Who Would Give You The Skin Off His Back and Steal Your Eyeballs? Charles Ponzi.
I got several wrong guesses, but no one was able to correctly answer the question, "What is the name of the famous Italian financier who once donated 122 square inches of his own skin to help a young woman who had been burned after a gas stove burst into flames?" The answer is Charlie Ponzi, whose name is inextricably linked to the infamous scheme in which dollars are "borrowed" from new investors to pay old ones.
Almost everybody has heard of a Ponzi Scheme, but few people know the history of Charlie Ponzi himself. In 1920 when Ponzi was a newly married immigrant living in Boston, he became aware of international postal coupons. These were coupons issued by sovereign nations that could be exchanged for stamps in another country. The idea behind the coupon program was to promote international trade. Ponzi realized that the price of these coupons in Italy was so low, he could buy six cents worth of U.S. stamps for about the equivalent of one cent in Italian Lira. Ponzi thought if he could get enough money together to buy a bunch of these coupons and then sell the stamps, he could make a large profit. Unfortunately for Ponzi, none of the banks he talked to would loan him any money.
So he decided to turn to plan B. He rented a small office at 27 School Street in Boston and hired an Italian grocer to be his agent, and began selling Ponzi notes that promised a 50% interest rate in 90 days. A month later, he had his first set of investors. Eighteen people put up $1770 to invest in the first group of notes. According to Mitchell Zuckoff, author of Ponzi's Scheme, Ponzi would have had to purchase 53,000 coupons to invest the original $1770.
Somehow, Ponzi forgot his original intent was to use the cash to buy international postal coupons. Instead, he used money from new Ponzi notes to pay off the older notes. The early investors, delighted at the fast money, told their friends and many of them reinvested their profits into more Ponzi notes. And the cash continued to roll in. In April, Ponzi sold 471 notes, collecting over $140,000, and opened his first branch office to sell even more notes. May saw even more growth as 1525 investors bought over $440,000 worth of the Ponzi notes.
Ponzi, ever the showman, bought a large house and a fancy car as he got richer. In July 1920, Ponzi's business, the Securities Exchange Company, brought in over $6,500,000 from over 20,000 investors. Remember, that just eight months earlier, Ponzi had been refused a $2,000 loan, and now he was sitting on almost $10 million dollars. Adjusted for inflation, this equals roughly a billion dollars in today's money. The major newspapers of the day began following his rags-to-riches story. For a short while, Ponzi was perhaps the most famous man in America.
Of course, you know that a story like this must have a tragic end. The Boston Post eventually broke the story of Ponzi's prior prison record for forgery, and the paper published articles questioning the viability of his strategy. The Boston Post won a Pulitzer Prize for its reporting and Ponzi went to jail. Those still holding Ponzi notes after the money ran out eventually recovered only a fraction of what they invested.
I re-tell this story because the many parallels between Charles Ponzi and Bernie Madoff are important for investors to be reminded of today. While many of Ponzi's victims were Italian immigrants, many of Madoff victims were, like him, Jewish. It is just human nature to believe in people who are "like" us. Both Ponzi's victims and Madoff's victims ignored clear warning signs because they wanted to believe in these charismatic men. This is the classic confirmation bias that we discuss in chapters 7 and 8 of my book. And both Madoff and Ponzi attributed their success to a secret or "proprietary" trading mechanism or "black box" that they could not share with the public. (see page 121 of The Naked Portfolio Manager for more on this).
The story of Charlie Ponzi goes to show that it is clearly best to not put your confidence in charismatic men, secret trading strategies, or unexplainable "black boxes" when it comes to investing. Demand answers, and stick with clearly defined, transparent rules - what we call "naked strategies" - and you will be much better off as you develop your portfolio.
Almost everybody has heard of a Ponzi Scheme, but few people know the history of Charlie Ponzi himself. In 1920 when Ponzi was a newly married immigrant living in Boston, he became aware of international postal coupons. These were coupons issued by sovereign nations that could be exchanged for stamps in another country. The idea behind the coupon program was to promote international trade. Ponzi realized that the price of these coupons in Italy was so low, he could buy six cents worth of U.S. stamps for about the equivalent of one cent in Italian Lira. Ponzi thought if he could get enough money together to buy a bunch of these coupons and then sell the stamps, he could make a large profit. Unfortunately for Ponzi, none of the banks he talked to would loan him any money.
So he decided to turn to plan B. He rented a small office at 27 School Street in Boston and hired an Italian grocer to be his agent, and began selling Ponzi notes that promised a 50% interest rate in 90 days. A month later, he had his first set of investors. Eighteen people put up $1770 to invest in the first group of notes. According to Mitchell Zuckoff, author of Ponzi's Scheme, Ponzi would have had to purchase 53,000 coupons to invest the original $1770.
Somehow, Ponzi forgot his original intent was to use the cash to buy international postal coupons. Instead, he used money from new Ponzi notes to pay off the older notes. The early investors, delighted at the fast money, told their friends and many of them reinvested their profits into more Ponzi notes. And the cash continued to roll in. In April, Ponzi sold 471 notes, collecting over $140,000, and opened his first branch office to sell even more notes. May saw even more growth as 1525 investors bought over $440,000 worth of the Ponzi notes.
Ponzi, ever the showman, bought a large house and a fancy car as he got richer. In July 1920, Ponzi's business, the Securities Exchange Company, brought in over $6,500,000 from over 20,000 investors. Remember, that just eight months earlier, Ponzi had been refused a $2,000 loan, and now he was sitting on almost $10 million dollars. Adjusted for inflation, this equals roughly a billion dollars in today's money. The major newspapers of the day began following his rags-to-riches story. For a short while, Ponzi was perhaps the most famous man in America.
Of course, you know that a story like this must have a tragic end. The Boston Post eventually broke the story of Ponzi's prior prison record for forgery, and the paper published articles questioning the viability of his strategy. The Boston Post won a Pulitzer Prize for its reporting and Ponzi went to jail. Those still holding Ponzi notes after the money ran out eventually recovered only a fraction of what they invested.
The story of Charlie Ponzi goes to show that it is clearly best to not put your confidence in charismatic men, secret trading strategies, or unexplainable "black boxes" when it comes to investing. Demand answers, and stick with clearly defined, transparent rules - what we call "naked strategies" - and you will be much better off as you develop your portfolio.
1 Comments:
This is a great story of greed run rampant. Didn't P.T. Barnum say there is a sucker born every minute? In my Heroes book we have a chapter on evil, and now I wish I had included a section on Charlie Ponzi. Thank you, Bob, for ever reminding us of the importance of taking emotion out of the equation and sticking with Naked strategies of investing.
Post a Comment
<< Home