What Do European Stamps and Secret Stock Trading Strategies Have in Common?

Carlo Ponzi

Everyone has heard about Bernie Madoff, the former President of the NASDAQ stock exchange who swindled $50 billion from would-be investors.  The scope of the fraud was new, but the format was not.  Madoff’s ponzi ran out of gas as the global financial crisis deepened and the onslaught of redemption requests intensified.

Ponzi schemes, which promise high profits from fictitious sources, have been around since the 17th Century.  They spring up all over the world, and vary in scale.  In the 1990s, for example, two-thirds of the population of Albania poured $1.2 billion into Ponzi schemes, some of which were endorsed by top government leaders. (See Wikipedia or The Week, January 30, 2009, for interesting historical details)

The scam’s name comes from Carlo Ponzi (photo above), who immigrated to Boston from Italy in the early 20th Century and promised to double investors’ money in 90 days.  More about him later…

Here is how Ponzis work: The operator of the scheme sits at the top of a “pyramid” by bringing in a small number of early investors.  High dividends are paid to this first wave of investors from funds invested from the next round of investors, and so forth and so on.  The operator either milks money from the the start or waits until the “house of cards” is about to fall to extract his fortune and get out of dodge.  What all Ponzi schemes have in common, according to Carlos Ponzi biographer, Michael Zuckoff, is “a three-step playbook: splash, cash, and dash.”

Carlo Ponzi, who’s name is forever linked to this form of fraud, told American investors he could double their money in three months by buying and selling European postage stamps.  He was so successful in netting cash, that at one point he was able to raise $1 million in investments in just three hours.  (In the early 1900s, this was a boatload of money)  Unsurprisingly, Ponzi’s $15 million fraud came crashing down after only nine months.  It turned out he had only purchased $30 worth of stamps.

Why do such schemes seem to play out again and again?  Greed is part of the answer, but does not account for it all.  Most successful Ponzi schemes play on networks, peer pressure, and a sense of entitlement and being on the inside.  John Bennett (Foundation for New Era Philanthropy) in the mid-1990s touted his faith credentials to lure some of the most respected Christian organizations in the world into his investment scheme before his “house of cards” collapsed.  Bernie Madoff pursued a similar strategy, netting investors from his religious community, wealthy Jewish philanthropists with whom he socialized at his Palm Beach country club.

Given this short history lesson, what can we learn?

• If something sounds too good to be true (except God’s grace and mercy), it probably is;
• If assets are not held by an independent, third-party custodian who can verify their existence, “run for the hills,” and call the SEC while doing so.
• Honesty rewards; dishonesty bankrupts.  It isn’t always so immediately but is always true in the long term.  As Proverbs 21:5-6 reminds us,

“The plans of the diligent lead to profit as surely as haste leads to poverty.  A fortune made by a lying tongue is a fleeting vapor and deadly snare.”