In a Ponzi scheme, potential
investors are wooed with promises of unusually large returns, usually
attributed to the investment manager’s savvy, skill or some other secret sauce. The returns are repaid, at least for
a time, out of new investors’ principal, not from profits.
This can continue as
long as new investors line up with cash, and old investors don’t try to
withdraw too much of their money at once.
Ponzi schemes are also known as
pyramid schemes, from the shape of any chart that reflects their basic premise
— that ever-growing layers of new recruits are needed to provide gains to the
smaller, earlier cohorts. A gigantic pyramid scheme virtually bankrupted
Albania after the fall of Communism.
Ponzi schemes are named after
Charles Ponzi (pictured above), the flamboyant con man whose scam followed a
particularly spectacular course. Mr. Ponzi began telling New York investors in
December 1919 that investments in foreign postage coupons could yield 50
percent returns in 45 days. By redeeming coupons bought cheaply overseas for
much higher amounts in the United States, he could double their money in three
months, he claimed.
Mr. Ponzi was a fast-talking
immigrant and college dropout, and his scheme — according to Mitchell Zuckoff,
Mr. Ponzi’s biographer — rested on the eagerness of ordinary working people to
benefit from the wealth they saw being generated around them as the economy
recovered from World War I.
Mr. Ponzi was convicted of mail
fraud in 1920 and served time in federal and state prisons before he was
deported to Italy in 1934, never having become a citizen. He died penniless in
Rio de Janeiro in 1949 and was buried in a pauper’s cemetery there.
The $65 billion fraud that Bernard L. Madoff perpetrated has been called the
largest Ponzi scheme in history. Though the magnitude, scale and details are
different, Mr. Ponzi’s scheme and Mr. Madoff’s fraud each reflect their
respective, super-heated financial eras.
Source - nytimes.com
