The real Ponzi behind the scheme

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(Fortune) -- Charles Ponzi wouldn't have thought much of Bernard Madoff.

Legendary Wall Street trader Madoff reportedly admitted last week that his success was

an illusion, a fraud in which investors were paid not with the fruits of his own acumen, but

with money from other investors. Prosecutors quoted Madoff as telling an associate that

his $50 billion business was "basically, a giant Ponzi scheme."

Nearly 60 years after his death, Ponzi still has plenty to answer for. But if the allegations

against Madoff are true, he has tarred what little was left of Ponzi's semi-good name. That

might come as a surprise to people who consider Ponzi synonymous with fraud. But his tale

is more complicated, and more nuanced, than that.

In 1903, Ponzi was a 21-year-old good-time-Carlo who had squandered his inheritance and

washed out of the University of Rome. He boarded the S.S. Vancouver with $200, bound

for Boston, but by the time the ship landed a cardsharp had relieved young Ponzi of all

but $2.50.

For the next 14 years, Ponzi roamed throughout the U.S. and Canada, seeking fortune and

adventure but more often finding poverty and misadventure. Clever and charismatic, at

various times he was a hero -- saving the life of a young nurse by literally giving her the

skin off his back for primitive, but successful, skin grafts -- and a criminal, serving time for

passing a bad check and for helping fellow Italians to sneak into the U.S. from Canada.

When he returned to Boston in 1917, Ponzi was still seeking his big break. First, though, he

fell in love with a beautiful woman named Rose Gnecco. All she wanted was a little house

filled with children, but Ponzi wanted her draped in diamonds and furs.

He tried and failed at several businesses. Then, in late 1919, he opened a letter from an

acquaintance in Spain. Pinned to the corner of the letter was an International Reply Coupon,

an obscure little document that could be used to purchase a postage stamp at a fixed price

in 63 countries that were members of the Universal Postal Union.

A lifetime of experiences coalesced in Ponzi's mind -- among other jobs, he had worked as

a bank teller and a clerk for an import-export company, and was a hobby stamp collector.

He knew that European currencies had been depressed by the Great War, so the value of

the coupon would fluctuate depending on where it was bought and where it was used. For

instance, a person could buy 66 International Reply Coupons in Rome for the equivalent

of $1. Those same 66 coupons would cost $3.30 in Boston. If he could buy coupons in Rome

and trade them in Boston, Ponzi could earn 230% profit, before expenses, on every $1.

In essence, Ponzi was thinking arbitrage. Best of all, it was technically legal.

First, though, Ponzi needed seed money to buy coupons in bulk. He hung out a shingle as

the Securities Exchange Co. (more than a decade before the creation of the federal Securities

and Exchange Commission). Thousands of investors responded to his promise of 50% return

in 90 days, soon doubled to 100% in 90 days -- well within his theoretical business model.

Over the next seven months, Ponzi collected roughly $8 million (about $100 million today)

and became one of the most talked-about men in the U.S. Imitators quickly followed, with

one especially brazen group opening an office down the hall from his, prompting Ponzi to

proclaim that he was the "real" financial wizard amid a sea of fakes.

Problem was, Ponzi never figured out how to translate his idea into reality. There weren't

enough International Reply Coupons in circulation to carry out the plan, and even if there

were, the logistics would have been impossible. Fifty-three-thousand coupons would have

been necessary just to satisfy the first 18 investors.

In the meantime, he bought Rose a mansion, tooled around in a luxury car called a

Locomobile, invested in banks and businesses, and brought his mother over from Italy.

Hardly the moves of a take-the-money-and-run swindler. Indeed, there's considerable

evidence that, when he realized the coupons were unworkable, Ponzi was seeking a

legitimate way to repay all his investors, ideally with the promised interest.

Soon, though, lethargic regulators were roused to action by a suspicious newspaper editor.

By August 1920 they proved that Ponzi had been repaying investors whose notes came due

with money from more recent investors. The move had long been called "Robbing Peter to

Pay Paul," but would henceforth be known as a Ponzi Scheme.

Why then would Ponzi -- whose fall took him from pinstripes to prison stripes -- look down

on Madoff? Remember, Ponzi started with nothing and thought he had found a legitimate,

if far-fetched, road to riches. If the allegations against Madoff are true, he enjoyed great

success but couldn't deign failure. Prosecutors say that when he began losing money, he

indulged in greed and hubris to create imaginary profits. He allegedly knew all along it was

a scheme, and it only unraveled when the economy turned, his investors sought their

money, and he tried to siphon off a last few hundred million for undeserved bonuses.

Sure, it bore a certain resemblance to Ponzi's downfall. But be fair and call it a Madoff scheme.

Source

[Trumplestiltskin 5,791]

Charles Ponzi

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