There's a developing story around Sino-Forest Corporation (TSX: TRE).

[randomness]

Muddy Waters Research accuses it of being a "a multi-billion dollar ponzi scheme", "accompanied by substantial theft".

John Hempton observes:

There is a cottage industry in doing forensic analysis of Chinese frauds. I have analysed many and put only a smattering on the blog.

But I have never seen anything this big or this amazing.

Read the report. I am in awe.

Felix Salmon explains:

What’s certain is that in the wake of all this, either Sino-Forest or Muddy Waters is going to lose all credibility: one of them is a multi-million-dollar fraud. Muddy Waters is short Sino-Forest, of course. If Sino-Forest turns out to be a slightly dodgy Chinese forestry company and not a Ponzi scheme, you can be sure that Muddy Waters has been covering its short all day and has banked a huge amount of money by putting out extremely misleading material. On the other hand, if Muddy Waters is right, then Sino-Forest is toast.

Comments

[bryant]

There's an interesting similarity between the reputed ease of believing that a Chinese forestry company is corrupt and the ease of believing that J. Random Gold Farmer is Chinese. Financial bugaboo of the times, I guess.

[r-ness.livejournal.com]

As Pearl said recently, "China's trendy".

[achinhibitor.livejournal.com]

Salmon says "if I was a market participant trying to understand what was going on here, I’d certainly welcome some journalistic help in explaining what exactly Muddy Waters is saying and how credible they are." I can't imagine why. As one Canadian observed, "I'm convinced that the average IQ of North America could be raised significantly by eliminating every 'journalist' in the country." Or Dave Barry, "This is basic journalism procedure; it's what enables journalists who cannot correctly fill out their mileage reimbursement forms to write about the collapse of Enron."

[r-ness.livejournal.com]

I think you're being too hard on Felix Salmon here. He's a columnist, and there are definite differences in role between columnists and reporters.

Now, he may be asking some of his co-workers who are actual reporters to go find out something about the story.

Put another way, I don't expect Megan McArdle to go out and find this out, either.

[achinhibitor.livejournal.com]

True, I don't expect McArdle to investigate it, but I do expect her to understand what information is available. But journalists ... Let's just say the Boston Globe regularly confuses "million", "billion", and "trillion". I wouldn't send their reporters (or editors) to balance my checkbook, much less investigate a sophisticated fraud.

[achinhibitor.livejournal.com]

Maybe I'm wrong. The Toronto Globe and Mail had a intelligent article on Sino-Forest: http://www.theglobeandmail.com/report-on-business/key-partner-casts-doubt-on-sino-forest-claim/article2066110/

[achinhibitor.livejournal.com]

Given the financial ziggurat recently built in the United States based on the endless appreciation of house prices, it's not clear to me where "legitimate business" ends and "Ponzi scheme" begins...

[cerebralpaladin.livejournal.com]

Well, there is a pretty clear distinction between actual transactions between real parties (even though they may be engaged in bubblicious behavior and may be relying on the greater fool theory) and complete frauds where there's no underlying transaction, only lies. If you buy a house, and then sell it a week later and make $10K, that's a real $10K profit for you, even though it may rely on craziness in the housing market, and even though if you keep repeating that you may eventually get burned. Likewise, if Sino-Forest buys 10,000 acres of forest for $10 million, and then forest next door sells at $2K/acre, Sino-Forest can entirely appropriately book a profit of $10 million by marking to market--even though that may be a bubble and Sino-Forest may end up losing money on the deal in the end. It becomes a Ponzi scheme when there's no actual forest, when Investor 1 is paid a profit on their investment and told that it's because of forestry deals, but actually there's no forestry deal making money, just Investor 2's money being handed to Investor 1 to convince Investors 3 and 4 to come in...

There are borderline cases, and even cases where the Ponzi scheme operator manages to convince themself that it will work out and is real (Ponzi himself apparently did not understand that he was running a fraud, even though he clearly was). But while bubbles and bad investment decisions are bad and can threaten the health of the economy, they're also not the same as out-and-out fraud. Of course, they may go hand in hand, as when mortgage originators made fraudulent mortgages for resale because they were trying to cash in on the bubble. But even then, you can distinguish pretty cleanly between the trying to cash in on the bubble (legal, but perhaps stupid and ultimately destructive) and the lying about the characteristics of the people taking the loans to sell more loans (fraudulent, illegal, and destructive).

[r-ness.livejournal.com]

Ponzi himself apparently did not understand that he was running a fraud

Funny! I did not know that.

[cerebralpaladin.livejournal.com]

Actually, I did a little checking on this, and I found that this may be false. Ponzi for many years (after conviction and incarceration) claimed that he was running an honest business, but wikipedia says that he admitted in a final interview shortly before his death that it was all a fraud. Of course, like all the "best" frauds, Ponzi's scheme had an actual potentially money-making venture at its heart. There was an actual arbitrage opportunity that he claimed to be using--it just wasn't big enough or easy enough to be practical, and it was easier to build a giant (and eponymous) Ponzi scheme instead. What is strange about Ponzi's case is that he kept running the scheme while everything fell apart. You have to wonder why he didn't take the money and run before the house of cards caved in. But then, you could say the same thing about Madoff. It's probably pretty hard when you have a giant pile of money, a big house, and social status, to run away with however much cash you can stuff in a suitcase or whatever, even though that's the only way to run a Ponzi scheme and succeed. (I suppose you could gradually fail your investment, while salting away cash, but even then you'll probably be exposed.)

[achinhibitor.livejournal.com]

Many years ago, there was a guy in Hollywood selling Ponzi investments to movie stars. When it went bang, an incredible amount of money was unaccounted for. I heard nothing more about it, so I assume that he settled in return for not being prosecuted, and keeping enough of the loot to retire comfortably. So at least that guy had the end-game planned out.

I suspect Madoff's problem was that what he really wanted wasn't the money but the status. If you want the status of being a bigwig, there is no exit strategy.

[dirque.livejournal.com]

http://www.youtube.com/watch?v=rPILhiTJv7E

:)

[r-ness.livejournal.com]

I saw that! I was even going to do a post on it, but then it got lost in the pile.

Did I tell you about the entire empty neighborhood in Tianjin I rode an elevated train through? Dozens of buildings towering overhead, two metro stations as yet unopened, all empty. And more construction going on around it.

Amazing. I'd like to check it out again now a little over a year later and see if anyone's living there yet.

[achinhibitor.livejournal.com]

http://www.youtube.com/watch?v=I6IQ_FOCE6I