15 January 2010

Ponzi Schemes: Growing and Collapsing

The picture of the man at the left is that of Charles Ponzi (taken in 1910) who had a pyramid money scheme named after him. A Ponzi scheme is a fraudulent investment operation that repays returns to investors from their own money or money paid by subsequent investors. Ponzi concocted the scheme in 1919 involving investments in postal currency, People were cheated out of $10 million . He was eventually jailed for wire fraud and deported back to Italy in 1934.

In 2009, according to The Associated Press, nearly four times as many of theses investor schemes fell apart as in 2008. The scheme is extremely simple: investors are attracted by promises of high profits paid with money from an ever increasing pool of new investors. There's no reserve fund.

Charles Ponzi became famous for using the investment technique in the early 1920's. He didn't invent the scheme: it was described in Charles Dicken's 1857 novel Little Dorritt. Ponzi took in so much money in his operation that he was the first person known for it throughout the United States and the fraud was named after him.

These Ponzi schemes usually collapse on themselves. Bernard Madoff had the ability to deceive individuals and institutional investors (as well as security authorities) for long periods of time. His variation on the Ponzi scheme is the largest financial investor fraud in history committed by a single person ($64.8 billion). Madoff pleaded guilty and is serving a 150 year prison sentence. More than 150 Ponzi schemes collapsed in 2009 including a $1.2 billion one by a dis-barred lawyer Scott Rothstein. These huge financial failures have resulted in many fraudulent schemes being brought to the attention of the authorities.

source: The Associated Press