Dream Investment or Nightmare Scheme?

Yaakov Frier was excited. Very excited. He’d found a solution to their struggle to save up money for a much-needed home addition project. There had been some chatting in the shul’s coffee room about an exciting new way to quickly double your money. It seemed like some company in Iowa had a finance system for farmers buying modern computerized machinery to improve crop yields and profits dramatically. Money loaned before planting season was doubly repaid after the harvest, some six months later. In the interim, the machinery and the entire crop was collateral on the investment. Yaakov didn’t know Iowa from Idaho, but a number of his neighbors had invested $5,000 the year before and indeed received checks for $10,000 just six months later.  Online research showed that the finance company had a beautiful office in downtown Des Moines and had sponsored many farm fairs and markets. Yaakov planned to send them his savings of $50,000 and looked forward to getting back his $100,000 check. Is this an investment opportunity or a pitfall?

Yaakov should actually be worried. Very worried. His dream investment may actually be a pyramid scheme (aka Ponzi scheme) which are quite common and exceptionally damaging. The Frum community is not immune to this financial disease, and multi-million dollar Ponzi schemes steadily circulate through our coffee rooms, online forums, and table chitchat. In fact, due to the trust Yidden tend to have in each other, we present an excellent target for “affinity frauds”: frauds which take advantage of a particular group based on religion, ethnicity, age, etc. Pyramid scammers hook their prey with innovative proposals which promise massive profits but inevitably, sooner or later, the “investments” collapse.  The trust which enables Ponzi schemes to spread quickly turns into a sense of betrayal: salt on top of the financial wounds. So, who was this Ponzi guy and what does he have to do with Yaakov’s farm financing investment?

Ponzi: From Famous to Infamous

Charles Ponzi was an Italian immigrant to the United States, who came to the new world in 1903 with “$2.50 in cash and $1 million in hopes”. Possessing an abundance of ego, charisma, and chutzpah, he expected to become rich and famous quickly. After bouncing around doing odd jobs and five years spent in jail for small-time frauds, he hit upon the scheme which for a short time did indeed make him fabulously wealthy and world-renowned. In 1919, Ponzi received a letter from Spain which contained an international postal coupon to cover the cost of return postage. Because of different currency values, this voucher, which cost the equivalent of 5 (US) pennies in Spain, could be redeemed in the US for 6 pennies, an immediate 20% profit. Ponzi figured that he could do this exchange on a massive scale, through agents buying millions of dollars’ worth of these coupons in foreign countries and shipping them for redemption in the US. The gains would be huge, and Ponzi began collecting money from investors promising returns as high as 30% a month!

Ponzis Inevitable Collapse 

Had investors done their research they’d have learned that Ponzi’s plan was impossible. As the Boston Post later reported, the postal authority had regulations in place preventing the speculative use of the coupons. Also, while Ponzi’s $15 million scheme would have required the purchase of tens of millions of postal vouchers, there were only about 27,000 of them in existence! A 1920 Federal audit of Ponzi’s books showed that he’d bought just $61 in coupons. An illusion of profitability was kept up by using inflows from new investors to pay “dividends” to previous investors, and the “financial wizard” was now $7 million in the red (equivalent to $175 Million in 2017!). Meanwhile, he used investor money to fund the purchase of a new mansion, a custom-built limousine and diamonds for his wife and in less than a year Ponzi had crashed several banks and financially ruined many thousands of people. After spending 15 years in prison, Charles Ponzi died alone in a charity hospital, but his name lives on in infamy as one of history’s biggest crooks.

Pyramids Built on Quicksand

Yaakov should learn from the Ponzi story that fancy offices aside, looks can be deceiving and the $10,000 checks Yaakov’s friends had received may be the bait being dangled to lure in the big fish. Ponzi was no financial wizard, but he was a marketing genius who played the role of a successful financier while leaving the actual selling to commissioned agents. Besides for a carefully cultivated image of success, the key to Ponzi’s rapid rise (and the heart of every pyramid scheme) was the fraudulent payment of non-existing “dividends” to early investors with funds from new investors. When Ponzi used the second group of investors to pay dividends to the first bunch, word of their good fortune snared an even larger third group of investors whose money was used to pay “profits” to the second group and so on. The cultivation of an ever-larger level of investors to pay the previous ones explains the pyramid nature of the scheme and also why it must collapse eventually when the fraudster runs out of available victims. But in its initial stages, when payments are flowing as promised, Ponzi schemes can look very legitimate and fool even sophisticated investors.

Warnings Of Ponzis In All Forms

While Ponzi schemes share some characteristics, criminal ingenuity has packaged them in an array of guises. Ponzi expert, Tamar Frankel, documents pyramid schemes in real estate, stocks, mortgages, synthetic rubies production, hydroponic farming, purchasing tropical islands, gold mines, oil, tax liens, and many others. Sometimes the pitch cleverly hides the investment component by offering instead a substantial discount on gift cards or even business supplies. While some schemes are easy to spot, Bernie Madoff, preparator of the most extensive Ponzi scheme in history, was able to fool thousands of very savvy people for decades!! However even Madoff’s scheme gave off warning signals for a long time before it went bust. Investors need to recognize these signs and reduce their chances of becoming another Ponzi statistic.