Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi, a dapper 37-year-old Italian immigrant, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in 1919.
Ponzi conceived a unique arbitrage system and he thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons.
Ponzi told investors that he could provide a 40% return in just 90 days compared with 5% for bank savings accounts.
Ponzi was deluged with funds from investors, taking in $1 million during one three-hour period!
This bonanza started a frenzy that went beyond the Italian North End and spread throughout New England.
When Ponzi was exposed by the Boston Post, he had taken in $10,000,000 and purchased less than $30 worth of International Reply coupons.
He had been redeeming his promissory notes with new funds from would-be greedy investors standing in block-long lines to reach his 16 clerks.
Though a few early investors were paid off to make the scheme look legitimate, an investigation found that Ponzi had only purchased about $30 worth of the international mail coupons.
In 1920 Ponzi went to federal prison for using the mails to defraud and later to Massachusetts state prison for grand larceny.
Receivers for his bankrupt Securities Exchange Company paid back about 35 cents on the dollar after puzzling over his bookkeeping for years.
Ponzi died a pauper in Brazil in 1949.
Decades later, the Ponzi scheme continues to work on the "Rob-Peter-to-Pay-Paul" principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses.
Modern Ponzi scheme victims are less likely to be ignorant immigrants but are still vulnerable because they are preoccupied with other concerns. Doctors, entertainers, and retirees, for example, are frequent targets of Ponzi-scheme promoters.
What best describes and distinguishes a true Ponzi scheme is motive. If the promoters intend to milk investors by paying for borrowed money with more borrowed money, fully realizing that the pyramid must collapse, then it can correctly be characterized as a Ponzi scheme.