Ponzi

Ponzi circa 1920

Ponzi circa 1920 (Photo credit: Wikipedia)

Ponzi, The Incredible True Story of the King of Financial Cons by Donald H. Dunn. Carlo (Charles) Ponzi, born in Italy in 1882 and died in 1949 in Rio de Janeiro, Brazil, did not invent the Ponzi scheme, but he gave it its modern-day fame. I purchased this book when the Bernie Madoff scandal was in full flower, but I did not get around to reading it until after Barack was re-elected. Ponzi’s life is a fascinating tale of small successes and many failures until he had an inspiration.

He discovered that postal coupons purchased in one country could be used in another country, and thus exploit currency exchange rate differences. Huge percentage profits were possible, but the dollar amounts were small. Ponzi decided to proceed as if dollar profits were unlimited. He sold notes to buyers who were promised a 50% return on their money, at first after 90 days and later reduced to 45 days. When the banks were paying only 4% in 1920, word spread rapidly that Ponzi was paying 50% every 45 days. Lines started forming as people rushed to take advantage of the get-rich opportunity that Ponzi offered.

For 6 months, Ponzi prospered and then the wheels started to come off. Ponzi refused to reveal how he was redeeming the postal coupons that he claimed were the source of his profits, as similarly Bernie Madoff refused to reveal how his stock buying and selling could consistently beat the market in both Bull and Bear markets. To succeed for a time, a Ponzi scheme must grow in size as new investors’ money is used to pay off older investors. Eventually someone will question how such large operations function without leaving a trace of evidence of doing what they say they are doing. There were not enough postal coupons in the world to support Ponzi’s operation, and the stock tickets supporting Bernie Madoff’s operation were counterfeits.

During the GOP primary season, there were accusations that Social Security is a Ponzi scheme. Untrue. All the numbers supporting Social Security revenues and obligations are known and public information. In a true Ponzi scheme, the operator refuses to tell how he/she generates the extraordinary returns. Mitt Romney’s tax proposals where he refused details more closely resembled a Ponzi scheme than Social Security does.

No One Would Listen

Charles Ponzi (March 3, 1882–January 18, 1949)...

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No One Would Listen, A True Financial Thriller by Harry Markopolos. The Bernie Madoff story written by the whistle blower who brought him down and sent him to prison. Seldom do I read a true life tale as good as this one is, that I hated to see it end because I learned so much.

Harry Markopolos worked for a firm on Wall Street that competed with Bernie Madoff in the hedge fund business. His co-workers and superiors asked him to design a product that they could sell to compete with Madoff. After months and years of trying, he decided that he could not design a legal product that would show the consistency and the high returns that Madoff claimed. Markopolos and a small team worked on their own time for no compensation to discover how Madoff operated. They concluded either that he was violating the law by front-running, which is insider trading, or more likely that he was operating a Ponzi scheme.

Markopolos approached the SEC repeatedly over the years and was ignored. It took the Great Recession to bring down Madoff when redemptions outran new deposits in his scheme. The total losses will never be known because some of the victims don’t want their losses know. It is estimated that the losses exceeded $65 billion dollars. Markopolos lists in great detail the flaws in the SEC with suggestions for improvement. Mary Schapiro, the current head of the SEC, is trying to improve the performance of the agency. It would informative to get Markopolos’s opinion on how she is progressing.

Harry caught the fraud investigating bug and has devoted himself to it full time since the Madoff case. He devotes his time to discovering fraud in the financial world and in health care, by which I think he is referring to the pharmaceutical industry. Here is a paragraph from the book.

“…from the pharmaceutical world, which I had discovered was ripe with fraud. As I had learned in my investigations, the health care industry makes Wall Street look honest. It’s a $2-trillion-a-year business with no controls and with limited auditing. On Wall Street the crooks at least have the decency to try to hide their frauds, but those people cheating Medicare don’t even bother doing that. Wall Street is only taking your life savings, but in health care they may be stealing your life. I was surprised to discover how little ‘care’ there is in health care. It’s obviously no surprise that the pharmaceutical industry is a completely profit-driven business, but the methods companies devised to earn some of the profits were surprising—and in the case I discovered, illegal.”