity ward in Rio de Janeiro in January 1949, taught English and French.

From then on the scam became known as the Ponzi Swindle, and over the years they have turned up on a regular basis in one form or another. One in Portugal, paying a relatively modest 10 per cent, was run by Maria Branca dos Santos for nearly fourteen years from 1970. She received ten years in 1988. In September 2003, Reed Eliot Slatkin, an ordained minister of the Church of Scientology in America, was sentenced to fourteen years following a Ponzi which had taken upwards of $200 million, said to be the largest since the ones run by the great man himself. Now it has been consigned to the peanut heap by Madoff. Some of the money had been sent to various of their churches and Scientology agreed to refund $3.5 million.

In Madoff’s case, given he pleaded guilty and, for the present at any rate, has denied that anyone else was actively involved — something which is difficult to accept — it may be years before the exact workings of his scheme are unravelled. He claims to have started his finance house in 1960 with $5000 savings from his work as a Long Beach lifeguard. At one time he was a non-executive director of NASDAQ. At present he claims money went straight into a bank rather than the market and straight out again to pay the astounding 46 per cent interest and to finance his lifestyle which included the obligatory aeroplane and boats.

A successful Ponzi — or should we now call it a Madoff? — relies on the charisma of entrepreneur and product, high rates, initially prompt payment of interest, an ability to deflect searching inquiries by investors and, throughout, unwillingness to return capital, staved off by offering those investors slightly better terms to those of their original payment.

It also relies on the greed and even tacit complicity of the investor who is led to think that he or she is getting information not available to those outside the scheme. Indeed with many frauds there is a degree of complicity between the promoter and the punter. All of us by now have been offered a share of money in a Nigerian bank account of which the government knows nothing, the Tsunami money which has gone missing or the sack of Al Qaeda gold discovered in Afghanistan. We are invited to participate in victimless crime and most Ponzis slyly invite us to benefit through an implied insider trading or similar edge.

Is a Ponzi really any different from a chain letter or a bubble, two other well known scams? Not really, they are all brothers or sisters. The chain letter must eventually fail because there are not enough people in the world to subscribe just as there were not enough International Reply Coupons in Ponzi’s day. The bubble, which involves artificially boosting the price of a company’s shares, will always burst because the promoters will want their money out and the bottomless diamond or gold mine which was both the cornucopia and the magnet for the investors will turn out to be worthless. History will always repeat itself. Think of the South Sea Bubble and the Mississippi Land purchase two centuries ago.

How do you avoid being the victim of a Ponzi or any other scam for that matter? Apart from the really mean fraudsters who pretend to be the gas meter reader to obtain entry into an old lady’s house or pose as an Afghanistan veteran, the only reason that scams succeed is because the victim is greedy. Greedy for money or sex or both. If building societies are only paying 2 per cent interest why should we be s ingled out to be so lucky to be paid 10 per cent? Why should this gorgeous looking creature on the website be interested in nerds like us? Answer: Because he or she wants our money.

One thing, however, is certain. Someone, somewhere is at this very minute working out the details of yet another Ponzi. What we have to make sure is that we are not among the future victims. And not being lured by the siren call of big returns or illusory sex is the way to do that.