Ponzi Schemes Throughout History

By Becky Laughner

Ponzi schemes have captured the tors to support the fictitious returns. Instead, Ponzi paid dividends on his public’s attention recently with the The Museum’s new exhibition, “Scan- notes with money collected from subse- fall of Bernard Madoff’s investment dal! Financial Crime, Chicanery and quent investors, which in turn required Robbingfund, which, at approximately $36 PeteCorruption that rRocked to America,” Payhim to find yet Paulmore investors to cover billion, is the biggest financial fraud focuses on the most infamous Ponzi his increasing liabilities. Ponzi realized in history. The principle behind a artists: Charles Ponzi, Ivar Kreuger that such a plan is not an easy under- Ponzi scheme is simple. The Secu- and . taking, but he had confidence and rities Exchange Commission defines cunning in spades. He also concocted it as investment fraud involving the The Original Ponzi Artist a plausible investment strategy. payment of returns to existing inves- The eponymous Charles Ponzi gained To attract his initial investors, Ponzi tors from funds contributed by new his notoriety when he coaxed approxi- advertised his high returns, explain- investors, with the organizer usually mately $7 million from investors in ing that investment money was being focusing on soliciting new investors 1920. Ponzi began making a name used for the “lucrative” arbitrage of in order to provide promised payouts for himself in Boston, promising a International Reply Coupons (IRCs). to earlier investors instead of engag- 50% return in 45 days with the pur- The Universal Postal Union introduced ing in legitimate investment activity. chase of his “Ponzi notes.” An Italian IRCs in 1906 as a way for people Since no legitimate profits are gener- immigrant and self-made businessman, to purchase postage for someone in ated, Ponzi schemes are not sustain- Ponzi set up a firm with a seem- another country, particularly neces- able and inevitably collapse because ingly officious and legitimate name, sary in that era due to the explosion they require more and more deposi- the Securities Exchange Company, and of immigration across Europe and in sold fake securities to investors. His America. IRCs could be purchased Ponzi artists (left to right): Ivar Kreuger, many investors did not realize that in one country and then redeemed in Bernie Madoff and Charles Ponzi. his company made no actual profit. another for standard letter postage

Financial History ~ Spring 2010 16 www.moaf.org to a foreign country. Although the of the Boston Post (now defunct, but and was eventually deported back rate of exchange was set by regula- which won a Pulitzer in 1921 for its to Italy. He lived there briefly until tions, the devaluation of currencies coverage of Ponzi and his crimes) he got a job through a cousin in the across Europe following World War became suspicious and brought the airline industry and moved to Brazil. I wreaked havoc with rates, creat- scheme to the attention of financial He worked there quite successfully ing a potential arbitrage opportunity. reporter Clarence Barron (founder until World War II disrupted the air- In theory, the trade of International of Barron’s) to look into Ponzi’s line’s service between Italy and Brazil. Reply Coupons could produce a profit, operations. Barron determined that Despite his innate genius and charis- but there have never been enough cou- Ponzi was most likely a fraud but matic personality, he spent his life try- pons in circulation to support the scale the final straw came after the Boston ing to get rich quickly and ultimately of Ponzi’s scheme. Most investigators Post revealed Ponzi’s dubious his- died penniless in Rio de Janeiro in never probed deeply enough to realize tory and criminal past in its pages. 1949 at the age of 67. that his IRC plan was a hoax, and if The news triggered runs by investors they attempted to do so he claimed to exchange their notes, causing the The King he could not reveal his source for the scheme to unravel. When an audit was Ivar Krueger was known as the “Match coupons for fear that a competitor conducted to determine how much King” because his factories produced would steal his methods. Most of all, money had been lost, the final tally more than two- thirds of the world’s his impressive knowledge of the intri- was almost $4 million. Six Boston matchsticks at the height of his reign cacies of the postal system was enough banks were also ruined, and Ponzi’s in the 1920s. Although famous for his to convince anyone who questioned investors received only about 30 cents matchstick making, Kreuger was actu- his tactics. on the dollar for their investments. ally a financial genius who mastered Ponzi’s scheme was eventually For his crimes, Ponzi served almost several industries. Using his experi- exposed. The editors and reporters 10 years in federal and state prison ence in finance, he was able to utilize Museum of American Finance

Stock certificate for shares in Ivar Kreuger’s company, Kreuger & Toll, dated October 22, 1931.

www.moaf.org 17 Financial History ~ Spring 2010 a successful entrepreneur and financial manager. It would not be until later that Kreuger would begin his scheme. In 1922 Kreuger made a triumphant return to America to court the promi- nent investment bank Lee, Higginson & Co. With his extensive knowledge and ability to recite facts and statis- tics on even the most arcane financial topics, Kreuger impressed the Lee, Higginson & Company board, and a partnership was formed. Together they introduced numerous securities to the American public over the next 10 years until Kreuger’s death in 1932. Securities were issued for Kreuger & Toll, International Match and Swed- ish Match Company, the largest of Kreuger’s companies, though it is believed that Kreuger supervised over Museum of American Finance 400 different corporations worldwide, International reply coupons like this formed the basis for Charles Ponzi’s money-making scheme. some of which were legitimate and others that only existed on paper. creative accounting practices with- concrete building material used pri- Because Kreuger was incredibly out getting caught, and move money marily in America, Kreuger came up secretive and he alone controlled his around via off balance sheet liabilities with the idea of introducing it to businesses, he treated his companies and inter-company holdings and raise Europe. Partnering with Paul Toll, a as one giant corporation and freely massive capital by introducing com- fellow Swede and Kahn’s representa- moved funds between them, often plex hybrid securities. tive in Europe, the two pioneered new to the confusion of his accountants. Kreuger’s life reads like a movie construction methods and formed the This provided him liquidity and the script. Born in Sweden to a family extremely successful Swedish engi- ability to pay consistently high divi- with a small match factory, Kreuger neering firm Kreuger & Toll. With dends, usually 20–25%, even on his actually got his start in business in the Kreuger’s business savvy, the company failed ventures. (One of Kreuger’s engineering and construction industry. quickly developed a near- in unsuccessful endeavors included a try After finishing school in Sweden, he construction in Europe and Scandi- at the film industry, which he loved. left for the US to make a name for navia. Soon, though, Kreuger set his He is credited with discovering Greta himself and spent several years floun- sights on bigger things and parted Garbo, a fellow Swede and long- dering, attempting to set himself up in ways with Toll. Leaving him to run time friend.) Kreuger realized that he different regions of the country. Even- the construction company, Kreuger could use the capital raised from Inter- tually Kreuger got a lucky break that established and ran a spin-off hold- national Match securities to negoti- enabled him to pursue engineering. He ing firm bearing the same name as his ate loans to foreign governments in spent much of his life as a young adult construction company. exchange for match . He traveling the world assisting in major Kreuger began pursuing a different then turned around and used profits construction projects including the industry: . Due to its abun- of his monopolies to pay returns on stadium for the 1912 Olympics, the dance of natural resources, especially his securities and negotiate the issu- city hall, the Metropolitan timber, Sweden had long been a major ance of new securities. Playing on the Life Tower, the Flatiron building, The player in the matchstick market. Begin- incredible confidence US investors had Macy’s building, ’s ning with the takeover of his family’s in him, Kreuger would occasionally stadium and many beautiful hotels match factory and then with other fac- issue securities before the negotiations around the world including the Plaza tories in the region, Kreuger quickly with national governments for match and St. Regis hotels. came to dominate the - monopolies that funded the securities After stumbling across “Kahn stick industry. Unlike Ponzi, Kreuger were finalized. Iron,” an innovative new reinforced produced actual profits and was quite Kreuger was remarkable in that he

Financial History ~ Spring 2010 18 www.moaf.org existed as a sort of private financier to at one time the largest market-maker taking sole credit for the entire scheme. the world, negotiating complex loans in NASDAQ securities. Founded in It is curious that a serious investiga- with governments. He essentially 1960, Bernard L. Madoff Investment tion was never made. In hindsight, the achieved what the Dawes Plan did Securities LLC was mostly known for signs are all there and we know that by himself; in a little over a decade, market making and acting as the mid- a handful of people had picked up Krueger negotiated loans with match dle man in the transaction of buying on the suspicious nature of Madoff’s deals to Peru, Poland, , Esto- and selling stocks. He was a pillar in profits. In May 2001, both Barron’s nia, , Greece, Hungary, , the securities industry, providing solid and a trade publication called Mar/ Portugal, , Yugoslavia, Ger- advice for almost 50 years. When Hedge published investigative reports many, , Bulgaria, , he turned himself in, he caught the on his hedge fund, both citing the , and after extensive world off-guard, including the Securi- impossible annual returns, Madoff’s negotiations without a resolution, he ties Exchange Commission. decision to charge a paltry commission fabricated a deal with Italy, even forg- It is estimated that Madoff’s fraud instead of collecting management fees, ing the Minister of Finance’s signature began sometime in the 1980s or early and Mar/Hedge additionally noted the on fake bonds. He was able to cover 1990s, meaning he collected between unlikelihood of Madoff’s hedge fund his liabilities and support new busi- $10–17 billion in bogus investments being one of the largest in the world ness endeavors by collecting funds in only 20 years. Estimated losses while remaining virtually unknown. from new security issues by Kreuger with fabricated gains are thought to Harry Markopolos also vociferously & Toll and its subsidiaries in a giant, be approximately $65 billion. There proclaimed Madoff to be a fraud, complex Ponzi scheme. are many similarities between Ponzi, picking up on suspicious behavior as After the Crash of 1929, Kreuger’s Kreuger and Madoff’s schemes. Like early as 1999 and even reported his companies appeared to weather the Kreuger, Madoff’s legitimate activi- misgivings to the SEC on more than stormy economic climate better than ties acted as a cover for his fraudulent one occasion. most. Not believing that the crash dealings. Madoff oversaw a secretive, At age 71, Madoff went to trial and would continue, Kreuger continued guarded arm of his renowned firm pled guilty to 11 federal offenses, possi- paying out false dividends and even that provided wealth management ser- bly sparing his family and those around extended his liabilities by negotiat- vices. Keeping it separate from the rest him from admitting responsibility. He ing a $125 million loan to . of his business, even physically seg- was sentenced to 150 years in prison, It was impossible to raise sufficient regating it on another building floor the maximum allowable sentence with funds in the aftermath of the crash to from the rest of his operations, it was no possibility for parole. keep up with his obligations. Eventu- under this secret division that Madoff None of these three stories have ally, Kreuger began to falter on his ran a Ponzi scheme with money from happy endings. Between severe prison payments. Realizing he would soon his wealthier clients. Madoff did not sentences and death, each financier be discovered, he committed suicide in openly advertise his special private paid duly for their crimes. Even if they March 1932. A financial crisis ensued wealth management services, creating believed their schemes were only a almost immediately after Kreuger’s the illusion of exclusivity. The fund temporary means to an end, they all death, but it would not be for another consistently paid out a steady return ultimately proved that fraud does not couple of years that the full extent of of 12% (less ostentatious than Ponzi’s pay (for very long) and that a Rob- his deception would be known. 50% or Kreuger’s 20–25%). Once Peter-to-Pay-Paul scheme is never sus- granted the privileges of investing tainable. Despite these three examples, Bernard Madoff with Madoff’s fund, depositors were which vividly illustrate this important In 2008, the largest Ponzi scheme reluctant to question the details of his lesson, Ponzi artists continue to prac- in history was revealed by the mas- methods or strategy. tice their art. Just as Kreuger ignored termind behind it: Bernard Madoff. As a well-respected financial man- Ponzi’s fate and Madoff disregarded Unlike Ponzi and Kreuger’s pasts, ager, a man who had testified before them both, small scale Ponzi schemes Madoff’s background provided no Congress and who had also worked are still amazingly still being revealed indication of his capacity to commit alongside the SEC in the regulation of even with Madoff’s name still in news- fraud. A co-founder and former chair- NASDAQ in its early days, the SEC paper headlines. FH man of NASDAQ, he served on the found it unnecessary to interrogate his board of the National Association operations as well. His swindle was Becky Laughner is the Museum’s of Securities Dealers, was active in not actually discovered until he turned Assistant Director of Exhibits and philanthropic circles, and his firm was himself in, revealing everything and Archives.

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