Property Grunt

Thursday, December 18, 2008

How to avoid a Madoff

This man should not be walking alone on the streets.

DISCLAIMER:I am not an expert in finance or law. This is just my opinion so take it with a grain of salt. Also I am going to go off in a tangent or two but they will have a point.

If you have read any of those articles regarding Madoff a common theme is that a lot of these people exercised the “putting all my eggs in one basket” mentality. This story about a former editor turned artist is especially disheartening.

These are not stupid people. Whether you are able to accumulate 100 grand or a hundred million, it does take a bit of intelligence and self discipline which these people obviously exhibit. So what happened?

I think the great Eric Hoffer can explain this.

People whose lives are barren and insecure seem to show a greater willingness to obey than people who are self-sufficient and self-confident. To the frustrated, freedom from responsibility is more attractive than freedom from restraint. They are eager to barter their independence for relief of the burdens of willing, deciding and being responsible for inevitable failure. They willingly abdicate the directing of their lives to those who want to plan, command and shoulder all responsibility.

Page 109 paragraph 93
The True Believer
Eric Hoffer

Basically these people felt they could not be bothered because they either felt they did not have the financial acumen that Madoff claimed to have or they felt they being held responsible for their own financial livelihood was too much of a burden.

This is the wrong attitude to have with money. Whether you have earned it or inherited it, that is your money. You are responsible for how it is spent, how it is cultivated and how it is lost. You can’t deal with that? Then feel free to give it to me. I will be more than happy to permanently take it off your hands as long as you do not want it back.

Martial arts, particularly kung fu often have an air of mystery and exoticisms. This is due in part because of kung fu movies and the ignorance of people. The irony is that there is nothing mysterious about martial arts at all. They are simply a set of coordinated physical exercises that combines breathing techniques and mental visualization.

The source of all this mystery stems from how martial arts were taught. Back in ancient China there was really no barrier of entry to learn techniques. All you had to do was to observe the technique practice it and then presto, you would be able to utilize it. Of course this took a couple of years but you get the idea. A lot of masters feared that their techniques would fall in the wrong hands and be used against them. That is why schools often practiced at night in secret and some masters usually only taught 60 percent of what they knew in case a student turned on them so they would be able to lay the smackdown on any of their students.

Interesting bit of trivia-Bruce Lee got into a lot of trouble by violating the rule of secrecy when he was one of the first teachers to openly teach non-Chinese people martial arts in San Francisco. This led to a challenge match from other masters, which became the catalyst for his philosophy known as Jeet Kune Do.

Please observe the following video.

It looks like this guy is not doing much, however in a fight, this guy could probably kill or maim you. One of the ways the masters preserved their secrets was to develop techniques that were based on deception. This served two purposes. If someone did steal a technique from a school, they only knew the movement itself, they would have no idea what the applications were. It is sort of like giving someone a Ferrari, unless they know how to drive stick, the transmission is going to be grind itself into paste and the car will be completely useless to them. The second purpose is that when it used in combat, the person being attacked would lower their guard by the weak appearance of the technique.

Unfortunately this mysterious nature of martial arts has brought a ton of charlatans out of the wood work who claimed to be the masters of this martial arts when in fact they are no different than carnies at a fair, like these jokers.

Madoff is no different than those charlatans who claim they have been blessed by the spirit of Bruce Lee. He used an air of mystery to rip people off with his ponzi scheme and was able to avoid disclosure by claiming it would result in theft of his investment techniques. Despite playing close to the vest, he was able to keep his marks on the hook as long as he did because of the "returns" of his investments.

It has been reported he would often turn away prospective investors and create an armor of exclusivity that was so strong that people joined The Palm Beach Country Club just so they could have the chance to give him their money.

So how does one prevent from getting entangled with a Madoff? Well it appears just knowing his friends is not enough since he ripped them all off. Perhaps go to the SEC?

Madoff warnings 'ignored for 10 years'

The world's biggest fraud could have been averted if the Securities and Exchange Commission (SEC) had acted on numerous warnings about Bernard Madoff's financial impropriety years ago, the regulator's chairman admitted last night.

Christopher Cox, the chairman of the SEC, effectively admitted mea culpa over the scandal after conceding that tip-offs were repeatedly made to the investors' watchdog but never resulted in any investigation.

Hmm. Now how the hell did that happen? You don’t think? Could Gawker be right about this?

Ponzi Schemer's Label-Whoring Niece Married SEC Lawyer

It is purely circumstantial but it appears Madoff had one or several angels at the SEC making sure that any accusations of fraud fell on deaf ears, allowing him to maintain that impeccable reputation of his.

Instead of looking at his friends or the SEC for help, perhaps looking at the people who do not want to be his friends is next best thing.

“The numbers were too good to be true, for too long,” said Girish Reddy, a managing director at Prisma Partners, an investment firm that invests in hedge funds. “And the supporting infrastructure was weak.” Mr. Reddy said his firm had looked at the Madoff funds but decided against investing in them because their performance was too consistently positive, even in times when the market was incredibly volatile.

Reddy and others who walked away from Madoff knew something was up. They weren’t quite sure what it was but there something Madoff was doing that was not kosher and they were determined to stay on a pork free diet.

In the episode 85 of the final season of the Shield, titled "Party Line" , Vic Mackie hires a bunch of Mexican gangbangers to hunt down his ex-friend Shane. When the Mexican gangbangers catch up to Shane and his family, Shane convinces them to let him go for 20 grand. As he is getting the money, the gangbangers notice that he has 100 grand and renegotiate for the rest of the money at gunpoint. This incident is a key plot point that ultimately sets Shane and his family on a path of no return.

I realize this is a tv show but it always gets on my nerves when characters do stupid things like this. What Shane should have of done was take 90 grand and gone to Mexico with it. He should have opened up multiple accounts in several banks and divided the money among these accounts and in safe deposit boxes.

He should have taken the rest of the 10 grand divided it up in increments of $500 and hidden them in his truck and on himself. If he had followed that plan the worse that could have happened to him was that he would be ripped off for 10 grand. In other words he should have exercised a strategy of diversification and asset allocation.

Want to play eggs in a basket? Fine, make sure you have plenty of baskets to spread your eggs. You also need to understand what type of baskets you are going to use. How strong are they? What could make the basket fall apart?

If the basket does fall apart then at least you have other eggs to fall back on. If these people had exercised a strategy of re balancing and diversification, they would have still have lost money with Madoff but not as much as they did now.

For those of you who have no idea where to start with your education, I recommend the following three links.

Investor Education Alliance

As I stated in a previous entry, take your time. Even with that massive rate cut the fed gave, it still hasn't jarred the markets into motion so it appears that it will be awhile before things start to cook. Make an effort to understand what you are investing in.