The Enigma of Martin Armstrong (revisited)

Martin Armstrong's name is surfacing once again, as cyclically recurrent as perhaps predicted by his theories. One would be forgiven for possibly attributing this to the recent revelation that another Ponzi (Mr Madoff's) was surpassed that of his own. Or it might be that people were having second thoughts on the veracity of his theories given the state of the financial system and the bucking of the asset-price destruction trend by Gold, much the same way the Hebrews turned to golden calfs after dessicating in the desert for a while. Or it might be that Mr Armstrong has been writing again, (though this time from behind bars), and that it has received some traction by goldbugs, still enamoured by errrr ummm that about him they find attractive. Whatever the reality, Mr Armstrong is the nexus between them, and so I thought it opportune to re-post (with a few editorial clean-ups) an old post from Aug 2006 entitled "The Enigma of Martin Armstrong".

Anyone with anything to add (for the Record) on the specifics of PEI, it's trading, Japanese Repair Bonds, Cresvale, Marty's affiliation with Magnum "scion" Dion Friedland, should feel welcome and encouraged to do so here. Read on....


Monday, August 21, 2006

The Enigma of Martin Armstrong

Some memories fade, but are never entirely forgotten. The same holds true for certain personalities, particularly the bizarrre and eccentric. One such notorious individual is Martin Armstrong a.k.a. Princeton Economics a.k.a. self-professed expert in the history of money and things gold, and in keeping true to my theme, of things Japanese. He was accused of a large Ponzi fraud, of hiding the alleged spoils, and of being the purveyor of the notoriously unvaluable "Cresvale Bonds" that besotted Japanese corporate investors and populated their portfolios, much to their eventual chagrin. Coincidentally, as a result of some inexplicable synchronicity, I was wondering only a few weeks ago what's become of Mr Armstrong and was preparing a post to that affect, so it is timely coincidence indeed that, after languishing for six-and-a-half years in a Manhattan jail cell, he finally pleaded guilty to charges of "fraud" on Thursday, August 17th 2006.

For those unfamiliar, or too merely too young to know, Martin Armstrong was a confidence trickster, if not an outright fraudster for which he was accused. Martin Armstrong was also a Bad trader. A very VERY Bad (note upper case "B") and inept trader. And it is reasonably certain Martin Armstrong committed fraud to cover up his very bad trades. And then he committed more trades in an attempt to cover up his fraud on a hope and prayer all would eventually come good. Most of these were in Nikkei and in Gold. Contrary to the laughable ineptitude with which he implemented his "strategies", by most accounts he was smooth, suave and authoritative, in a way that encouraged people to entrust to him their money. Which he then duly lost. Many many hundreds of millions of US dollars. Perhaps billions of US dollars, but we don't know precisely because Mr Armstrong has not spoken other than (until this week) to deny his accused. The official court dockets (available on-line) from his 1999 indictment in the Manhattan district of US Federal Court read like a Shakespearean comedy. The more he traded, the more he lost. So much and so bad were his trades that his colleagues, and brokers mercilessly joked about it behind his back. He was, according to the same court docket, so consistently wrong-footed in his punts that he would have done far better flipping a coin to decide whether or not to be long or short. Or use the infamous "Ask the 8-Ball" Method. Or consult Nancy Reagan's financial astrologer, or even seek the advice of Anatole Kaletsky. Anything but use his own judgement.

Though his company, Princeton Economics, had head offices in the US, he traded from Tokyo in an office overlooking the gardens of the Imperial Palace. For Japan had a special place in his scheme. You see, ironically, the Japanese too, in undertaking their own form of financial-speculation-gone-awry known as Zaitech, had lost billions in late 80's and early 90's on dubiously-thought-out wrong-footed speculation and stock-market investment. Like Martin Armstrong, shell-shocked by large lossess, they were too ashamed and/or embarrassed to tell their shareholders that they had punted wrongly, or in UK football vernacular, scored the financial equivalent of an "own-goal". Not willing to come clean, they found themselves with a serious problem and yearned for a clever and tidy solution that would absolve them of the thing they feared most, which was NOT the losing of the money itself, but accepting responsibility for it, a dilemma not unlike that faced by I. Lewis "Scooter" Libby.

Enter Martin Armstrong and the almost forgotten Cresvale Securities. He too had a problem since his golden-tongued investment plans, proved rather less robust than hoped [and promised] and resulted in large trading losses for his clients. It seems from the prosecution's accusations that he was able to continue his scheme (until this point) and make payments to the clients who redeemed by using the proceeds from new investors. This, however was proving more difficult as losses mounted, and so he desperately needed new clients. Big clients. Well-heeled clients who wouldn't be asking for their money back any time soon. Such as money from the trust of someone deceased. Better yet, a dead-pet trust!!. Or even better: a Japanese corporate client that themselves had a big dirty secret to hide.

And so they found each other: the companies, like an inveterate gambler, desperate for an investment saviour who with promises of high returns - would, over time, regain their previous losses, rescuing them from certain the humiliation and shame that they most dreaded (not to mention a demotion to the Corporate Travel Office, or Janitorial Services Dept.) and Armstrong, now with a fresh load of clients, and more importantly, their cash. In between them stood Cresvale Japan, the securities firm who brought them together, gave legitamacy to both their pursuits, and took nice fees out of the middle in the process, and in so doing torpedoed themselves out of existence.

The scheme ( I am conjecturing here) worked something like this: Japanese Corporate 'Y' perhaps had lost $100,000,000 speculating through a subsidiary, selling say Nikkei Put Options or buying boatloads of overvalued shares after consulting with Madame Inoue's Buddhist toad (tip: this is one of my favorite posts!!). They were able to hide this financial pustule for a while by playing "pass the parcel". perhaps between offshore subsidiaries with different year-ends. Thus their consolidated accounts still showed these losses as assets at their full value on their balance sheets. So Armstrong/Cresvale proposed they swap $50,000,000 of new money for a "repair bond" with a maturity value equal to the full $150,000,000 ($100mm of losses + $50mm of new money) and then let Magic Martin do his thing. Here, they might have been sweet-talked, or they might have seen it more cynically as a win-win for If things went right, they would make their money back and everyone wins. If something went wrong, well they can blame the investment losses on Armstrong, call it fraud, and take write-offs, without having to take responsibility in the first instance. (note: this is sketch of the essence, not the actual details).

This is all interesting, but what really fascinated ME about this story is that in the mid-90s, certain un-named American value investors had eyed a number of Japanese companies that they believed "cheap" because they seemed to have large amounts of un-specified cash & marketable securities reported on their balance sheets, relative to their now-diminished market capitalizations. In some cases these balances were in excess of the firm's entire market capitalization. Many reasons were put forth explaining the phenomena such as: "empire building"; "small-float and closely-held"; "saving for a rainy day"; "deflation"; "management conservativeness"; "investor pessimism"; "adverse taxes upon large distributions"; "legal inability to conduct share buy-backs" etc. All these seemed somewhat plausible. Conspicuous by its absence, except as speculated by the most hardened, battle weary cynical gaijin observers was: "because it doesn't exist".

But clearly some people HAD to know about their losses. For other foreign banks (Paribas, Lehman, etc.) were in the so-called "repair bond" business. Other financial institutions had been counterparties to their sales of embedded Nikkei Put options. And many of the companies themselves were household names. Maybe their businesses were not as fraudulent as Armstrong's, but nonetheless their audited accounts and subsequent actions foraying into esoteric transactions were meant to deceive shareholders by masking losses and allowing them be amortized over many years.

Since I am here, writing this, readers must suspect that none of these things went according to plan. When the Armstrong fraud broke, many of the guilty Japanese Corporates had to come clean. Sort of. They claimed they were victims of fraud (and perhaps some truly were unsuspecting purchasers of Cresvale Bonds), but the "repair Bond" concept and angle was often lost on most external observers. Yakult Honsha (TSE#2267) was said to have $1bn of losses alone from their Armstron-relatedg assiociation, as well as engineering firm Chudenko (#1941); specialty chemcial maker Gun-Ei Co. (#4229) pharma co's. Kissei (#4547), and Towa Pharm (#4553), machine-tool giant Amada Corp (#6113), pneumatic specialist SMC (#6273), eletronic parts mfgr Alps Electric (#6770) advertising agency Asatsu (#9747), office furniture maker Itoki Crebio (#7972) and more than 50 other firms were deemed to be "stung" in the Ponzi's unraveling. Yakult's losses were apparently so big that they couldn't blame Armstrong for all of them with a straight face, but many other co.s did, and [perhaps as planned] were "absolved" of culpability for their original sins.

The epilogue was that Armstrong, accused of Fraud, sat in jail for contempt of court, and was not brought forth to trial for his alleged failure to turnover evidence and in particular, to tell authorities the whereabouts of $15mm of gold and silver coins and bronze statues he'd reputedly squirreled away. It was the longest such languishment for contempt in United States history. All the while, he's claimed that he was innocent of the fraud itself. I make no judgement here, but it seems likely from the court documents and testimony of accused accomplices at HSBC he that committed fraud in the form of the ponzi that used new proceeds to pay old losses. His brokers, Republic Bank, (now the behemoth HSBC) coughed up nearly USD$600mm for their part in not alerting authorities to the potential wrong-doing, which court documents allege, they were well aware. That said, a good portion of the suspected so-called "losses were not "embezzlement" or "theft", per se, as the newspapers and Japanese Corporates would have readers believe, but out-and-out ineptitude and shitty trading. The subsequent deceit and using proceeds of one investor to pay another, and, well, we know what that is called.

His reversal and decision to enter a guilty plea may reflect that Armstrong the man met Armstrong the fraudster. Or it may reflect Armstrong's understanding that having spent six years in jail, an admission of guilt might allow him to squeeze a few years of freedom in his (no pun intended) "Golden Years".

For investors, the only the protection they can afford themselves is doing appropriate due diligence and being highly skeptical of anything that purports to be "too good to be true", or turn base metals or paper into errrrr ummm gold.