In the world of financial fraud, a “ Ponzi scheme” is famous. Here is the story behind how the scam got its name. Charles Ponzi started the Security Exchange Company on December 26, 1919. He thought he had discovered a way to purchase American stamps in a foreign country at significantly lower amounts than they were worth in the United States. He claimed his idea was so successful that anyone who gave money to his company would be repaid their original loan plus 50 percent interest within 90 days. Friends and family quickly offered their money to Ponzi and they were handsomely rewarded, being repaid their original loan and the 50 percent interest within just 45 days. Thanks to an article in The New York Times, word spread quickly about Ponzi’s business, attracting thousands of people seeking a similar payback. He might have had a successful business had his idea actually worked. The problem, however, was that it didn’t. The 50 percent interest paid to early investors did not come from the profits of a successful underlying business idea (which didn’t even exist) but instead was obtained fraudulently from funds contributed by later lenders. Eventually, the Ponzi scheme collapsed on August 10, 1920, after an auditor examined his accounting records.
Required:
1. Assume that on December 27, 1919, Ponzi’s first three lenders provided his company with $ 5,000 each. Use the basic accounting equation to show the effects of these transactions on December 27, 1919.
2. If the first two lenders are repaid their original loan amounts plus the 50 percent interest promised to them, how much cash is left in Ponzi’s business to repay the third lender? Given what you discovered, how was it possible for Ponzi’s company to remain in “business” for over eight months?
3. Who was harmed by Ponzi’s scheme?