Free lunches, sucker’s bets and Ponzi schemes

You know the cliché about free lunches… right? There aren’t any. In the classic musical Guys and Dolls, based on the wonderful short stories by Damon Runyon, arch-gambler Sky Masterson tells the following story

“When I was a young man about to go out into the world, my father says to me a very valuable thing. ‘Son,’ the old guy says, ‘I’m sorry that I am not able to bankroll you a very large start. But not having any potatoes to give you, I am going to give you some very valuable advice. One of these days in your travels, you are going to come across a guy with a nice brand new deck of cards, and this guy is going to offer to bet you that he can make the Jack of Spades jump out of the deck and squirt cider in your ear. But, son, do not take this bet, for if you do, as sure as you are standing there, you are going to end up with an ear full of cider.’ ”

There is a wealth of examples, warning stories and morality tales like this one. They exist to warn us from believing that it is possible to earn large sums of money with little-to-no effort. One of the most famous get-rich schemes that is not an urban legend, gave its name to an entire genre. Known as a Ponzi Scheme, it was the brainchild of an Italian born, American resident named Charles (Carlo) Ponzi in 1920.

After Ponzi arrived at the US in 1903 he spent a few years trying a variety of jobs, finally settling in Boston and trying his hand in publishing and selling a magazines dedicated to the exportation of goods. One of the interested buyers lived in Spain. He ordered a magazine and included international postal reply coupons to the correct amount. These coupons were common practice at that time; one would exchange the coupon for local (in this case, American) stamps and use the stamps to send the magazine to Spain.

As he cashed the coupons, Ponzi discovered that when one bought a “block” of ten stamps in Spain, they cost the equivalent of 1 US cent in Spanish money, yet were cashed in Boston for 10 stamp of one US cent each! This 10 to 1 ratio got Ponzi’s imagination running – he then set out to put build an elaborate scheme where he would buy stamps in Spain, cash them in the US for stamps at 10 times that amount, then sell the stamps to a third party and pocket the difference. It was the perfect scheme (and legal, too!) but, unfortunately, Ponzi’s scheme was outdone by the most obvious of hindrances involving postal fraud: bureaucracy. The time and effort I took to convert funds and send them across the world in post-PC days caused Ponzi’s plan to implode. Ponzi, however, failed to disclose his difficulties – he created a company named The Security Exchange Company and promised to deliver 50% interest in less than 45 days (“double in 90” was Ponzi’s mantra.)

Ponzi was able to show “real” return by paying early investors with money he got from those who invested later; this is known today as a “rolling pyramid scheme.” People could see money pouring in – and returned with larger sums of money as further investment. Huge amounts of money poured in and Ponzi, now a millionaire, enjoyed the short-term (and, eventually, short lived) fruits of his labour. Time was running out on Ponzi. Federal investigators caught-on on Ponzi’s quick-rich scheme and demanded an audit of his business. Investors sieged his offices and demanded immediate payout. Following his arrest and conviction, auditors found that Ponzi collected enough money to buy millions coupons. In reality, said the auditors, in appears that he bought only a few.

An imaginative version of Ponzi’s scheme is known as “The Monkey Scheme”:

Once, it is told, a man arrived in a village. He announced that he is a collector of monkeys, and offered to buy monkeys for $10 each. The villagers (who knew that the local forest had thousands of monkeys) went in, singles, couples and families, to capture monkeys. The collector bought each of the monkeys brought to him for $10 and put it in a massive cage he built in the centre of the village.

After a while, the monkey population diminished, the villagers battled to find any more monkeys. The man than increase the price for each monkey to $20, and the villagers returned to the forest to captured monkeys. When the monkey population dwindled again, the price was increase to $25. By now, it was almost impossible to find a single monkey in the forest.

The man announced that he is willing to pay $50 per monkey and, since he needs to go away on business for a few days, his assistant will purchase all monkeys found. When the man left, his assistant called the villagers and said: “look at the thousands of monkeys in this cage. My Boss wants them all for his private zoo. I will sell you these monkeys for $30 each, and when my Boss comes back, you will be able to sell him these monkeys for $50 and pocket $20 profit per monkey!” The villagers got their savings together and bought every single monkey – thousands and thousands of them – from the assistant.

The next day, the assistant was gone, neither him nor his Boss were never seen again. The villagers were left with thousands of monkeys they bought with their precious savings.

Greed keeps Ponzi Scheme alive and, as Sky Masterson can attest, no one is immune. He himself falls for a “sucker’s bet” and, as he prepares to face the consequences, he rubs his ear in embarrassment.

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