Archive for the ‘Business and Finance’ Category

A Tale of Two Merchants

In Business and Finance on May 8, 2009 at 6:04 am


Manufacturing Doesn’t Make Money, Sales Do

By Antonio Graceffo


A college business professor once dazzled his class by reducing the world’s myriad businesses to a single sentence: “All companies do one of two things; they make or sell a product or service.”


For years, I thought this guy was a genius, until I started working in the financial sector. I realized right away that services are products, so I could shorten his statement to “All companies do one of two things; they make or sell a product.”


With more experience, I realized he was completely wrong. The statement should read: “All companies sell a product.”


That’s it! Simple language. Companies sell products. Making products costs money. That’s why manufacturing is on the cost side of the balance sheet. Selling products makes money.


So many people around the world are pointing at the US right now, blaming the Americans for causing the world economic tsunami. They are specifically targeting the greed of American consumers, who used credit to by products, and blame the laziness of American workers, who don’t make products anymore.


While many people are saying the Americans are now receiving their due for their greed and laziness, it is important to point out that the allegedly good and hardworking countries are also suffering too. So, producing products is not insulation against economic downturn. Next, it should be noted that those countries that built their economies on manufacturing were largely making products for the US market. The greed and excessive credit use of American consumers produced the demand for those products and created employment in those foreign countries. Finally, if the Americans did go back into the manufacturing sector, this would eliminate the need for overseas factories, which would result in widespread unemployment in the very countries who are pointing their finger at the greedy, lazy Americans who buy too many products which they refuse to make themselves.


America has become the eternal middleman. But this is not necessarily a bad thing. The golden rule of business is: you must sell products to make money. You don’t have to make products to sell them.


When I was working at a large private bank in the US, the senior vice president told me a story about the bank’s first foray into real, brick and mortar, manufacturing business. The bank invested heavily in a soap powder factory in China. The bank sent monthly checks to the local manager, who sent back reports of how soap productions was going. This was in the early days of capitalism in China and the ability to earn wages drove the Chinese laborers to work twenty hour shifts, seven days per week, with no bathroom breaks. Soap production in this factory was higher than any similar project the bank had ever undertaken anywhere else in the world. Back in New York, the bankers were congratulating themselves on their great success. After a while, however, they noticed that there was one thing missing from the manager’s reports. There were no sales. So, a representative flew from New York and took a tour of the factory.


Sure enough, there was a huge, factory, which operated like a well-oiled machine. The workers were at their places, running three shifts, twenty-four hours per day, 365 days per year. Everything seemed to be in order. The New York banker noticed there was one massive building, the biggest building in the complex, which they hadn’t toured.


“What is in that building?” he asked.

“That’s where we store the soap after we make it.” Said the factory manager. He went on to explain that every few months they had to build a larger warehouse to accommodate the growing quantity of soap.

“But aren’t you selling the soap?” asked the banker.

“Yes, we want to sell the soap, but no one ever comes here to buy it.” Said the manager.

“What is your marketing plan?” asked the banker.

“We are willing to sell soap to anyone who comes to the factory.” Answered the manager.


An employee believes that his work, his labor, somehow generates an income. This has been his working experience his whole life. Somehow, punching that clock twice each day caused a check to appear at the end of the week. An owner realizes that work, labor, and manufacturing all cost money. Only sales bring money into the company.


My experience has been that the bulk of people are employees and always will be. They do their job because someone tells them to, and they have no idea where or how their salary is generated. This is the mentality that causes factory workers to protest the closure of a factory whose products no longer have a market, or of manufacturing sector employees pointing fingers at the people who bought the products they were producing and calling them greedy.


One of my largest clients in New York was a holocaust survivor. Let’s call him David. David was a Jew, born in Poland. His parents were killed when the Germans marched in and began rounding up Jews. His Christian neighbors took pity on the fourteen year old boy and hid him in a cave in the mountains. He spent a period of years, alone, starving in this cave. When the war ended, he was so weak and malnourished he could hardly walk. He went into the city looking for work, but no one would hire him because he looked so pathetic. He saw some men moving furniture and begged them to let him help. He tried to lift a single chair, but collapsed. The men handed him some bread and sent him on his way. The same thing happened again and again, with people handing him a little food and sending him away. He became slightly stronger and sometimes was able to work for an hour or two before getting fired.


One day when he was fired, the employer handed him a bottle of vodka as payment. Not knowing what to do with the vodka he inadvertently wound up selling it to an allied solider. It was the most money he had ever seen in his life.


He used the money to buy food. Then he worked as a laborer, and used his meager laborer wages to buy vodka, which he sold to soldiers at a profit at the end of each day. Very quickly, he saw that working as a laborer made no sense, as he could sell a single bottle of vodka at a profit in the morning, walk back to the distributor, buy more vodka and sell it again in the evening and make more money than he could laboring.


Still malnourished, he found the back and forth too physically demanding, walking to and from the distributor buying single bottles of vodka. He convinced the distributor to extend him credit, to give him a whole crate of vodka, which he would sell and return that evening to pay for. He used his small vodka profits from the previous day to pay a man with a donkey cart to carry the vodka for him.


When I met David, nearly fifty years later, I asked him to tell me about his assets. We were in his plush office on the twentieth floor of a skyscraper in New York City. He took me to a massive window and began pointing at buildings.


“I own that building. That building. That building…”


“Sorry, for a moment there, I thought you pointed at the Empire State Building.”


“Yes, I did.” He said, and moved on to the really important assets.


He kept pointing. At first I was trying to write the addresses down in his balance sheet, but realized the point of the story was simply that he was really, really rich and that on any given day, his wealth could be estimated in the billions, or maybe hundreds of millions, or zero and none of it mattered. He was alive. He was healthy. His children had attended the best American universities, and he had taught them to make money. His grandchildren were attending university, and they all did their internships in his many companies. And they had learned to make money. His wealth and his knowledge was an insulation: “Never Again!” he seemed to say. Never again, would he or any member of his family suffer the way he had.


That starving little boy in Poland, fifty years earlier, never made a bottle of vodka. He certainly didn’t pick up a hammer or pour cement in the construction of the New York skyline. But he created more jobs for more people than any laborer or craftsman ever did. I could spend a lifetime following the hundreds of thousands or even millions of workers whose wealth and prosperity was derived from working on one of David’s many projects.


And while David may not have been the one who taught me golden rule of business, he was the one who drove the message home. Sales, not manufacturing makes money.


All businesses in the world do one thing. They sell a product.

Antonio Graceffo is a martial arts and adventure author living in Asia. He is the host “Martial Arts Odyssey,” a web TV show which traces his ongoing journey through Asia, learning martial arts in various countries.


His books are available on

Contact him:


Join him on

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This episode was edited by Antonio Garceffo and features the official Martial Arts Odyssey intro and outro by Andy To.



Lies About Real Estate Investing

In Business and Finance on December 29, 2008 at 4:54 pm

Your home is not an investment.

By Antonio Graceffo


The current world financial tsunami started with the collapse of American mortgages. Many people who over-strapped themselves, and bankrupted their families with homes they couldn’t afford believed they were doing the right thing. Their whole lives they were told that a home is a great investment, money in the bank. Now they are learning, a bit too late, that it’s not.


Money, as in money in the bank, by definition must be devisable, portable, and universally exchangeable for the purchase of goods or services. Your home is none of these things.


If you like a home and wish to live in it, by all means buy it, but don’t kid yourself into believing it is an investment. Investments, by definition, generate income or appreciate. Investments also don’t cost you all of your income to maintain or put you into years and years of debt.


The home can be an endless money pit. Your mutual funds may go down in value, but they never ask you to repaint them, furnish or repair them, and you don’t pay annual taxes or interest for the privilege of owning them. Mutual funds, stocks and bonds, all have a ready market available for them which is a mere phone-call away. Any number of external factors may make it impossible for you to sell your home.


In bad economic times, when you have lost your job, or in the face of the current world economic tsunami, you can stop paying into your mutual fund account without any negative effects. But if you stop paying your home mortgage, you lose everything.


When I was working in New York City, a friend called me from the suburbs to tell me that a heavy wind had blown down the awning on her back porch. The damage would cost $2,000 to repair. Later, when a water leak in an upstairs bathroom caused damage to the drywall, more money went out. While the drywall was being replaced, it was discovered that the wiring was also faulty….Money out, nothing in.


On the same morning I checked my investment portfolio online. The storm hadn’t affected it.


For most Americans, their home is the largest investment they will ever make. And people are proud to tell you how much they “made” on their home. But actually, the gains are only on paper unless you sell the home, which they don’t usually do, because they want to live in it. So, it is arguable if your home is an investment at all. For financial planning purposes, it is not. Now in the face of this new financial crunch, as home prices plummet, do people who haven’t moved out of their homes say they “lost” on their investment?


Buying a home gives people the illusion of an investment.


Once, we went out on a financial planning call to a man, call him Mr. Smith, who believed he was financially ready to retire, at age 51. The minute we walked in the door, his wife begged us, “please tell him not to quit his job.” Obviously this was an argument they had been having for sometime, but the mood between them was extremely hostile, particularly since the man had already turned in his two week notice at his job.


“I don’t have to work.” Boasted the man. “I am a millionaire.”


We looked at his portfolio and it was only valued at $900,000.


“Close enough for government work.” He said.


At closer examination nearly half of his $900,000 was the estimated value of his home.


“So, where are you planning to live after retirement?” asked my partner, Steve.

“Here, of course.” Answered Mr. Smith. “The kids are close by. We love the neighborhood, and we are very attached to the house.”


“So, how will you use the value of your house to finance your retirement?” asked Steve.


Mr. Smith didn’t have an answer. That meant his total net-worth was about $450,000. Half of that was tied up in his wife’s 401K, which they couldn’t draw on until she reached the age of fifty-nine and a half.


Not only would Mr. Smith not listen to our arguments that he was in no position to retire, he actually got angry and threw us out.


Denial is a common emotion when people’s financial beliefs are challenged by experts or when undeniable reality steps in and crushes people’s dreams.


Another form of denial is the profit people claim to make on their house sale, during good markets. “I bought my house for $150,000 and sold it for $220,000, so I earned $70,000 profit.” This is what a proud Mr. Jones told me at a pool party on Long Island. Apart from the fact that he now needed to buy a comparable home in a comparable neighborhood, which would cost him the same money, he had actually lost on his home purchase. When he bought the home there were loan origination fees, closing fees, and other sundries. During the length of time that he was living in the home he was paying interest. And of course, he bought furniture and did maintenance and renovations on his home.


People will go into debt to buy a living room suite or a widescreen TV, kidding themselves into believing that anything they buy for their home is an investment because it increases the resale value of the home. But in reality, resale value is not effected by the presence or absence of a home entertainment center, unless you are planning to include it with the sale of the home.


To know what the profit is, one would need to total all of these expenses and subtract them from the sale price.


Living in an apartment, I was never tempted to buy anything. With the money any of my homeowner friends paid for furniture for a single room of their home, I paid a years rent.


When I was doing investment advisement, one of the most common reasons people gave for not wanting to invest in the stock market was that they preferred real estate. “I want something I can see and touch.” They would tell me. If they were those rare individuals who bought rental properties and collected rents, then they were right. There can be huge advantages to owning real estate. But most people aren’t collecting rent, when they claim to be investing, they just meant they were buying a home to live in.


Some of my old-school Italian clients bought a huge house, but they lived in the basement and rented out the upstairs. That qualifies as an investment. The tenant covered the mortgage while the family lived virtually rent free. Then, someday, the family could sell the house, to collect the appreciation, or could just move upstairs, in a fully paid for house.


Sadly, these people were absolute minority of homeowners. Most families chose to live in the main house and rent out the basement. This meant they were paying the bulk of their mortgage out of pocket.


Another friend of mine, Robert, had the forethought to buy a large townhouse in an undesirable section of a major American city ten years ago, when no one wanted live there. Seven years later, the house had more than doubled in value. He sold it, and cleared more than $200,000 profit.


Probably 60% of this number was real profit, over and above what he had spent on renovations, mortgage payments, and other house related expenses. Even with those deductions, his profit was way above what he would have earned if he had invested in the stock market. So, he was one of those rare Americans who actually made real money on a real-estate investment.


But, as is always the conundrum with selling the primary residence, Robert still needed a place to live. Having already done the whole, living in the crack neighborhood and waiting for it to change thing, he moved into a better neighborhood, where he bought a much nicer home, worth $1.7 million dollars. He used his entire $200,000 profit as a down payment and began paying $10,000 a month on an interest-only mortgage.


His strategy was to wait till this incredibly desirable neighborhood became even better. At that point his house would double in price, as the first one had. He would sell it at a massive profit and maybe start over again, this time, buying a castle.


That was the plan. But in 2008, the US economy slipped into a serious recession. The $1.7 million dollar homes aren’t moving as fast as they did a few years ago. Depending upon how the loan agreement is written, there may be a chance that if the home (the collateral) drops in value, the loan could be called. And he would lose everything.


In the current market, where Wall Street is dropping like a stone, $200,000 would buy a lot of stock. Or, maybe better, $200,000 would buy a lot of cash, which is probably the safest thing to be invested in right now.

Antonio Graceffo is the former assistant head of Private Wealth Management for one of the largest private banks in the United States. He is now a martial arts and adventure author living in Asia. His book, The Monk from Brooklyn, is available at See his videos on youtube.


His website is

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Leveraging Main street

In Business and Finance on December 21, 2008 at 4:51 pm

By Antonio Graceffo


A late night TV commercial, in the 1980s, showed sad people, sitting around their kitchen, with no money to buy a new home entertainment center. Then a friend suggested, “Why not take a home equity loan?” The next scene showed the happy couple, not only enjoying their new home theater, but also fanning themselves with hundred dollar bills. The announcer came on and said, “Don’t just sit there on all that cash. Take a home equity loan and live the life you deserve.”


This commercial basically suggested that people put their home ownership at risk in order to finance the purchase of consumer goods that they didn’t absolutely need. It was just one of many easy-credit programs which used to be targeted only at the poor, but have steadily been creeping up and up the American social ladder, infected both the middle and the upper income groups.


Back in the early 1990s, when I was essentially homeless and working construction, my coworker, Red, told me about coming home and finding a check for $1,500 dollars in the mailbox. Basically, these checks were sent out by “banks,” shady credit institutions, who lured the poor into debt slavery. The back of the check, the part you had to sign in order to cash it, was actually a loan agreement, locking you into some horrible repayment plan, with high interest, origination fees and late penalties.


I think it is no longer legal for companies to send these checks out, unsolicited, to strangers. But, if these guys had already borrowed through this company, then they were considered existing customers, and it was Ok. I once borrowed from a company like this, and noticed that what I thought was a loan agreement was actually a credit account. This meant, even if I managed to pay back the principal plus interest, I could just draw it out again, without going through an application procedure. What was worse, at any time during the repayment process, you could call up, no internet in those days, and check your credit balance. Any cash in the account could be drawn out and the debt started over from zero again.


It took me three years to pay off a $3,000 loan.


“I was so tempted to cash that baby.” Said Red, a hard drinking, semi-employed brick carrier, with a wife, several children by other women, and a trailer to support.


“Why didn’t you?” asked Jason, who was probably thinking of the big meal they would eat at a Mexican chain restaurant, sharing Red’s windfall.


“Darleen said she’d leave me if’n I got further into debt. Every Friday when we get paid, I gotta go give most of it over to the Quick ‘N’ Pawn so’s’n I don’t lose the TV.”


Pawn was another scam. Red had been $30 short on the rent for the space where he parked his trailer, so he took the only thing of value he had left, his TV, down to the pawn shop. His intent had been to borrow $30 and pay it back, plus the vig, but I think they call it interest in semi-legitimate credit institutions. If he missed a payment, he would lose the TV. The strategy of the pawn shop is to try and push the guy to borrow more. This way, the guy would be more likely to miss a payment a few weeks down the road, and he would lose his TV. The pawn shop then had all of his payments, up to that point, plus they would sell the TV, price which they would make sure was higher than what they had loaned him.


The pawn shop had talked Red into borrowing $100. He paid his rent, then used the rest for a big Mexican meal, complete with nachos and beer, and invited Jason and me. The rest he used to buy an answering machine for his wife. The next week, when he couldn’t make his interest payment, he gave the pawn shop his answering machine. Now, he was in danger of losing his TV. And a check for $1,500 had arrived in the mail.


Fast forward nearly ten years:was working as financial consultant for a European investment bank. They sent me into consumer banks to invest money for the regular banking customers. At one point, I was responsible for seven bank branches in Manhattan. Depending on which branch I was in, I handled investments for the UN, and used all my various languages in the meetings. I handled investments for politicians, entrepreneurs, mom and pop, you name it. And I saw the whole gamut of personal finance, from top to bottom, which families made good decisions and which made bad ones.


One of the branches was in the garment district, and while I was called into handle investment for factory owners, I would see the workers lined up to cash their checks. I always avoided going near that branch on the first and fifteenth of the month, because the factory workers scared me. They would be lined up around the block, hundreds of them, waiting to cash their checks, because they didn’t have bank accounts. Because it was payday, a lot of them had been drinking. Occasionally, violence would erupt. The bank actually had to hire extra security guards for those days.


At other times, I was at a branch by Wall Street, where the patrons, mostly traders, had more money and education. But, on Fridays, there was also a line out the door, and around the block, with very well dressed men, holding briefcases, waiting to cash their enormous pay checks. Unlike the factory workers, who would clear less than $200 a week, these checks were sometimes in the tens of thousands of dollars. Ten thousand dollars a week! That was more than a factory worker made all year. This branch also had to have extra security because they would have millions of dollars on hand that day.


Why were these well paid men cashing their paychecks rather than depositing them?


Because they bought stock several days earlier and had to pay for delivery of the stock on Friday. The stock they bought was speculative. In the late 1990’s it was very possible that in the three to five days it took until you absolutely had to pay for the stock, it would go up enough that you could sell it, without having paid for it, and clear a profit. Or, you could borrow money, pay for the stock, and then sell it. If the stock didn’t go up, then you needed to pay out of your pocket, and sit and wait and sell it next week. Hence, the need for tens of thousands of dollars.


But, it gets better than this. These men were also using the financial concept of leverage, whereby they could borrow money, depending on the stock, they could get credit worth several times the value of the stock. Why did they do this? To buy that much more stock, and earn more money.


If you buy 100 shares and they go up by a dollar, you made a hundred dollars. You would then sell the stock and pay for it, and pocket the difference. But wouldn’t it be better to buy 1,000 or 10,000 shares? Then, if they go up by one dollar, you made $10,000. If your friend made $10,000 and you only made $1,000 wouldn’t you feel foolish?


At that time, there were technology securities which had growth rates of 100% or even 190%. So, if you break that down to how much that was per day, it was a huge growth in the three to five days until you needed to pay for it.


It seemed at that time, that everything you bought went up. People were doing anything they could to buy stock and get in on this cash cow that all of their neighbors were doing so well with. In the commercial banks where I worked, I saw the customer come in, and take out a home equity loan, drawing every penny of available equity, and then come over to my desk to buy stock. Once, and I swear this is true, a man came in, filled out all of the necessary paperwork, told me how much and what he wanted to buy. Then, he walked over to the ATM machine and drew out a cash advance on his credit card to pay for his stock trades. As I was in a more conservative end of the business, we weren’t even allowed to accept cash. So, he wrote me a check, said, “wait a minute on that.” He walked over to the teller window and deposited his ATM cash. When he got his deposit slip, he waved and smiled at me, as if to say, “OK, go ahead and process that trade.”


He left the bank without even stopping by my desk again.


Many of my trader friends told me they used their American Express cards to buy stock. With Amex, you don’t have a credit limit, as such, and if you pay in thirty days, you don’t pay interest. So, they would buy stock, and hold it for thirty days, sell it, and pay off the bill when it came in. But because of settlement rules, it was possible to hold the position for 33 or even 35 days.


Picture using a $10,000 cash advance on a charge card to buy $50,000 worth of stock, that you can’t afford to pay for, because you are hoping that it will go up in the next 34 days. I don’t know about you, but that would be a long sleepless 35 days for me. But for these guys, this was their normal routine, month in and month out.


I heard stories, although didn’t actually see it with my own eyes, of guys taking cash advances of tens of thousands of dollars, buying hundreds of thousands of dollars worth of stock they couldn’t afford, and holding it for thirty days.


In addition to being insane about trading stock and “leveraging” their position, one commonality between all of these educated, well-off men was that they sneered at the “jerks” who fell for the home-equity credit scams on TV.


“Can you imagine someone being that stupid and using their home equity to buy a stereo?” They would say.


The late 90’s and into about 2000, Wall Street was experiencing what financial experts call a bubble. It is a time when the market goes up and up. Prices and returns inflate until, eventually, like a bubble, they burst. And then you are left with a soggy, deflated balloon, and no house.


When Charles Edward Merrill, founder of Merrill Lynch, coined the phrase, “Bringing Wall Street to Main Street,” he didn’t mean that normal people should be leveraging their kid’s college fund, their retirement monies, or their home. He was trying to level out the playing field, and give the regular Joe a chance to participate in the stock market. But somehow, the concept became perverted and blown out of proportion on a scale that would probably have sent Merrill spinning.


Everyone was focused on “let your money work for your you.” But, comedian Jerry Seinfeld pointed out, “What if my money gets fired?”


In addition to leveraging assets and salaries, people in New York, and elsewhere, decided that they, like big corporations, should hire accountants, who knew how to “work the system.”


“Why should the government be making money on your taxes?” was a common phrase that was thrown about, as people sat in Starbucks, drinking a $4 late and swapping tax avoidance strategies.


A friend of mine, a Wall Street trader, earned $800,000 in one year. His accountant used aggressive, but legal strategies to postpone ALL of his tax payment until the following year. And why did my friend want to do this? So that he could use his tax money to buy stock.


His plan was brilliant. Use the $250,000 in his tax account to buy stock, fully leveraged, of course. And when the stock went up, he would sell it, and use the profits to pay last years taxes and this years taxes. Or, maybe he would look for another loophole to push the tax debt further one more year.


Since a technology mutual fund could gain 190% per year, my friend, and others like him, saw their debts as decreasing in value at a rate of 190% per year.


Unfortunately, for my friend and others like him, a basic rule of both physics and finance is, what goes up, must come down. The bubble burst.


If you use leverage in a stock account, the stock is essentially the collateral securing the loan. This method works great in an upward market. But now, let’s say that your stock drops in value by 10%. You no longer have enough collateral to secure the loan. The loan comes due in the form of a margin call. This basically means, you have to repay the loan, or put enough money into the account to make up the shortcoming in your collateral.


But money, cash, was the one thing none of these guys had. Cash was stupid. Cash was for losers. Cash prevented you from “leveraging,” from maximizing your returns.”


So, how did they make up the deficit in the face of a margin call? They sold stock. But they were now selling it for less than what they had paid for it. So, they had to sell more than what they lost. For some of these guys, the credit card bills, home-equity loans, or whatever crazy credit bills also came due, and now they were in serious trouble.


My friend, the trader, who postponed his $250,000 income tax payment, lost everything. On Wall Street, if you wind up in trouble with the IRS or have any personal credit issues, bankruptcy or foreclosure, you generally lose your license and your job.


The tax debt which my friend believed was decreasing at a rate of 190% wasn’t. Those gains in his portfolio were “paper gains,” not real. But his tax debt was real. Suddenly, he had no money, no job, and a $250,000 tax bill staring him in the face.


Like a recovering alcoholic who could never go near a bar again, my friend needed to find the simplest, most secure, quietest job he could. He started working at the post office. His new salary was $40,000 a year. And he will be paying off his tax debt for the rest of his life.


This would be a good place to end this article. We saw how crazy the bubble was and how stupidly people used credit in America. But sadly, it doesn’t end here.


When technology stock blew up, people went to small cap. When the stock market more or less imploded, people ran to real-estate.


“I can’t believe how stupid we all were with stocks before.” A friend of mine told me. “But I learned my lesson. Real estate is the way to go. It’s safe. You can see. You can touch it. And it always goes up in value.”


This particular friend used his house as collateral to invest in as many condominiums as he could. When last I checked with him, they were still unrented. And in the face of the current trend of foreclosures and lack of consumer credit, I don’t see how he could sell them.


If I had a chance to pull him aside at a cocktail party I would tell him, “I got a hot tip for you, the new, new thing.” Then I would look over both shoulders to make sure no one is listening and tell him the financial secret handed down to me by the film, “the Graduate.”


“Plastics” I would say. “Technology didn’t work out. The market tanked. Real-estate went bust. But if you want a fool-proof investment, buy plastics.”



Antonio Graceffo is the former assistant head of Private Wealth Management for one of the largest private banks in the United States. He is now a martial arts and adventure author living in Asia. His book, The Monk from Brooklyn, is available at See his vieos on youtub.


His website is

Join him on

Contact Antonio:





Article: Bernie Madoff the New King of Ponzi

In Business and Finance on December 16, 2008 at 3:50 pm

Bernie Madoff the New King of Ponzi

By Antonio Graceffo


On December 11, 2008, Bernard Lawrence Madoff (born April 29, 1938) chairman of Bernard L. Madoff Investment Securities LLC was arrested by the FBI. At that moment, he moved from being a hedge fund principal with suspiciously consistent returns, to being a suspect, thought to have bilked investors out of $50 billion. So far, according to the FBI and other sources, this is the largest investment fraud ever committed by a single individual.


People all over the world read the headlines, and knew this guy must have done something bad, but a lot of people don’t know exactly what a hedge fund is, or what Madoff did wrong.


A hedge fund is a private investment company which accepts money from a limited number of investors. The reason it is called a hedge fund is that the strategic intent is to hedge or counter balance the market. In other words, hedge fund managers are hoping to use a strategy which causes their fund to go up when the market goes down. To do this, hedge funds often use investment instruments which are considered higher risk than what you might find in your 401K. These could include puts, calls, option, and exotic options, and derivatives to name a few.   


Hedge funds are regulated outside of the scope of “normal” investment companies, such as mutual funds. Their shares are also not readily available to the public. Compared to the scrutiny a mutual fund is subjected to and the disclosure requirements they must meet before selling shares to the public, hedge funds are like the Wild West of the investment world.


Because of the perceived risk involved and the lack of regulation and investor protection, investment in hedge funds is generally only open to “accredited” investors. There are strict rules as to how much the minimum investment must be. Generally the minimums are quite high, often in the millions. Rules also stipulate that the millions you invest in a hedge fund should be no more than a certain percentage of your total net worth or total investable assets. Hedge funds are generally not allowed to advertise and are often limited in the number of investors they are allowed to accept.


The basic idea is that people investing in hedge funds are extremely wealthy. They have experience with investing, and their hedge fund investment is just a piece of their overall investment strategy. These people usually have advisors, such as brokers, planners, accountants and attorneys who should be looking out for their interests. The investors in a particular fund often know each other and know and trust the fund manager. The fund doesn’t advertise, so it acquires new investors simply through word of mouth. Someone invests, makes money, and tells two friends. They tell two friends, and so on.


Hedge funds are in no way illegal or immoral. They serve a purpose which exists outside the scope of the average person’s radar. The investors in hedge funds are often institutional investors, such as endowment funds and retirement and pension plans.


So, what did Madoff do wrong?


It was publicly known that Madoff paid brokers “for order flow.” This means giving a commission directly to a broker for buying shares. The rules on how brokers are compensated; who can pay them, and how much, are very strict. You never want to create a situation where a broker might be tempted to sell an inferior or inappropriate investment to a client, simply because he was to receive a bigger or additional commission.


While hedge funds are subjected to less stringent regulation than mutual funds, they are not completely outside of the law. These funds are required to file certain disclosure documents, showing what they were invested in. But, just before the end of each quarter, when these documents should have been prepared, Madoff’s fund sold out their investment positions. So, no one actually knew where the money was invested.


Another reason outside entities were keeping Madoff in their sites was because of his returns. Over a period of years, Madoff’s investors received a steady 10.5% return on their investment. This number is not so shocking, if we consider that small cap stocks, over a long enough time line, are expected to yield a similar return. What is strange however, is that Madoff’s returns were consistently between 12% and 13%. Normally, we would expect an investment to fluctuate much more widely over a ten year period.


Just to put this in perspective. I checked the ten year average of a technology mutual fund that I sold while I was an investment advisor, working in New York City. From 1998 – 2001 the fund experienced a growth of nearly 300%. If you had invested $10,000 in 1998, your investment would have been worth over $35,000 in 2001. Today it would be worth about $7,500. Checking a small cap mutual fund, which we would expect to be somewhat less volatile than technology, your $10,000 investment in 1998 would have hit a high of about $35,000 in 2007 and would currently be worth about $17,000. 


This type of fluctuation is in sharp contrast to Madoff’s two-point swing.


The big crime that Madoff committed was Ponzi.


Ponzi is a name given to an investment scam, first popularized in the USA, in 1903, by Charles Ponzi. The idea is, you get a bunch of investors, and promise them high returns. They all give you an initial investment, let’s say 100,000 each to make the math easy. At the end of the first quarter, you pay them all their quarterly earnings. You send each investor a check for $5,000.


WOW!, Thinks the investor. I earned $5,000 in one month. That means 5% per month, or 60% per year. This is great. The bank is only paying 2.7% per year. And so, the investor invests more. And he tells his friends to do the same. As long as you keep sending checks to the investors, they will keep investing, or at the very least, not want to take their money out. As long as new investors join, you will have money to continue making payments to the old investors. They think they are earning interest, dividends, or investment returns. But in actuality, all they are getting is their own money back.


For Madoff, the final nail in the coffin came when investors demanded $7 billion of their cash back, and he didn’t have enough left to pay them. Now, he faces up to 20 years in jail. But he will always be remembered as the New King of Ponzi.



Antonio Graceffo is the former assistant head of Private Wealth Management for one of the largest private banks in the United States. He is now a martial arts and adventure author living in Asia. His book, The Monk from Brooklyn, is available at See his vieos on youtub.


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Tomorrow’s Spending Today

In Business and Finance on December 11, 2008 at 12:53 am

More on the Global Financial Crisis

By Antonio Graceffo


Even if you haven’t been to business school, at is base, business is pretty simple.


Step 1: Buy a widget for a dollar and sell it for a dollar ten.


Now it starts getting technical.


Step 2: If you sell more widgets, you make more money.


As a business owner, selling more products is better than selling less. Wow, so far this is making my head spin.


So, how can you get people to buy more widgets?


Step 3: The obvious way to get people to buy more widgets is to lower the price of your widget. You can do this by employing Mexican or Uzbek children in your factories, or by instigating a war and capturing the necessary raw materials.


But at some point, the widget is as cheap as it is going to get. Walmart came up with an interesting business strategy. Every other company in the world was trying to increase profit margins (the difference between your cost and the price you sell at). Walmart, on the other hand, was trying to decrease this number. The idea was to strip the costs down to nothing, then keep reducing the profit percentage, but increase the number of widgets sold.


Selling a million widgets, with a 2% profit makes you more money than selling 100,000 widgets with a 3% profit.


This method worked for a while, and the US consumer market just kept growing and growing.



Super stores, warehouse marts, and large box stores were popping up everywhere. When I was living in Europe I tried to buy a five pound box of my favorite breakfast cereal, “Chocolate Super Bombs.” The clerk looked at me and said, “But you are only one person. Why do you need five pounds of cereal?”


Americans owned significantly more products than people in other developed countries. When my sister told her European boyfriend she was going shoe shopping, he answered, “But you already have shoes.”


When I was teaching English in overseas, students often asked me, “Teacher, on TV we see many American movies, and there are always monsters in the basement. What is a basement?”


“It is a place to store things you purchased but never use.” I answered.


The follow up question would inevitably be. “In some movies, the monster is in the attic. What is an attic?”


“An attic is also a place to store things we bought but don’t use. But an attic is above the house, instead of under it.”


Did buying a lot of products increase the frequency of monsters?


“Teacher, in American movies, when people want to commit suicide they drive their car in the garage and turn on the car engine. What is a garage?”


“It is a place where you store one of your automobiles.”


“But some garages look so messy, and some people still park on the street.”


“That is because Americans also store unused products in their garage.”


Some American homes had three or more rooms designated as depositories for products that they had purchased but didn’t use.


Step 4: If low profit margins and low cost weren’t enough to move products off of the shelves, sellers could use sales and coupons to entice buyers. In some cases, products were sold at a loss. These products were called “lost leaders.” The thinking is, you come in the shop to buy a lost leaser and hopefully make ten other compulsion purchases while you are there.


When I was a student in Germany, I discovered that Germany had very strict rules against sales. And lost leaders were actually illegal. You couldn’t sell a product below cost. The German rational was that by selling low cost products, large stores had an advantage over small stores and this was in detrimental to a free market.


My American classmate, John-the-Republican would get angry. “Having the government tell you what price to charge for your products is detrimental to a free market.” He would complain. One day, he came back from a shopping excursion to Stuttgart, where he had just bought a new album. “Do you know why this CD was $30? Because I am paying for some old guy’s retirement.”


At that time, Germans were taking early retirement in their mid fifties. The unions were pushing for a four day work week. Women (or men) could collect three years of maternity leave benefits from the government. An advocacy group in support of unemployed people was complaining that with recent government benefit cuts, “many unemployed people earn less than those who are working.”


Germany had one of the lowest unemployment rates in western Europe and yet it was more than double US unemployment.


In the face of so much money going out and so little coming in, the government still put money and resources into campaigns, telling people not to consume.


We American students all said that selling more products was better for the economy. It created jobs and created financial movement. We suggested lifting bans on sales and lost leaders.


The German’s rebuttal was telling of the differences between the two countries/cultures. My Germans classmate said, “Each week, people will buy the products they need. If you decrease the price, people will still buy the same number of products, because they don’t need more products. And you will earn less money.”


“But when they are in the store, won’t they suddenly see other products that they needed or wanted?” We asked. “For example, in America we have end displays at the ends of the aisles, which feature a different product each week. Or we have compulsion purchase products near the registers.”


“That should be illegal.” Retorted our colleague. “You are making people buy things they don’t need.”


Then I pointed out that making people buy things they don’t need isn’t as bad as packing them in trains and shipping them off to concentration camps. And the conversation pretty much deteriorated from there.


One interesting point that the Germans made was that, if you decreased the price of product, lets say cans of tuna, German consumers would still buy exactly the same amount. If they normally bought two cans a week, and you decreased the price, they might buy eight cans. But they wouldn’t consume eight cans. They would just be buying a month’s supply in one day. So, while your sales would spike during the week of the sale, they would slump, and average back out for the rest of the month. But your profits would be lower.


In sales, we call this shifting tomorrow’s spending to today. In America too, sales we walk a thin line in developing sales strategies. The question comes up, “how can I get people to buy more today, but still buy again next week?”


This is why American producers keep developing new types and brands of products. In the former East Germany, if you were lucky, and if you had connections, and if you had foreign exchange coupons, you could go in a shop and purchase a brown box, marked with a black stamp, which read, “COOKIES.”


In the new Germany, you go in the supermarket and there is about half an aisle dedicated to cookies, candies, chocolates, breakfast cereal and a number of other products. Most grocery stores in Germany only carry about six or eight flavors breakfast cereal and they are all the same size.


There are also very strict rules in Germany about how these products are marketed. In general, advertising which targets children is discouraged, if not illegal.


Big grocery stores in the US have an entire aisle dedicated to breakfast cereal. There are thousands of brands, most of which are tied to cartoon commercials and memorable characters or movies. Tony the Tiger, Dig’em the frog, the Roce Crispy Guys, Count Chocula, Boo Berry, Frankenberry, Fruit brute, Lucky the Leprechaun, and my all time favorite, Captain Crunch.


Inside of each brand are numerous varieties. Captain Crunch comes in regular (which cuts the inside of your mouth, peanut butter, Captain Crunch with Crunch Berries, and new, Choco Donut Captain Crunch. And each flavor comes in a variety of sizes.


If one brand, flavor or size in on sale today, you buy more. But next week, you also but, because you want a flavor or brand. The same is true for consumer goods, such as TVs, DVD machines, computers, clothing, cars, and even houses… By creating so many new choices and types, the manufacturers guarantee that a decrease in prices this week causes a spike in sales this week, but by releasing a new product next week, they can also expect a spike in sales next week.


The spike became the norm.


This strategy has gone on and one for years. At some point, even the US consumer ran out of money. You can only take advantage of sales if you have cash.


Step 5: Extend liberal lines of credit to your customers.


From the 1950s to the 1970s you to had show income, savings, and credit history to obtain credit cards. Buy the 1980s college students and unemployed people could obtain cards simply by filling out the application form. By the 1990s, unwanted credit cards actually arrived in the mail. You had to simply call to activate them.


Now, you had spikes in sales, driven by the invention of new models and brands. You kept your profit margin low, so your end product was low, but your overall product was high because your sales were high.


The US had the lowest inflation, lowest unemployment, and one of the highest qualities of life of developed countries. This last claim is more of an opinion, but we definitely owned more stuff than anyone else.


The Germans argued that our low unemployment rate was artificial because it included low paid workers who were below the poverty line. In Germany, less people had jobs, but everyone who had a job could afford to eat and live. They also argued that our sales figures were artificial because they were built on an ever growing consumer debt, which would eventually have to be repaid.


I personally know a couple whose credit card debt had reached one year’s salary. That will never be paid off.


Companies who cut their profit margins to almost nothing also used debt to expand and sell more products. They were functioning on such a narrow shoestring, that as soon as the hint of this financial tsunami hit and consumer spending dropped by a small percentage, the shops collapsed into bankruptcy.


Many economists predicted that the system couldn’t go on forever, and that the whole economy would eventually blow up.


I guess they got it right. And now, we will be paying for yesterday’s spending tomorrow.


Antonio Graceffo is a martial arts and adventure author living in Asia. His book, The Monk from Brooklyn, is available at See his vieos on youtub.


His website is

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The Banking Debacle Explained

In Business and Finance on October 5, 2008 at 5:15 am

By Antonio Graceffo


I did not go into banks and do an audit. Neither did I do an in-depth analysis of the current banking industry dilemma. I wrote this piece, however, just to explain in simple terms, how a bank can become insolvent because of poor credit policies and over-inflated assets.


Banks make money by making loans to people. The largest loans most consumers will ever take are home loans. The more home-loans a bank makes, the more profit they make.


When a bank loans money, for example $100,000, to a consumer to buy a home, that loan is carried as an asset on the bank’s balance sheet. The value of the loan is the loan, plus the interest. This seems simple, but there is one more fact that has to be calculated in. Not everyone is going to repay their loan. So, the value of the loan is discounted by the percentage chance that the person won’t pay it back.


Simple English: (This is a simplified example and doesn’t reflect real life numbers or factors such as the time value of money, or the rate and or schedule of repayment. It is only an illustration of how credit worthiness affects the value of a loan.)




Mr. Mork wants to buy a house. He applies to the bank for a $100,000 mortgage.

The bank evaluates Mr. Mork’s credit and deems him 80% likely to repay the loan. The bank has a policy that says they can only loan money to people who are 80% likely or more. So, Mr. Mork qualifies.


The bank loans Mr. Mork $100,000. With all of the interest that Mr. Mork will pay over the life of the loan, the loan is worth $150,000. (These are not real numbers.) The value of the loan on the balance sheet, however, has to be discounted by 20%. So, it doesn’t go on the books as $150,000. It goes as $120,000.


The bank makes a profit of $20,000.


The more loans the bank makes, the more money they make. So, it is in the bank’s interest to make more loans.


Mr. Warf and Mr. Data also apply for $100,000 bank loans. The bank does a credit check and deems them 70% likely to repay the loans. So, they are denied.


The bank CEO wants to make a larger profit. His annual bonus and compensation package is based on a percentage of the total revenue of the bank as well as his annual performance. So, he wants to loan more money. He is not permitted to loan money to people with a 70% likelihood of repayment, because this is set in the bank charter (or other public document.) he can’t change this policy because when the shareholders bought shares, they understood that this bank was only going to make loans to people who were 80% likely to repay. If the CEO started loaning money to un-creditworthy people, he would be violating that agreement.


Luckily, someone at the bank has an idea. They decide that their current credit evaluation procedures are too stringent. So, although they won’t loan money to anyone who is less than 80%, they will reduce the requirements to reach the 80% bracket. They reevaluate all of the loan applications from last year and under the new credit evaluation procedures, a number of people suddenly jumped to the 80% grid.


The CEO goes before the board and says, “My revolutionary new credit procedure will allow us to make three times the loans we made last year. So, our profit will increase 300%. And, I am happy to reassure you that we won’t be loaning money to anyone lower than 80%.”


Most of the board likes it. They don’t really understand what changes are being made behind the scenes, but they like it. A few board members have degrees in accounting. They see through this suicidal procedure and try to convince the others to block it.


The CEO or his PR people go before the shareholders. Before the meeting, they have already gone to the worst ghetto or trailer park imaginable. They come back with a poor, but honest, hard-working family, who “deserve” a place of their own.


“Would you deny Jorge and Roselda a decent house and a good school for little Pablo and Conchita? You fatcats sit back in your beautiful homes in suburban America. Your kids go to private schools. You sit back and collect dividend checks based on the sweat and labor of thousands of people like Jorge and Roselda, but now you are denying them a home.” If the shareholders are not in tears yet, he begins quoting Jimmy Stewart, from “It’s a Wonderful Life.”

“It is people like Jorge and Roselda who do most of the working, and, paying and dying in this town. Is it too much to ask that they do it in four decent rooms with a bath?”


The credit evaluation policies are changed. The bank makes three times the number of loans they did the previous year. Two thirds of those loans would not have qualified the previous year. The CEO triples the income of the bank. He gets a huge bonus. Often, new policies are accompanied by a “golden parachute.” There is a fear that a CEO is will not try anything new, because if it fails, he could be left with nothing. So, to encourage executives to think out of the box and try to pioneer new policies and lines of business, risky businesses are often accompanied by a “golden parachute.” Basically this is an incredibly lucrative compensation package paid to an executive if his “brain-child” revolutionary new idea fails.


There are other financial analysis that come into play here, but these are technical details. So far, this has been a simplified version of the problem. One more detail is this. People who default on home loan don’t usually miss their first or second monthly payment. The credit analysts would know, with some certainty, when a particular person would likely default. Maybe, for example, the average loan will default after four years or five years. So, the CEO announces that this last major program is the crowning achievement of his career. He will over see it for five years and then go into retirement. At which point, he will collect his percentages for the brilliant increase in the bank’s revenues.


The problem worsens.


What is an overvalued asset?


The banks borrow money from a central bank, in order to loan money to the public. They also sometimes sell debts to outside companies, in order to get cash to loan to other people. Banks, like everyone else, have to qualify as being credit-worthy. So, when a bank wants to borrow money, they have to show their assets listed on their balance sheet.


Now, Jorge and Rosalinda’s mortgage was $100,000 and they were meant to repay $150,000 with a 20% probability of failure to repay, so their home loan is valued at $120,000 on the bank’s balance sheets. So, they borrow money accordingly. But, according to last year’s policies. This loan would not have been made, because Jorge and Rosalina were only deemed 70% likely to repay the loan, which means the real value of the loan is only $105,000. So, the bank is over-extended. It can’t make good on the money it borrowed.


Another wrinkle.


Now, consumers are asking: “How do these guys live with themselves? It is so obvious that this is a ponsy scheme which will eventually explode.”


Well, maybe not so obvious.


One of the reasons that the bank executives were willing to lower the credit requirements of consumers was that they knew the average person wouldn’t default for five years (five years is just an example). At that time, the bank would take possession of the house, and resell it, to recoup its losses. By that time, the bank would have collected five years of mortgages plus the value of the resale of the house. So, the money could be repaid.


The bank calculated the probability of selling the house, and what the value would be, and it looked like a safe bet. If Jorge and Rosalinda defaulted, there would be 100 other buyers, willing to buy the house at its appreciated value. The banks bets were covered.


This next bit is an extremely simplified example, so if you know deeper economic theory and banking procedures, please don’t rip me apart. This is just a way of explaining it so everyone can understand it.


Five years down the road, the CEO retired, taking his millions with him. Jorge and Rosalinda defaulted on their mortgage, and the bank took control of their house. Jorge and Rosalinda lived in a housing development which was all financed under the same set of loans, with the same diluted credit policies as Jorge and Rosalinda’s house. So, the same week, 70% of the houses in the development defaulted. Now the bank is sitting on a ton of foreclosed houses.


They try to sell the houses, but in the mean time, the convenience store, the auto-repair shop, the restaurants…every business which was serving the housing development has closed because 70% of the people are gone. Prospective home buyers drive out, take one look at a deserted neighborhood, with no businesses close by, and they decide not to buy. So, the houses get harder to sell.


Let’s say that they do decide to buy anyway. They apply for a loan. Since the bank is getting slammed with foreclosures and lack of income, they decide to raise their internal credit policy back up to the previous, more stringent rules. Now, instead of 100 qualified buyers for these houses, they only find 10. So, 90 homes are now on the bank’s balance sheets. They are unsellable assets. The laws of capitalism basically say, if you can’t find buyers at $100,000 you drop the price to $90,000 and then to $80,000… The price of the house keeps dropping till it finds a market of buyers willing to buy it.


Now, remember that these houses were being carried on the bank’s balance sheet to secure major loans the bank took. But, the houses are steadily dropping in value. In a simplified example: The bank carried a house at $120,000 and borrowed $120,000. Now the house is only worth $90,000. the bank’s creditors come in and say, “You have to give us $30,000 in cash to make up for the shortfall of your collateral.” The bank doesn’t have $30,000. So, they can’t pay their creditor.


The creditor can take the house from the bank, but the creditor will now have a loss of $30,000. And remember this didn’t happen on one home loan or in one bank. It was across the industry, which means the companies who extended credit to the banks are now in danger of collapse. The banks are also in danger of collapse.


The buyout package which has been in the news, from what I can see, will be loaned to banks, to pay their creditors, so banks and their creditors can stay in business.


How does this affect you?


If you have large amounts of cash in a bank, FDIC insurance will protect up to $100,000 worth of cash. So, if the bank went belly up, your $100,000 would still be safe.

IMPORTANT! Not all money stored at banks is FDIC insured. If you have mutual funds, IRAs, or money markets they will probably not be covered. Check with your banker and make sure your money is in an FDIC insured account.


As a side note: credit unions and S and Ls are not banks. They often are not covered by banking regulations and are not FDIC insured. If you have money at those types institutions, or money in a cash account at a brokerage house, check with your representative and find out if you are covered under FDIC.


If your money is FDIC insured and the bank dies, your money should be fine. BUT if there is a credit crunch, which there is, this means that some banks are failing and others have no money to lend, this will send ripples through the whole economy. Certain types of business can only stay open if they have access to nearly unlimited credit. For example, a car dealership or a taxi company, or car rental business often does not own the cars on the lots, they are all financed. If there is no cash available in the finance system, these businesses cannot buy or lease cars, which will ultimately mean they will have to close.


The employees will lose their jobs. So, if you are an employee of these types of firms you will be directly effected. If you work for a company which sells services to these types of firms, you will eventually be effected, because your company will lose its customers.


Construction, real-estate, and land development is another sector which is completely dependent on the availability of credit. If credit dries up, all of these employees stand to lose their jobs. People who sell good and services to these industries or their employees will lose their customers and possibly have to close.


All of these employees will suddenly lose their income, which will mean defaulting on their personal debt and home mortgages…..


On a global note: The US is one of the largest consumer nations in the world. If millions of Americans lose their jobs and lose their access to credit, they will stop their consumer spending. There are entire manufacturing companies in China, for example, who only sell products to Wallmart. Any foreign country with a positive trade balance with the US (meaning countries selling products to the US) will lose their customers, and eventually have to close.


The flutter of a butterflies wings in New York becomes a typhoon in Asia.


Antonio Garceffo is a martial arts and adventure author living in Asia. His book, The Monk from Brooklyn, is available at See his vieos on youtub.


His website is

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