A variation of the pyramid scheme is the Ponzi scheme, made infamous by Italian immigrant Charles Ponzi in 1920s Boston. A Ponzi scheme also relies on recruiting, but unlike a traditional pyramid operation, there is no product and no commission for recruiting. Instead, in a typical Ponzi operation, the con artist presents potential investors with a phony investment opportunity and promises them an extravagant rate of return on their money.
Because there is no real investment opportunity, the perpetrator pockets a portion of the money and uses the rest to pay off other investors. This last point is important, because it is responsible for both the success and the eventual failure of the Ponzi scheme. The success of a Ponzi con lies in its ability to fool people into thinking it’s actually working. In other words, if you’ve paid into an investment and you start to receive money back, you are a happy investor. This method of “robbing Peter to pay Paul” ensures that Paul will remain your best friend – as long as the payments keep coming.
Charles Ponzi’s swindle is the textbook example. Ponzi, a charming and resourceful ex-con, hatched a scam in 1919 involving international reply coupons, essentially pre-paid postage coupons that could be used around the world. As Ponzi explained to his clients, his investment involved a complicated plan to take advantage of price discrepancies by buying the coupons on the cheap overseas and redeeming them for a profit in the United States. He promised investors that he could double their money in three months, a remarkable feat.
Many of his early investors were, like him, Italian immigrants. They trusted Ponzi and found his proposal irresistible. The money began pouring in, and Charles Ponzi began living the high life. Many of his investors were persuaded to reinvest rather than cashing in their profits. When they did ask to be paid, he simply used money from other investors to cover the payments. For a time, the scheme prospered. Hopeful investors, large and small, lined up to put their money into Ponzi’s hands.
In the end, however, Ponzi’s plan was doomed, as is the case with all pyramid and related cons. Ultimately, the debts will always exceed the profits. Moving money around can only go so far. At the beginning, incoming funds can cover occasional payments to investors, but as the number of investors grows, the elaborate juggling act that is the pyramid or Ponzi scheme will inevitably fail. Increasing scrutiny from the media and the authorities finally led to Charles Ponzi’s arrest and imprisonment on charges of fraud. He eventually left the United States and died a pauper in Rio de Janeiro.
Charles Ponzi was not the first to initiate a bogus investment scheme, and he certainly was not the last. In one of the most high-profile Ponzi schemes of all time, New York fund manager Bernard L. Madoff was accused of perpetrating a $50 billion scam affecting thousands of individuals, non-profits, foundations and educational institutions.
Madoff, once a respected Wall Street financier, is alleged to have maintained an elaborate international Ponzi scheme disguised as a highly convoluted investment fund that no one but he could understand. In 2008, as the U.S. economy began its downward spiral and investors began looking to pull out their cash, the entire operation fell apart. It was later discovered that in true Ponzi fashion, Madoff had not actually bought any stock with his clients’ money. After the swindle came to light, victims confessed that they had never really understood the financial statements provided to them by Madoff, but simply assumed everything was above board because their investments, at least on paper, were thriving.