How Ponzi Schemes Work

Other Notable Ponzi Schemes

As we mentioned earlier, Charles Ponzi didn't invent the scheme himself. Ponzi's biographer, Mitchell Zuckoff, writes of his predecessors, Sarah Howe and William Franklin Miller. In 1880s Boston, Sarah Howe offered female investors a chance to make money in the Ladies Deposit. She garnered half a million dollars from more than a thousand women, using some of the funds to pay off other investors and pocketing the rest. A couple of decades later, William Franklin Miller came along and tried the scheme again to even bigger success. He promised unheard-of returns, and when he came through on his promises, more investors poured in, handing over a million dollars in total before he was exposed [source: Zuckoff]. In Miller's case, the victims were so thrilled by the success of their investments that they chose to reinvest their earnings in his scheme [source: Zuckoff].

Clearly, Ponzi wasn't the first to implement the scheme, and he wasn't the last -- not by a long shot. Since his stunt in 1920, many Ponzi schemes have been exposed around the world. Some in the past few decades have been the most damaging, however. In Albania in 1996 and '97, several schemes using the Ponzi method swindled a total of $2 billion from the public (the amount equaled about 30 percent of the country's gross domestic product) [source: Shiller]. Once the scheme was exposed, riots broke out, causing several deaths.

Until late 2008, the reigning champion of Ponzi schemers was Lou Pearlman. Remember the boy band craze that started the late 1990s? The bands Backstreet Boys and 'N Sync were two of the most popular musical groups of the period, and each was created and financially backed by Pearlman. By 2006, authorities found out that he'd been orchestrating an enormous, long-running Ponzi scheme, which helped him initially fund the bands. For a good 20 years, he had convinced others to invest in nonexistent companies for which he claimed to have FDIC and AIG insurance.

Pearlman received a jail sentence of 25 years for conning $300 million from investors. For every million he paid back, a month was cut off of his sentence [source: Sisario]. If you think that's a lot of money, brace yourself for Bernie Madoff.