From the December 2008 issue of Research Magazine • Subscribe!

Beantown: Booms & Busts

Boston has played a key role in American financial history since the beginnings of the nation. That role sometimes gets overlooked, partly because so much other, non-financial, history has been made in Boston, and partly because New York City is so closely identified with finance in public perception that many people forget that the United States has other important financial centers as well.

Indeed, that tendency has been magnified in recent, crisis-plagued months, amid all the talk about "Wall Street" versus "Main Street," with the implication being that the nation's major financial institutions are all based in one city, or even along one street. Such, however, has never been the case, and a great deal of financial history has been made in cities across America including Chicago, San Francisco and Charlotte, N.C.

Boston, moreover, has a unique tale to tell, one that rivals New York's financial history in centuries-long duration, and which includes impressive innovations in fields ranging from commercial banking to mutual funds to venture capital. Boston also was the arena of one Charles Ponzi, and thus holds a special, if not exactly proud, place in the history of financial swindles. (See sidebar, "The Ponzi Schemer.")

Revolution and CommerceWhen in Boston, a good place to get a sense of the city's history, and of finance's role therein, is the Old State House, which once was the seat of government in Massachusetts and now contains a history museum. Initially known as the Town House, the building is where the British governors of the Massachusetts Bay Colony presided in the 1700s.

From early on, the building also housed a merchants' exchange on its first floor, and some merchants, including one John Hancock, rented warehouse space in its basement. It was among these merchants that opposition grew to the Writs of Assistance that Britain enacted in 1761, which gave broad power to customs officers to search private property. Hancock became a leader of the increasingly revolutionary opposition, along with Sam Adams, a skilled organizer who had been an unsuccessful brewer.

The balcony of the Old State House overlooks the site (now marked by a circle of paving stones) of the Boston Massacre, where British soldiers fired into a crowd and killed five colonials on March 5, 1770. (Future president John Adams, Sam's cousin, proved his skills as a fair-minded lawyer while defending the soldiers.) The Declaration of Independence was proclaimed to Boston from that same balcony on July 18, 1776.

Hancock, who became the first non-royal governor of Massachusetts in 1780, may be best known for his giant signature on the nation's founding document. But also of lasting effect was his central role in founding the Bank of Massachusetts in 1784. This was one of the first chartered banks in the country, and ensured that Boston would take its place alongside New York and Philadelphia among American financial centers.

The need for a real bank in Boston had been evident for a while. Back in the 1760s, a merchant named Nathaniel Wainwright had acted in effect as banker for shopkeepers and others in the city. He accepted deposits and issued interest-bearing personal notes, which circulated like currency. Unfortunately, he went bankrupt in 1765, causing a panic.

The Bank of Massachusetts, also known simply as the Massachusetts Bank, financed the first U.S. trade mission to China, in 1786, and five years later funded the first U.S. voyage to Argentina. It was renamed the Massachusetts National Bank in 1864, and in 1903 merged with First National Bank of Boston to become the Bank of Boston, which merged with BayBank in 1996 to become BankBoston, which was acquired three years later by Fleet Bank, which in 2005 was merged into Bank of America.

And thus Bank of America can now trace part of its ancestry back to the 1780s, and the institution holds some historic documents to prove it (which have been displayed in recent years at its Charlotte headquarters). These include ledgers containing the accounts of, among others, Hancock, Sam Adams and Paul Revere, and a 1784 register of the bank's original 105 shareholders, of whom, incidentally, 15 were women.

Hancock lived until 1793, and was succeeded as governor by Sam Adams, who served until 1797. State officials moved to the new State House the year after that, and the Old State House was used mainly for commerce for a few decades. Then it became Boston's City Hall in the 1830s, and 13 leading brokers in 1834 set up shop nearby on State Street as the Boston Broker's Board, later known as the Boston Stock Exchange.

The Old State House reverted to commercial use in the 1840s, and would continue as such until the 1880s when a historical society was founded to preserve it (after Chicago had made a disconcerting offer to buy the building and relocate it). An 1876 drawing of the building shows it bearing commercial billboards such as: "Security Insurance Company, Capital $200,000."

But the main financial action increasingly was down the street, and the Boston Stock Exchange built expansive new headquarters at 53 State Street in 1891. A photo hanging in the Old State House museum shows the exchange's opening day at the new location; traders congregate around a sign reading "Atchison," for the Atchison, Topeka and Santa Fe Railroad, one of several railroad stocks that traded in Boston. For much of the 19th century, Boston was the country's leading market for trading industrial stocks.

The BSE remained an important regional player through the 20th century, even as exchanges everywhere became less crucial amid the growth of electronic trading. It was acquired by Nasdaq in 2007.

Old Money, New IdeasBoston in the 1920s was the cradle of the mutual fund industry. In March 1924, broker L. Sherman Adams and others pooled some $50,000 and launched the Massachusetts Investors Trust. This was the first modern mutual fund, one that allowed investors to move money in and out readily. The fund company, today MFS Investment Management, survived the 1929 Crash and expanded in 1934 by buying up assets of a rival fund from Brown Brothers Harriman.

It was also in Boston that mutual funds became a truly big thing, as investment management techniques originally developed for wealthy Brahmins became available to the masses. In 1943, Boston lawyer and investor Edward C. Johnson II took over the Fidelity Fund, and in 1946 he set up Fidelity Management & Research as a company to manage it. By the 1970s, Fidelity was undergoing explosive growth and selling funds directly to the public, making ample use of advertising and toll-free phone numbers.

Today, Fidelity remains headquartered in Boston alongside other major fund players including Putnam Investments, John Hancock Funds and State Street Global Advisors. The latter firm pioneered the burgeoning field of exchange-traded funds with its introduction of the original SPDR, based on the S&P 500 index, in 1993.

Venture capital is another area in which Boston has spearheaded crucial innovation. Georges Doriot, a French-born professor at Harvard Business School and general in the U.S. Army Quartermaster Corps during World War II, in 1946 founded the American Research and Development Corporation, one of the first two real venture capital firms. (The other, founded the same year, was J.H. Whitney & Co., in Connecticut.)

Previously, the field known as "development capital" had been a province of wealthy individuals and family-owned businesses. ARDC, however, made this a professional matter, raising funds for new ventures from institutional investors. ARDC struggled in its first decade, but in 1957 Doriot made a winning investment of $61,400 in Digital Equipment Corporation. By 1971, DEC had nearly $150 million in annual sales.

The following year, Doriot, having invested in over 150 companies, merged ARDC with Textron. He later regretted that move, as he worried that venture capital had become too focused on speculation over management. Nonetheless, his success inspired numerous other entrants into the field, and Doriot, who died in 1987, is rightly remembered as "the father of venture capital." Boston, in keeping with his legacy, boasts a formidable cluster of venture capital firms today.

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Charles Ponzi, born in Italy in 1882, arrived in Boston in 1903. Then he went to Canada, where he spent some time in prison for forging a check. Not wanting to tell his mother about this, he wrote to her that he'd gotten a job as "special assistant" to a prison warden.

Ponzi returned to Boston in 1917. Two years later, he got a letter from Spain with an international postal reply coupon for mailing a catalog Ponzi was proposing to publish. With that, he came upon the idea of investing in these postal coupons, and making profits from differences in international postage rates.

He started his own firm, the Security Exchange Corporation (not to be confused with the then nonexistent Securities and Exchange Commission) and encountered enormous interest among investors. Unfortunately, Ponzi's business plan, though legal, was unworkable, involving multiple currency exchanges and postal bureaucracies.

Still, Ponzi promised a 50 percent return on investment in 45 days, and for a while he kept his word. The trouble is that he was paying investors merely by giving them money from later investors. Such deceitful dealing would come to be known as a Ponzi scheme.

Millions of dollars flowed in, and Ponzi became wealthy fast. He bought a mansion, sported a gold-handled walking stick and gave elaborate jewelry to his wife. His mother arrived by ocean liner, traveling first class. People cheered Ponzi on the street.

But suspicions were growing. Postal inspectors were wondering what exactly was going on at Security Exchange, and bank examiners were chatting with Ponzi's banks. The Boston Post, after some favorable coverage of Ponzi, began snooping around. The paper asked eminent financial journalist Clarence Barron to weigh in on the subject. Barron said there was no way Ponzi's reported returns could come from postal coupons.

Some investors rallied around Ponzi, while others pulled their money out. The Post sent a reporter to interview Ponzi about his life before he became rich, and found the story full of holes. Soon, the paper's Montreal correspondent discovered that someone with the (misspelled) name Charles Ponsi had done time up there a decade earlier.

Spurred by all the coverage, officials managed to figure out that Ponzi was insolvent. He was arrested on August 13, 1920, just a few weeks after things had started to unravel. Ponzi was sentenced to five years in federal prison for mail fraud and was let out over a year early to face state charges. He jumped bail and sold bogus real estate in Florida but the authorities caught up with him in Texas. He was sent back to prison and finally released in 1934. An angry crowd heckled him at the prison gate.

Deported to Italy, he ended up in Brazil, where he worked for a while for the Italian national airline. Ponzi died in poverty in 1949.

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Kenneth Silber is a senior editor at Research. His work on science, economics and history has appeared in a variety of publications, including The Wall Street

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