As Old As The Pyramid Scheme

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Several million Russians learned about the downside of capitalism this summer when they were caught in a classic swindle. An outfit calling itself MMM and operating as an investment company offered fantastic returns on investments, upward of 3,000 percent a year. Although Russia now has a Securities and Exchange Commission, it moved too slowly to protect naive Russian investors. Once the Russian SEC issued a warning that the dividends seemed to have come from later investments, not profits, the market value of the shares dropped from the equivalent of sixty-two dollars to about fifty cents.

Swindles like MMM date back at least to the South Sea and Mississippi bubbles that racked London and Paris in the early eighteenth century. But they acquired a name only in the early twentieth, when an American named Charles Ponzi came up with a beauty of a crooked idea in 1919.

Ponzi had already served a term for forgery when he saw great possibilities in arbitraging international postal coupons. These allow someone to buy postage in one country and send it to a person in another country, who redeems it in the postage of that country.

Ponzi noted that postage rates varied greatly from country to country. He argued that one could buy international postal coupons in a country where rates were low, redeem them in a country where the rates were high, and sell the stamps to a third party for cash, pocketing the difference.

In fact, regulations made such an operation impossible. But Ponzi didn’t care about that. He had no intention of carrying it out anyway. He needed the idea only to get people to invest, and he offered 100 percent dividends for a ninety-day investment.

In the first month Ponzi persuaded fifteen people to invest sums totaling a mere $870. But the next month seventeen people, attracted by the dividends the first investors had received, put in another $5,290. By the fourth month he had 110 investors, and they had entrusted $28,724 to his care. Just two months later Ponzi had no fewer than 20,000 customers investing the fantastic sum of $10,000,000.

Unfortunately for Ponzi, greed is a two-edged sword. Knowing when to take the money and run is critical in operating a con game, and he waited a little too long. Ten million dollars, naturally, attracted a lot of attention, including that of the authorities. Ponzi ended up with five years in a federal prison and the dubious honor of adding his name to the English language.

All con games fall into one of two broad types. Some, like Ponzi’s, seek to separate relatively small sums from a very large number of investors. The rest try to extract large sums from one or a small number of rich, and presumably sophisticated, investors. Even with human nature being what it is, it is astonishing how often the rich are taken in by smooth talkers.

Jay Gould, for instance, one of the most rational, intelligent, and gimlet-eyed individuals ever to walk down Wall Street, was fleeced in 1872 by a Scot passing himself off as Lord Gordon-Gordon. (His real name is unknown, and I hasten to disown any connection.) To be fair to Gould, he became embroiled with Lord Gordon-Gordon not because of greed but rather because of desperation.

With the fall of Boss Tweed in 1871 and the subsequent, if temporary, outbreak of honesty in New York City and State governments, Gould’s control of the Erie Railroad began to slip away. The judges who had previously done his bidding were now trying to save their own skins, not Gould’s.

The majority of shares in the Erie Railroad had come to be held by British investors, and events were moving inexorably to a showdown as they linked up with American reformers to drive Gould from the presidency of the Erie. Presenting himself as a major shareholder of the Erie, Lord Gordon-Gordon seemed like the answer to a robber baron’s prayer.

There can be no doubt that this ersatz peer was a consummate actor. He made his first appearance in history in 1868, when he walked into Marshall and Son, Edinburgh’s leading jewelers, and passed himself off as Lord Glencairn. He bought some jewelry and paid by check. When the check proved good, the jewelry was delivered, and he became a frequent customer and was soon granted credit. By the next spring his account had risen to the then vast sum of £25,000 and Lord Glencairn vanished.

He reappeared in 1871, in of all places Minneapolis. He conspicuously deposited $40,000 in a local bank, set himself up in the best hotel, and took Minneapolis society by storm. Now calling himself Lord Gordon-Gordon, he claimed to be the heir of the Earl of Gordon, a claim he could never have gotten away with in Scotland. (There has never been an Earl of Gordon.)

At a banquet in his honor he expressed interest in acquiring lands owned by the Northern Pacific on which to settle the surplus of his Scottish tenantry. The railroad promptly arranged a tour for him that one journalist, his grasp of classical literature apparently as shaky as his knowledge of the British nobility, described as “the equal of that Apollodorus planned for Cleopatra.” The Northern Pacific put a private railroad car at his disposal, and he spent weeks having a grand time at the railroad’s expense. He certainly played his self-assigned role to the hilt, selecting sites, naming the future cities, and marking out where the church and the school of each were to be placed.