Thursday, February 11, 2010

Lessons Learned from Ponzi's Scheme

I just finished a biography on Charles Ponzi by Mitchell Zuckoff titled Ponzi's Scheme. This was a very interesting understanding of the psychology and motivations of a man whose name has far outlasted the name of many men more respectable than him. His legendary rise and fall, and his manipulation of financial instruments in the process, have made him legendary, in a very bad way.

Lesson 1 - While the press and mainstream media are often polarizing,  their effect is always attention and fame - for better or worse. Ponzi was on the front cover of the most relevant newspaper of his time two days in a row, one story praising him and another offering a much more skeptical perspective.  Believe it or not, both articles pushed his fame to even greater heights and, as a result, his company (called the Securities Exchange Company, interestingly) continued to grow in the short-term.  Many referred to him as the "wizard of finance" even though the second article gave many reasons to doubt.  The lesson - take what you read and hear about others with a grain of salt and help your business use the powerful tool of exposure through the media to improve your business.

Lesson 2 - Don't let greed, pride, and ego drive how you run your business. Ponzi was very motivated by his greed, pride, and ego.  He had a great idea to arbitrage off of currency and postal reply coupon mechanisms, but he was never allowed to actually use those mechanisms in his business.  He got some investors promising a 50% return in 90 days, then tried to use the mechanisms but was not able to.  He kept getting more investors as his fame grew, but he was never able to actually invest in these mechanisms and make the 200%+ profit he hypothetically could earn to pay his investors a 50% return on their money and still make a significant profit.  Although his profits were hypothetical, his spending habits were quite literal.  It was more important to him to gain fame and prominence by over-spending than to actually run a viable business and live within his means.  If he could have checked his pride, ego, and greed at the door, he would have put a stop to it all right in the beginning.  But he couldn't, and now he's a legend who ultimately died broke and alone.  The lesson - we all need to stay grounded and humble.  Whatever you need in your life to remind you to be that way, then get it into your life and keep it there. When convicted to five years in prison, Ponzi penned (translated to english) "Thus passes worldy glory."

Lesson 3 - Put your money where your mouth is. Ponzi's first verbal critic of any influence was Clarence Walker Barron, one of the most respected financial journalists and authorities of his time.  Ponzi had taken a great deal of money out of his growing company and invested it into bank stocks, bonds, and real estate.  He spent a great deal on fancy cars, big houses, and every luxury imaginable.  Barron took issue with Ponzi on several fronts, but the most important was this - why was Ponzi investing in so many low return, relatively speaking, investment opportunities that were far from offering a 50% return in 90 days.  If Ponzi really believed in what he was doing, why would he be so heavily diversified into such discouraging alternatives.  The lesson - if the person selling you something isn't using it, then that is your first sign you should not buy.

Lesson 4 - Success fosters lawsuits, whether merited or or not. In the beginning of his scheme, Ponzi owed a furniture dealer some money and paid him off with one of his investment securities.  The man, assuming Ponzi used his money as the seed capital to fund his new firm, saw the company begin to succeed (at least it appeared to be succeeding) and sued Ponzi for 50% of the company.  Even in the 1920s success bred pointless legal battles.  The lesson - make sure to reserve adequate funds to defend and protect yourself and your business.

There are certainly more lessons to be learned, but those were the most poignant to me as I experienced the amazing rise and fall of such an interesting character in the financial history of the United States.