Charles Ponzi was an Italian immigrant with a checkered history that involved fraud long before founding the Security Exchange Company to conduct the international postal reply coupon scheme that would immortalize him. Ponzi immigrated to Boston in 1903, however, in 1907 moved to Montreal, and worked as a teller at the Banco Zarossi, a rapidly growing bank that offered a 6% interest rate on accounts, which it paid for with the deposits of new customers. Banco Zarossi soon collapsed, and its owner, Luigi Zarossi, fled to Mexico with depositors’ money. [Messinger, Sugarman, Cramer. The Forewarned Investor. Career Press. 2006]
Ponzi spent 3 years in a Montreal prison for forging a check, only to return to the U.S. to spend an additional 2 years in prison for violating immigration laws. Ponzi resettled in Boston upon release, and in 1919 stumbled upon the scheme that would transform him into a legend. In August 1919, Ponzi realized that international postal reply coupons (IRC) could be redeemed in the U.S. for a greater amount than their purchase price. By December 1919, Ponzi registered the Security Exchange Company, but rather than exploit the exchange rate of IRCs, Ponzi exploited up to 40,000 investors, many of whom gave Ponzi their life savings, due to his promise of a risk free investment with enormous returns. [Donald Dunn. Ponzi. Broadway Books: NY. 2004]
Charles Ponzi paid enormous returns to his early investors with money raised from later investors. The scheme was not original, however, it took on Ponzi’s name, due to the magnitude of his scam. The Ponzi scheme has become one of the most notorious forms of investment fraud, and, according to Michael Clark, a Houston based lawyer who specializes in white collar defense, it also became the basis for the sub-prime mortgage financing that triggered a global financial meltdown. ["From Subprime Collapse to Credit Market Implosion and Beyond" by Michael Clark. Oct. 21, 2008. Securities Law Blog]
Sub-prime mortgages, mortgages worth 100% of the value of a property, became a hot market in finance in 2000. Mortgage lenders competed to loan money to the riskiest borrowers, which was deemed a safe and profitable act, due to the securitization of the loans. Mortgage lenders would quickly repackage the sub-prime loans into Mortgage Backed Securities (MBS), which would then be sold to an investment bank, which would then divide the MBS into Collateralized Debt Obligations (CDO) to achieve credit ratings that would enable them to be sold on international markets. ["Sub-prime Mortgage Collapse" by Paul Tustain. Money Week. Sept. 5, 2007]
Mortgage lenders enticed increasingly risky borrowers to participate in the sub-prime market with profits from the sale of MBS. As more individuals bought houses with sub-prime mortgages, the housing market boomed, and inflated the values of the CDO, which encouraged more sub-prime lending. The housing bubble, however, had the same architecture of a Ponzi scheme, and was doomed to collapse. ["Old Wine in New Bottles" by Mah Hui Lim. JARAF. Vol. 3 No. 1. 2008] Individuals inevitably began to default on their loans, and the value of real estate plummeted, which resulted in enormous losses for global financial institutions.
In 1920, Charles Ponzi became an instantaneous millionaire with an investment scam that delivered high returns to early investors by leaving later investors penniless. In 1949, Ponzi died in poverty. Charles Ponzi’s scheme, however, lived on to become a basic accounting principle on Wall Street, and is still claiming victims.
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