Sunday, May 10, 2009

Ponzi and Pecora: the Yin and Yang of Banking in Crisis

Though it might at first seem highly unlikely, the roots of the present financial crisis can be found in the “work” of two Italian immigrants: Charles (Carlo) Ponzi and Ferdinand Pecora. They are the Yin and Yang, the Alpha and Omega of American finance. As such, their stories are highly emblematic of our current predicament.

            Take Ponzi first. So iconic was his meteoric career that his name now identifies the scheme he made famous: the Ponzi scheme, wherein early investors are paid off with the money paid by later investors in a kind of pyramid fraud. It’s the scheme that was used to even greater advantage by Bernard Madoff (in fact, according to William K. Black, the whole fraudulent loan system was a “Ponzi-like scheme”). But Ponzi made it a true American game.

            He was an Italian immigrant who claimed Parma as home, but was actually from a tiny Italian village called Lugo. He arrived in New York in 1903 with only $2.50 in his pocket (having gambled away almost $200 he had originally). After several menial jobs like dishwashing, he learned English well enough to become the manager of an immigrant bank in Montreal owned by one Luigi Zarossi, himself a swindler who claimed he paid 6% interest on bank deposits (apparently using a kind of Ponzi scheme himself). When Banco Zarossi failed, Ponzi resorted to forging the check of a former customer, was caught, and sent to prison for two years. Released in 1911, he got involved in a smuggling scheme, spent two more years in prison in Atlanta, and eventually ended up in Boston where he married the former Rose Guecco in 1918 and started a business trying to sell advertising. Though the business failed, Ponzi picked up an idea for his greatest scam: redeeming postal stamps (International Reply Coupons) sent from one country, in the currency of another. Ponzi figured that IRCs could be bought cheaply in Italy and exchanged for U.S. stamps to a higher value. Then the U.S. stamps could be sold at what Ponzi claimed was a 400% profit.

            Though his stamp scheme quickly aborted on red tape and volume problems, Ponzi promoted it so skillfully among friends (he promised to double their investment in 90 days) that he was able to start his own Securities Exchange Company and pay off his initial investors as promised. This was in early 1920. Word of the fantastic profits spread, and investors began besieging his Boston office with cash. Ponzi had to hire agents to handle the volume, paying them lavishly for business they were now bringing in from all over New England. By May of 1920 Ponzi had made almost half a million dollars, and deposited so much in the Hanover Trust Bank (in Boston’s Little Italy) that he was soon able to buy a controlling interest in that bank. By July of 1920, he was being called Boston’s “Wizard of Finance,” had purchased a mansion in Lexington, MA, and was able to bring his mother from Italy to join him. He would arrive at work in a cream-colored limousine driven by a Japanese chauffeur, whence crowds would cheer him like a movie star. After one little speech he gave, one fan called him the greatest Italian of all.

            “But what about Columbus,” Ponzi asked. “He discovered America.”

            “But you discovered money!” was the reply.

            Several times, suspicions were raised and there were runs on Ponzi’s company, but each time he paid off his investors and restored confidence. But it was not to last. The financial analyst Clarence Barron made calculations regarding the supposed source of the investment returns, and found that 160 million postal reply coupons would have to be circulating, while in truth, only 27,000 were. Another panic resulted, but Ponzi again managed to dodge the bullet. He hired a publicity agent, William McMasters, who quickly found the secret to Ponzi’s scheme. McMasters, a former newspaperman, took his information to the Boston Post’s editor, got $5000 for his exposé, and on August 2, 1920, the front-page headline blared: “Declares Ponzi is Now Hopelessly Insolvent.” McMasters pointed out that Ponzi was millions in debt, and was paying off early investors with new incoming deposits. To make things worse, on August 11, the Montreal Police identified Ponzi as the Zarossi clerk once jailed for forgery. Federal agents seized Ponzi and his holdings, while swarms of investors screamed for Ponzi’s head.

            The new Columbus served a combined seven years on both a federal and a state count, and when he was released, he was deported to Italy for an immigrant violation (having never become an American citizen.) After several more jobs, one for Mussolini’s Latin Airlines in Rio di Janeiro, Ponzi remained in Brazil trying to eke out a living teaching English, but in the end died in a charity ward there, in January 1949, broke and alone at the age of 66.


            Ferdinand Pecora, at first glance, seems the opposite of Ponzi. Ponzi hailed from a small town near Italy’s east coast between Ravenna and Bologna, while Pecora was born in the deep south, in Nicosia, Sicily, from whence he emigrated to the United States with his shoemaker father. Where Ponzi was all flash and showmanship, Pecora is described as dogged and implacable, a lawyer and prosecutor who mastered details and never forgot a fact. Where Ponzi presented himself as a mandarin of finance, outfitted like the banker he pretended to be, Pecora is described as an “earthy populist” who liked to play pinochle and smoke inexpensive cigars (his salary with the Senate committee was $255 a month). But in another sense, the two were brethren: like Ponzi, Pecora had a flair for the dramatic and an eye for the limelight, which shone brightly upon him when he was featured on the cover of Time Magazine’s June 12, 1933 issue. And like Ponzi, Pecora made his name in connection with wrongdoing—only on the opposite side of the law. The irony, of course, is that the fierce upholder law, Pecora, was largely forgotten until recently, while the felonious Ponzi became a household word and the subject of countless stories and reports.

            Still, of the two, Ferdinand Pecora is, or should be, the more relevant to our time. This is due to his hero’s stint as chief counsel to the Senate Banking and Currency Committee and its 1933  hearings on the causes of the Great Depression.  It was a signal moment in American economic history: since the crash of 1929, 40% of all American banks had closed, with 9 million individuals and families losing their savings. The Stock Exchange had sunk to a fifth of its 1929 value, and 17 million Americans were unemployed. Refugee camps called “Hoovervilles” dotted the landscape, with desperate souls emerging from them to beg for food and work. As for Pecora himself, he had worked his way through New York Law School, become an assistant district attorney in New York, and helped to prosecute more than 100 “bucket shops”—fly-by-night brokerage houses that preyed on gullible investors. This became his on-the-job-training in the seamy side of Wall Street, and the background which led to his selection as the counsel for the Banking Committee.

            Beginning in February of 1933, the hearings, which were soon known as the Pecora Hearings, called Wall Street’s most powerful figures—Richard Whitney, president of the NY Stock Exchange,  Albert Wiggin of Chase National Bank, Charles E. Mitchell of National City Bank (today’s Citibank) and J. P. Morgan Jr.—before it to testify.  Pecora himself interrogated many of them, driving them into corners, forcing them to reveal astonishing bits of chicanery that had helped fuel the 1929 Crash. Where Wiggin of Chase and Mitchell of National City had been praised for their supposedly Herculean efforts to halt the Depression, Pecora showed that Wiggin had actually profited from his bank’s falling prices by selling shares short. Mitchell and his cronies at National City had not only given themselves millions in interest-free loans to get them through the crash, but had also passed off bad loans to Latin America by concealing them in securities sold to investors (sounds a lot like the legendary “mortgage-backed securities” that have poisoned our own global financial system.) Pecora’s greatest moment probably came when he grilled J. P. Morgan Jr., the “Lion of Wall Street,” about his taxes. Pecora asked Morgan if he had paid income tax in 1930. After a silence, Morgan replied, “I cannot remember.” It was a lightning bolt, but Pecora was not finished. He asked Morgan about his taxes for 1931, and again for 1932. Each time Morgan answered in the same way: he couldn’t remember. Bulldogging even deeper, Pecora asked about the Morgan banking partners. The Lion of Wall Street knew nothing about taxes paid by them either. Pecora did know, and stated for the record that the sum of the taxes paid by J.P. Morgan and its partners for 1931 was $5,000. The resultant furor led Time Magazine, in its cover article, to coin a name for the bankers that Pecora had now made infamous: “banksters.”

            Pecora’s hearings rocked the nation and are considered key to the passage of the New Deal regulations that followed, regulations like the Securities Exchange Act of 1934 that created the SEC and reined in Wall Street’s worst excesses for more than 50 years. It was not until the 1990s that laws like the Glass-Steagall Banking Act were jettisoned to pave the way for the Wall Street piracy we have witnessed recently. As for Pecora himself, after his investigations closed in July 1934, President Roosevelt made him a commissioner on the SEC his hearings had helped establish. After that, Pecora was appointed to the New York State Supreme Court in 1935, where he held forth until 1950 when he resigned for an unsuccessful try at the Mayor’s job in New York. When he died in 1971, he left his own account of his hearings in the book he wrote in 1939, Wall Street Under Oath: The Story of Our Modern Money Changers. Too bad some of our own Wall Street “banksters” and alleged regulators didn’t read it before the roof fell in. Now they may get the chance, for increasingly we are hearing calls for a new Pecora and new congressional hearings to investigate the “banksterism” that led to our recent financial collapse. As Michael Winship said in his article on Pecora that appeared recently on Truthout:

            “Ferdinand Pecora, a nation turns its lonely eyes to you.”


Lawrence DiStasi

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