Sunday, 20 November 2011

PPF interest rate increase. Ponzi Alert! Like Social Security? (Part I)

Charles Ponzi was born Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi on the 3rd of March, 1882 in Lugo, Italy.  He grew up in Italy and came over to the US in 1903.  He started off by doing odd jobs, including working as a dishwasher in a restaurant and later waiting tables.  He then went to Montreal, Canada and worked in a bank for a while as a teller.  Here he got his first taste of handling other peoples money, until the bank failed and the bank promoter ran away to Mexico.  Penniless, Charles was soon driven to frustration, and he forged a cheque, was promptly arrested, and ended up spending a few years in prison.  It was here in prison, that he met his role model, Charles Morse, a wealthy wall street businessman with a penchant for swindling his clients. 

Wait a minute, you might ask!  What does this biography about Mr. Ponzi, have to do with the PPF rate increase in India?  And where does the Social Security angle come in to play?  Well read on my dear friend, and soon all will be clear. 

Let's get back to Mr. Ponzi.  He moved back to the US, got married, and tried his hands at several businesses that did not succeed.  He chanced upon an International Reply Coupon, and hit upon the idea of using this IRC in a form of arbitrage, which is not fundamentally illegal.  I could get into a bunch of jargon to explain what he was upto, but it could get too technical and obscure the real motive of his scheme.  Suffice it to say that he used the IRC scheme as a front to explain how his business made profits.  Basically he promised his investors that his business would be able to generate 50% profits in 45 days and 100% profits, effectively doubling your investment, in 90days!  Clearly any sane investor should know that such phenomenal returns are not possible, no matter how profitable your business is.  Still people fell for the scheme in droves and began to invest in Mr. Ponzi's company.  The beauty of his scheme was that, for his early investors, Mr. Ponzi truly returned 50% profits in 45 days, and doubled their money in 90 days.  Of course he did not have any underlying business at all, so there was no way for him to make any profits, let alone the astronomical profits he was promising.  So you might wonder, How did he manage to meet his commitments to his early investors?  Simple!  He took the money from his later customers, and gave it to his early investors as "profits".  In reality, there was no business, no investment and no profits.  All he did was collect money from more and more investors, and give a portion of it to his early investors as profits.  He used the bulk of the money collected to finance his own lavish lifestyle  He bought a huge mansion, and had air conditioning installed (a huge luxury in the early 1900s; akin to having your own personal helipad these days)  He maintained several personal bank accounts, and funneled the huge amounts of cash he was collecting into these accounts. 

The scheme was so well managed, that most investors did not have any inkling that something was amiss.  Many of his investors never actually cashed in the stupendous profits that they were supposedly making!  They were just happy receiving monthly paper receipts that showed how quickly their money was growing.  These were of course just worthless financial statements on paper, and there was no real money growth.  Still the documents looked formal enough to fool many investors, and several in fact rushed to add more money into the scheme, to benefit from the extraordinary  "returns". 

The first sign of trouble started coming in, when a few investors became suspicious about how Ponzi's business was making any money at all.  A finance writer in a leading newspaper of the time, published an article suggesting the whole scheme was a scam.  A few investors panicked and asked for there money back.  But Mr. Ponzi was a smart and daring operator.  Not fazed by this small setback, he quickly returned the money to these few investors along with the high interest amounts that he had promised.  He then sued the finance writer, and won the case in court.  At the same time, he ran several advertisements in leading newspapers extolling the virtues of his business, with testimonials from the few investors who had actually received money from him.  This in turn led to a new frenzy of investing in his firm, with more and more people flocking to put their hard earned money into his scheme, so they wouldn't be left out, from the phenomenal returns that their relatives and friends were supposedly making from Mr. Ponzi's business. 

Thus, he was able to run his scam for quite a few months, continually collecting money from more and more new investors, and using a small portion of it to pay off his early investors to keep them satisfied.  Most of the money simply went to support his lavish lifestyle and excessive spending habits.  In my next post, we will see how the scheme finally collapsed and its implications to his unfortunate investors.

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