Ponzi scheme was actually a case of failed arbitrage…

This is an amazing article on Charles Ponzi, the one on whose name all  fraud financial schemes are named. The website just made it paid and was really disappointing as it was free till yesterday…

The article makes for a great case study on several subjects:

  • Financial  frauds (of course)
  • Financial globalization: Yes, it was pretty active. As most studies show, financial globalization was very active before 1914. This is shown in the article as well..
  • International Arbitrage: A followup to second. The article shows how Ponzi scheme was basically because of Ponzi trying to arbitrage between Italy and US. International Reply Coupons are accepted as  stamps in most countries. However, IRCs cost less in Italy than in US. So the idea was to buy in Italy and sell in US. So Ponzi collected money from people promising returns as high as 50%.
  • Role of frictions: Just as we see in most financial research, role of frictions is ignored. Frictions could be anything and make much of the difference between success and failure.  Most ignore frictions only to realize things are far more complex. Ponzi scheme was also a victim of the same. There were large “frictions” in the scheme. First, he did not  have agents to buy IRCs in Italy. Second, one could not convert IRCs in Italy for cash in US. Third, cost of shipping was very high leading to negating the profits he would make If he somehow managed second condition. So there you go..ignore frictions at your own peril..
  • Human greed: Ponzi had a terrible record and had been to jail couple of times. So, investors should have seen his track record before lending him any money. However, the warnings were ignored as he offered crazy returns. Greed usually takes over pragmatism when it comes to financial decisions. The same thing continues over and over again.

There could be more such takeaways from this superbly worded article. Alas, it has become paid..

 

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