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Who Was Ponzi & What Was His Scheme?

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What is a Ponzi scheme? And why does it bear this name? First, you need to know a little bit about its namesake, Charles Ponzi.

Anyone can work a simple swindle, but you have to be a special kind of con man to have your name become synonymous with "fraud." Ponzi pulled it off, though. After arriving in the U.S. from Italy in 1903, Ponzi knocked around in a variety of unskilled jobs that usually ended when he got into trouble for theft or cheating customers. A few years later, he moved to Canada, where he spent a hitch in prison for passing a forged check. When he eventually drifted back down to the U.S., he needed a way to make some quick cash.

Making Money via Mail

Ponzi eventually found his way to get rich quick using a vagary of the postal system. At the time, it was common for letters abroad to include an international reply coupon "“ a voucher that could be exchanged for minimum postage back to the country from which the letter was sent. Thus, if you sent your buddy in France a letter, you could include a coupon so he could respond. (This practice still exists but is less common.) As exchange and postal rates fluctuated, though, there was an opportunity to make a profit. You only had to purchase postal reply coupons cheaply in some foreign country, send them back to the U.S. to swap them out for American stamps of a higher value, then sell these stamps. This arrangement was perfectly legal; it was just cleverly gaming the system. Ponzi started buying and selling postal reply coupons using agents in his native Italy, and he was making a good living doing it.

Unfortunately, whatever defect made Ponzi steal from his employers and pass bad checks prompted him to get greedy here, too. He started to recruit investors into his system with the promise of 50% returns in just a few days. Investors would pay their cash in, and sure enough, Ponzi would get them the promised return. Everyone was happy with the results, and word started to spread about this Italian financial wizard. Within two years, he had employees all over the country recruiting new takers for this foolproof investment strategy.

Ponzi was pocketing millions, and he enjoyed a sumptuous life outside of Boston. At his peak, Ponzi was raking in $250,000 a day, which enabled him to collect such necessities as gold-handled canes. He became a celebrity investor, almost like the Warren Buffett of his day.

The Scheme

Why is it hard to think of Ponzi's name without affixing "scheme" to the end of it, then? Ponzi's underlying "business" — the arbitrage on the postal coupons — wasn't actually as sound as he claimed. In fact, there wasn't even really a business. However, since so much money was flowing in from new investors, he could just pay off the returns for the old ones from the new cash. In fact, Ponzi didn't even need to pay off the old investors, since many of them wanted to reinvest their returns in this wonderful business. Ponzi's charms made it easy for him to placate any worried customers, and his con looked unstoppable.

Fuzzy Math

Eventually, though, smarter financial heads started looking at Ponzi's business. Clarence Barron, owner of the Wall Street Journal and founder of the financial magazine that bears his name, realized Ponzi must have been a huckster and went on the offensive. While Barron conceded that there probably was a way for a person to make a small amount of quick cash on the postal reply coupon scheme, he figured that Ponzi would have to be moving 160 million coupons around to raise the cash he needed to support the business. Since there were only 27,000 postal reply coupons circulating in the world, Ponzi's story didn't check out. (Things only got worse when the Postal Service reported that there wasn't a huge flow of the coupons from one country to the other.)

On top of that, Barron noted that Ponzi told newspapers he invested his own cash in real estate, stocks, and bonds like any normal investor. Barron pointed out the obvious question here: if Ponzi had this failsafe scheme in which he could make a 50% profit, why was he putting his own money into plain old investment instruments that would give him (maybe) a 5% return? Those certainly didn't sound like the actions of a financial genius.

Barron's conclusions ran as front-page news in the Boston Post in July 1920, which would have been damning for most cons. Ponzi was such a charismatic force of nature, though, that many people chose not to believe the paper's report. Few believed that their hero, the man who had "tripled" their life savings, was anything less than 100% legitimate. In fact, the morning that the Post ran Barron's report, investors lined up around the block outside of his office in an attempt to give him more money "“ even after they'd been told that they'd been scammed. Ponzi later boasted that he'd taken in a million dollars in new investments the day the report ran.

The Unraveling

Things were starting to look less rosy for the scammer, though. Although he'd largely placated his investors after Barron's report, Ponzi must have realized his window of opportunity was closing. He hired a publicist, William McMasters, but the PR man saw through Ponzi's lies and renounced his client in the press. James Walsh reprints part of McMasters' slam of Ponzi in his book, You Can't Cheat An Honest Man. Of Ponzi, McMasters said, "The man is a financial idiot. He can hardly add"¦He sits with his feet on the desk smoking expensive cigars in a diamond holder and talking complete gibberish about postal coupons."

The next month, regulators raided Ponzi's office and discovered that he didn't have a huge quantity of postal reply coupons. Since Ponzi had used the mail to notify his marks of how their "investments" were performing, he faced serious mail fraud charges; in total, the government brought 86 charges against him in two separate indictments. Ponzi pled guilty to one of these charges in exchange for a light sentence of five years.

He served around three and a half years, then got his release to face state charges, for which he received a sentence of nine more years. But before he could go back to jail, he jumped bail and tried to start new scams in Florida and Texas. (You'd think the government would have learned their lesson about trusting this guy.) Eventually, though, his time on the lam ran out, and he served his whole sentence.

Upon his release, Ponzi was deported to Italy and spent the rest of his life in poverty before dying in 1949 in Rio de Janeiro, where he's buried in a pauper's grave.

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Big Questions
Why Does Asparagus Make Your Pee Smell Funny?
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The asparagus has a long and storied history. It was mentioned in the myths and the scholarly writings of ancient Greece, and its cultivation was the subject of a detailed lesson in Cato the Elder's treatise, On Agriculture. But it wasn't until the turn of the 18th century that discussion of the link between asparagus and odorous urine emerged. In 1731, John Arbuthnot, physician to Queen Anne, noted in a book about food that asparagus "affects the urine with a foetid smell ... and therefore have been suspected by some physicians as not friendly to the kidneys." Benjamin Franklin also noticed that eating asparagus "shall give our urine a disagreeable odor."

Since then, there has been debate over what is responsible for the stinky pee phenomenon. Polish chemist and doctor Marceli Nencki identified a compound called methanethiol as the cause in 1891, after a study that involved four men eating about three and a half pounds of asparagus apiece. In 1975, Robert H. White, a chemist at the University of California at San Diego, used gas chromatography to pin down several compounds known as S-methyl thioesters as the culprits. Other researchers have blamed various "sulfur-containing compounds" and, simply, "metabolites."

More recently, a study demonstrated that asparagusic acid taken orally by subjects known to produce stinky asparagus pee produced odorous urine, which contained the same volatile compounds found in their asparagus-induced odorous urine. Other subjects, who normally didn't experience asparagus-induced odorous urine, likewise were spared stinky pee after taking asparagusic acid.

The researchers concluded that asparagusic acid and its derivatives are the precursors of urinary odor (compared, in different scientific papers, to the smell of "rotten cabbage," "boiling cabbage" and "vegetable soup"). The various compounds that contribute to the distinct smell—and were sometimes blamed as the sole cause in the past—are metabolized from asparagusic acid.

Exactly how these compounds are produced as we digest asparagus remains unclear, so let's turn to an equally compelling, but more answerable question:

WHY DOESN'T ASPARAGUS MAKE YOUR PEE SMELL FUNNY?

Remember when I said that some people don't produce stinky asparagus pee? Several studies have shown that only some of us experience stinky pee (ranging from 20 to 40 percent of the subjects taking part in the study, depending on which paper you read), while the majority have never had the pleasure.

For a while, the world was divided into those whose pee stank after eating asparagus and those whose didn't. Then in 1980, a study complicated matters: Subjects whose pee stank sniffed the urine of subjects whose pee didn't. Guess what? The pee stank. It turns out we're not only divided by the ability to produce odorous asparagus pee, but the ability to smell it.

An anosmia—an inability to perceive a smell—keeps certain people from smelling the compounds that make up even the most offensive asparagus pee, and like the stinky pee non-producers, they're in the majority.

Producing and perceiving asparagus pee don't go hand-in-hand, either. The 1980 study found that some people who don't produce stinky pee could detect the rotten cabbage smell in another person's urine. On the flip side, some stink producers aren't able to pick up the scent in their own urine or the urine of others.

Have you got a Big Question you'd like us to answer? If so, let us know by emailing us at bigquestions@mentalfloss.com.

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Big Questions
What Legal Authority Does Judge Judy Have?
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While Judith Sheindlin was a real, live judge—New York City Mayor Ed Koch appointed her to family court in 1982 and then made her Manhattan's supervising family court judge in 1986—she's not acting as one on her show. Neither are any of the other daytime TV judges (whether they passed the bar and served as actual judges or not).

TV court shows don't take place in real courtrooms and they don't feature real trials, though they are usually real cases—the producers often contact parties who have pending litigation in small claims court and offer them the opportunity to appear on TV instead. What you're seeing on these TV court shows is really just arbitration playing dress-up in small claims court's clothes.

Arbitration is a legal method for resolving disputes outside the court. The disputing parties present their cases to a neutral, third-party arbitrator or arbitrators who hear the case, examine the evidence, and make a (usually binding) decision. Like a court-based case, arbitration is adversarial, but generally less formal in its rules and procedures.

The power that Judge Judy and the rest of the TV arbitrators have over the disputing parties is granted by a contract, specific to their case, that they sign before appearing on the show. These contracts make the arbitrators' decision final and binding, prevent the disputing parties from negotiating the terms of the arbitration, and allow the "judges" wide discretion on procedural and evidentiary rules during the arbitration.

TV judges make their decision on the case and either decide for the plaintiff, in which case the show's producers award them a judgment fee, or with the defendant, in which case the producers award both parties with an appearance fee. This system seems to skew things in favor of the defendants and gives them an incentive to take their case from court to TV. If they have a weak case, appearing on the show absolves them of any financial liability; if they have a strong case, they stand to earn an appearance fee along with their victory.

If one party or the other doesn't like the arbitrator's decision, it can really only be successfully appealed if it addresses a matter outside the scope of the contract. In 2000, Judge Judy had one of her decisions overturned for that reason by the Family Court of Kings County. In the case B.M. v. D.L., the parties appeared in front of Sheindlin to solve a personal property dispute. Sheindlin ruled on that dispute, but also made a decision on the parties' child custody and visitation rights. One of the parties appealed in court, and the family court overturned the custody and visitation part of the decision because they weren't covered by the agreement to arbitrate.

Have you got a Big Question you'd like us to answer? If so, let us know by emailing us at bigquestions@mentalfloss.com.

This post originally appeared in 2012.

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