Paulson and the Chinese Fraud

Over the past three weeks, Sino Forest Corporation, a Chinese company which "manages" forest land in China and produces various wood products through subsidiaries has fallen from $20 to less than $2 a share. A research and investment firm, Muddy Waters Research, which specializes in "shorting" Chinese stocks (betting that the share price will fall rather than rise over time) published an extensive report detailing what they believe to be a pervasive fraud committed by the company's management.

Caught in the middle of this was John Paulson, a hedge fund manager famous for making $3-4 billion shorting the housing market in 2007-2008. His firm, Paulson & Co., reportedly lost more than $750M when they exited their investment in the debt and equity of Sino Forest Corp. yesterday. Though this should make liberals and tea partiers alike estatic (just rewards for fat cat bankers and all that), I think there are two lessons to be drawn from this incident.

First, China is far from a developed nation in terms of accounting and capital controls. If Muddy Waters Research is correct, the fairly obvious fraud has existed since the mid-1990s. Further, Western accounting firms are easily fooled by Chinese management. Ernst & Young, one of the "Big Four" accounting firms was the company's auditor, and several former partners served on the company board. This fraud was not Enron-esque, it was fairly simple and it speaks volumes that the company board's oversight failed. Makes you wonder if they all knew and that's why the company was never listed in the United States in order to avoid potential criminal charges for the Western board members.

Second, Paulson & Co. seems to have grown so large that it is unable to conduct proper due diligence on its investments. With $30 billion under management and 8 separate funds, the former smarter guys in the room may just be unable to find and validate enough investments to made an adequate return. You see this same effect in mutual funds where performance begins to lag as the size of the fund grows. Yet another reason why the vast majority of Americans should be using ETFs for their investments. They are cheap and remove the investor from the business of trying to find a good manager for their money.

Update: Paulson actually lost $468M

Are Gold and Silver the New Beanie Babies?

I have a perverse interest in reading about crazy people, whether serial killers or end of the world types. One group which has interested me over the past 2.5 years are the gold and silver bugs. They fervently believe that fiat currencies around the world will collapse when hyper-inflation strikes leading to the re-introduction of the gold or silver standard.

The predictions for future gold prices are insane and arbitrary. One blogger/investor thinks $5000 an ounce is logical given the current price of $1500. Though old, this forum on burying gold in your backyard is good for a giggle.

All of that brings me to the conspiracy theory about the financial terrorists at J.P. Morgan being short 3.3 billion ounces of silver. While obviously a farce, the story is popular among gold and silver bugs. A blogger, Kid Dynamite, did a good job of explaining why the massive JP Morgan silver short was a hoax.

My own personal opinion is that people are going to lose their shirts on gold and silver. Gold has zero value beyond that which another buyer assigns to it. It pays no dividends and is not used for any industrial purpose. In fact, it's one of the few assets with a guaranteed negative cash flow (excluding sale) due to the costs of storage.

NY Times on paying off your mortgage

I wrote a post on this last year, but the New York Times did a much better job recently covering the story. Not surprisingly they have better writers on staff, even if they tend to report misleading or incorrect information occasionally.

I still don't understand the psychological value of paying off your home as the article talked about. It confuses me that people wish to have a significant portion of their wealth tied up in an asset which is very illiquid and and has historically low growth potential. (Click on the link for seasonally adjusted home price index levels)

Casino War

I recently finished a road trip to California, likely the last road trip involving driving through West Texas, New Mexico, Nevada, and Arizona I will ever do. We did, however, stop in Las Vegas where I made the monumental mistake of booking a room in a hotel off the strip. Redemption came in trying out a well-reviewed tapas restaurant in the Cosmopolitan Hotel and Casino next door to City Center.

After dinner I walked through the casino floor and stop to watch some inebriated people do their best to lose money playing War. Yes, that's right, can you bet on the game you used to play as a 5 year old when it was raining outside and your evil parents wouldn't let watch TV. Considering the odds, it's an even worse game to play than roulette.

Speaking of roulette, being in Vegas reminded me of one of my favorite human interest stories, Ashley Revell, who bet his life savings on a single spin of the wheel and won $135K in 2004.