Risk-free Investing—Is it for Real?

October 23rd, 2012 → 6:33 pm @ // No Comments

What you need to know before investing in anything

Risk versus reward

This is the underlying fundamental dynamic behind every willful
decision in life. Every time a choice in direction is made, it is a trade-off
between the benefit to be gained and the potential for bad
consequences. Disproportionate potential for a negative outcome of a
decision can equate to a cost that exceeds whatever reward, or
potential reward may have resulted. Alternatively, if the potential for
gain is high enough, greater risk becomes more tolerable in trade. Most
often, choices that offer the highest potential for reward are
accompanied by correspondingly higher potential for risk. For some,
any risk is too great and neutralizes any reward potential, for others it is
just the opposite. Everyone has their own level of toleration of risk.
Multitudes of influences, including background and present
circumstances, combine within each individual to form their threshold
of risk tolerance at any given time. It must be considered.

In practice, the only risks that can be considered are those that are
perceptible in some way, be it from historical precedent, mathematical
probability, discernible influence of known variables, or simply the laws
of nature. The entire concept of insurance of every type is essentially
intended to moderate risk. Making a “good” decision, where the
reward mitigates the risk, boils down to possessing accurate
information about all of these factors as it pertains to the decision.
Since the goal of investing is to save and grow wealth, the risk factor is
always an important element. A methodical investment plan can be
undone by the losses resulting from unconsidered risk. Simplified, a
diversified portfolio is often divided so that most of the funds are held
in lower risk, even if lower potential yield, wealth preservation
investments or assets and a smaller part of the funds are used as “riskcapital.”
These may be more freely “gambled” with in higher risk
investments that have the potential to produce a positive return on
investment and grow wealth.

It is primarily the first part…the wealth preservation part…the
savings part of any portfolio that must be most carefully managed.
Money is saved so it can be there when needed later, such as for
realization of future plans, for retirement, or even provision for offspring.
Many investors and retirement savers were promised that their
funds would be safe if they would trust in the security of blue-chip
stocks, big-name brokerages and in various government assurances of
full faith and credit, financial stability, and deposit insurance. Many
investors and retirement savers have been obliterated in the aftermath
of the dissipation of this investment security mythology.

Some retirement savers and investors were completely sheared as
their Individual Retirement Accounts, which had been bundled in the
hoppers of diversified mutual fund management firms and then sunk
into high-risk “derivative” investments. They are derived from the
bundling together of multiple debt instruments, such as mortgages, and
sold as Mortgage-Backed Securities. They were given the highest credit
ratings based upon the companies that offered them. The investors and
retirement savers were assured by their brokers that these were the
strongest and most secure places they could put their money. After all
they were backed by mortgages, which are backed by real estate, so
there was little or no risk and on top of that, they would see their
money grow as the mutual fund realized a profit at the maturity of the

The problem was that these were not secure at all. They instead
were toxic assets composed of upside-down mortgages, where due to
the plummeting real estate prices, the properties no longer represented
an asset that could cover the mortgage, and of “liar” loans where little
or no down payment equity was taken in from unqualified borrowers to
offset their inability to realistically swing their payments. The savers
and investors believed they were making a safe move by opting for the
sure and secure world of mutual funds. In reality, their portfolios were
gambled on toxic junk. They were sold bad paper. They were told it
was good, but it was bad. They were lied to.

The ones selling the paper knew it was bad and in the most
despicable examples such as Goldman Sachs, made bets that it was bad
paper. In the infamous Abacus Collateralized Debt Obligations (CDO)
scandal, Goldman Sachs pushed through its brokers and affiliates the
sale of risky CDOs, then bet short against them, through the purchase of
Credit Default Swaps (CDS) which amount to credit insurance policies. If
the insured security which had been bought with the hard-earned
capital of the investors and savers were to tank, the credit default swap
would pay off…big time. That is, it would pay off for the holders of the
defaults swaps (read Goldman Sachs), not for the investors whose funds
had just imploded. These are usually bought as a hedge against loss by
the owners of the referenced debt-based security. They can also be
bought by speculators who do not own any of the “investment” that is
being covered from loss by the CDS and are essentially gambling that
the referenced security will experience a “credit event” such as default.
These CDS derivatives are usually offered by one company and are
referenced to the offerings of other companies. In a legendary example
of a total bankruptcy of ethics, marked by greed, corruption, and
conflict of interest, Goldman Sachs bought credit default swaps on its
own mortgage-backed securities or CDO products. The Credit Default
Swaps would have made a mountain of money for Goldman Sachs.
When charges were brought by the Securities and Exchange
Commission, Goldman Sachs simply “settled out of court” without
admitting any wrongdoing and paid $550 million in fines which were
only a tiny fraction of what they had made on the deals. Except for the
public relations black eye, it was very good business for Goldman Sachs.
Meanwhile, the critical life savings of millions of American retirees were
destroyed in a pit of corruption.

Others lost their assets when they were simply stolen by the
brokerage house that they had entrusted them to. Corruption and
cover up were the hallmarks of the MF Global Holdings scandal when
the company allegedly raided customer accounts just before filing
bankruptcy. It increasingly appears that instructions came right from
the top as former Senator and Governor of New Jersey MF Global CEO
Jon Corzine gave orders to use $200,000,000 (200 million dollars) of
investor funds to pay off an overdraft fee owed to the London offices of
JP Morgan. There are laws in the U.S. against the commingling, or
mixing together of the funds of a brokerage house and those of its
investors. In the international mega-corporate world that MF Global is
used to, these quaint national law isolationistic trade barriers can be
ignored by moving money around internationally. MF Global put the
investment funds of its American clientele into accounts in London,
where there are no such restrictions requiring the segregation of funds.

MF Global had overdrawn one of its accounts at the London Branch
of JP Morgan, so they transferred the money from their customers’
accounts to pay up. It was the combined money of investors, which did
not belong to MF Global that JPM received. Cash-strapped MF Global
had been up for sale to Interactive Brokers and had certainly wanted to
keep up the appearance of being a salable, solvent, going concern. The
“borrowed” funds probably would have been returned to customer
accounts, had the deal gone through, but a few days before the sale,
evidence of the missing customer “segregated” funds began to surface
and the buy-out fell through. MF Global filed for bankruptcy Oct. 31,
2011. $1.6 billion in customer’s funds are still believed to be missing, as
if they had vanished into thin air.

The money had, of course, been stolen to pay off MF Global’s
gambling debts to the JPM grand casino-London Branch. Upon the
dissolution of MF Global, the Bankruptcy trustee Judge Louis Freeh
planned to use the amount of funds that could be recovered for MF
Global’s creditors (but not their customers) to determine the size of the
massive “golden parachute” bonuses that its corporate executives
would be paid. A letter bearing the names of 21 members of the Senate
Agricultural Committee and calling the plan ”offensive on its face” was
sent to Judge Freeh pleading with him to not pay the bonuses. The
letter points out that,

“It is difficult to understand why you would even
consider paying anyone a bonus while nearly $1.6 billion
in customer money is still missing. And it is absolutely
outrageous to propose paying bonuses to the very
people who were responsible for the firm’s operational,
legal, and financial management at the time customer
money disappeared.

A fundamental principle of commodities trading is that
the firm’s money must be accounted for separately and
segregated from customer money. Throughout the long
history of futures markets, no firm has ever lost
10 Risk-free investing…Is it for real? 157
customer money of this magnitude – until MF Global.
The failure of senior management in this case is truly

–Letter to MF Global Holdings Bankruptcy Trustee Judge
Louis Freeh from the Members of the Senate
Agricultural Committee

Defunct MF Global has bilked thousands of its customers out of
their money, and if the bankruptcy Trustee says so, the very
perpetrators will be handsomely paid from the proceeds of the ensuing
fire sale. The damage to the creditability of the entire commodities
trading industry is indelible and is cited as the reason that many foreign
investors now want nothing to do with U.S. equity and commodity
trading houses. Even for the risk adverse investors who had trusted a
major trader to wisely use and protect their money, this turned out to
be the riskiest investment possible.

If preservation of value is the intended goal for a saver or investor
then neither the bond market offerings of non-interest paying T-bills,
nor the anemic interest rates of bank-offered Certificates of Deposit are
anywhere close to keeping up with inflation. Even cash in hand is not
safe, as the value of it is frittering away by the second through the
hidden tax of inflation, as millions of dollars per minute are added to
the money supply. When the inflation/deflation of the 2008-09 debtbased
equities bubble burst, many saw how their carefully picked
financial stocks could suddenly wither and die. All other equities classes
including energy, real estate, the resources sector, and the short and
long term bond markets and others all took unfathomable hits in value.
Stocks are inherently risky. These are high-risk portfolio growth
investments, not preservation of value investments.
Bank accounts, trade accounts, indeed all electronic accounts are as
vulnerable as the power grid to innumerable forms of catastrophe,
including the small but real possibility of Electro-Magnetic Pulse (EMP).
Even NASA has warned of the real potential threat and is studying the
sun’s activity with the aim to be able to predict, or at least give some
advance warning of Coronal Mass Ejection (CME) or solar flare events
that may inflict damage to the electrical infrastructure due to EMP.
Even human caused EMPs, resulting from a high altitude nuclear burst
could potentially throw the affected areas back to a pre-electrified age.

If such an event were to occur it would be years if not decades in
normal circumstances to obtain the electrical replacement components,
particularly transformers, to rebuild. With the exodus of heavy industry
from the United States, none of these components are made in the U.S.
The time it would take to rebuild the grid all depends upon the
assumption that any manufacturing facilities are still in operation, and
that if they are, that they are going to be willing to sell the parts needed
to repair an EMP-disabled America. In line with the maxim that “If you
can’t touch it, then you don’t really own it”, money in an electronic
account can disappear in a millisecond.

As the Dollar and all other fiat currencies have plummeted in value,
it has reflected in the “rising” price of gold which has averaged nearly
20% per year gain against the Dollar for over a decade. The price of
gold has not really gone anywhere; the value of the Dollar in gold has
gone down. Real, physical gold and silver, in one’s tangible possession,
is the only guarantee against loss due to inflation, liability, failure of
fiduciary responsibility, or downright criminal misappropriation. CDs,
Mutual Funds, stocks, bonds, or paper cash, all of which are
denominated in Dollars, cannot hold or preserve value in the long term.

Only precious metal can do that.

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