Friday, September 2, 2011

Risk management and sounding crazy

In early June Carson Block and his firm Muddy Waters research published a report which made outrageous sounding allegations against Sino Forest - then a highly respected Canadian listed Chinese forestry company that had borrowed well over $2 billion to develop and expand forestry operations in China.

The base allegation in the report was that most the forests did not exist and by implication the (more than) $2 billion borrowed was stolen. Presumably many more shares have been sold too taking the total theft well above $2 billion.

It was an outrageous jaw-dropping allegation and Carson made no attempt to soften the blow. His language was inflammatory because his message was inflammatory. When $2 billion is stolen by reputable people I can't see how you can say that without appearing inflammatory. Some people, understandably, refused to believe it.

In response I set about reading ten years of Sino Forest accounts and decided Ocham's Razor style that Carson being right was the only explanation that I could think of (and probably the only simple explanation) consistent with the facts. And I shorted some, and then shorted some more. The two main posts that outlined my thinking were here and here.

Still I am obsessed about discovering the ways my positions can be wrong (and my business partner is even more obsessed) and we followed the reports of everyone (and there were many) who doubted Mr Block's research.

Dundee Securities was the most prominent Sino-supporter labeling Muddy Water's research a "pile of crap". Somewhat more considered sounding (but also flat wrong just more reasonable sounding) was Metal Augmentor who found Carson "loose with the facts and somewhat breathless". On the naive-sounding side was Susan Mallin whose complaint was that she had "never seen a research report written in this manner". More prominent people were fooled too. I have heard Richard Chandler is not an idiot (but he seems to like losing money - I keep finding him invested in frauds and he does not answer my emails). He dropped $150 million on Sino Forest.

The analysis of these people was staggeringly weak and self-referential (I can't speak for Chandler because I never saw his analysis). They judged Sino Forest against data provided by Sino Forest or people associated with Sino Forest. This is an elementary mistake in assessing fraud. To find fraud you need to be able to judge against things you are fairly sure are not fraudulent.

Everything the Carson Block doubters said sounded reasonable. Certainly more reasonable than Carson Block sounded because Carson Block held the radical position. Sounding reasonable however was wrong.

I think what is going on here is a general problem. When someone says something - anything - that is so far from the consensus as to sound outrageous then they will be considered mad, and sometimes they will be considered mad even after they are proven right. This is iconic in the history of science from Galileo (who observed the moons revolving around Jupiter and the crescent shapes of Venus and deduced much from those) to the more minor genius of Émilie du Châtelet (who thought, contrary to Newton, that energy in a moving body was proportional to velocity squared). Galileo was imprisoned. Émilie was excused because she was a woman and from there sprung her eccentricities. Her status was as Voltaire's mistress, not as a great scientist.

The mad genius is iconic in finance too.

I have heard people say - even now - that Carson was sloppy and breathless in his allegations. He was not. He was right. Dismissing him as sloppy and breathless is in itself sloppy and breathless. Indeed siding with conventional sounding language, conventional sounding reason lost you a lot of money in the Sino Forest case. It was better to side with Carson - the seeming madman.

This happens again and again and again. If you have very non-conventional views - even if they are well supported - even if they are right - if you spell them out plainly you will be thought of as a madman because your views sound outrageous.

But a hedge fund manager has it easier than the scientist. The scientist would be ostracized for the views. A hedge fund manager just makes lots of money. If you are right and nobody believes you then there is a chance to make mega-spondulick$. Indeed by far the strongest opportunities for making really good returns come from doing something original. I shudder to think how much Carson and his backers made on Sino Forest but I think we could safely measure it in lifetimes of average earnings.

There is however a problem with this: a portfolio manager who sounds mad may indeed be mad. Even if they are not mad the market may be wrong longer than they can be solvent. Which brings me to the schizoid character of a really good money manager or money manager team. It is highly rational but it appears like controlled insanity. You need the slightly crazy idea-driven maniac who is prepared to think outside the box and you need someone to button them down, to make them appear reasonable and to act reasonable.

Sometimes the two people are in the same body (I know a few of these people and some are not pleasant people because they are so strangely strung). In Bronte's case they are in different bodies with my business partner appearing much more socially, intellectually and even politically conservative than me. We are an odd-couple rather than an odd person.

All this leads me to wondering about Warren Buffett - the greatest fund manager of them all. He is an unusual individual with strange personal predilections. But he sounds so rational. And he is amazingly self-controlled. Indeed his ability to sit on billions of dollars excess cash for years and years at a time waiting for the time to pounce is legendary and extraordinarily hard to duplicate. Buffett says that temperament is more important than brains in investing and I think this is what he means. But it is often Buffett against the world. Buffett is thought of as a has-been by many people. It doesn't matter whether he was avoiding tech stocks in 1998, 1999 and 2000. It does not matter whether he was buying Bank of America now. He is - of course - just mad.

The madness is an important part of how Buffett made all that money. But the self control is - I think - more important.

When we meet clients I do all the talking. Some people have even wondered why I am with Simon (my business partner). We fundamentally have nothing in common. But there is a reason... he is the best control mechanism I have ever found. It took me a long time (and some losses) to realize I even needed one - he has the temperament. But if the career of Warren Buffett is a guide (and I think it is) then to make money over very long periods you need an ability to think right outside the box and a lot of self-control. The self-control is what most people think of as the risk management.

I don't know how you judge the yin-and-yang of this - and I don't know how you pick the individuals or the teams that have it. But when you see two guys who present themselves as partners but one is voluble and one is quiet then make your assessments of the quiet one. Our record at Bronte is fabulous: if it stays fabulous (and I think it will) then it will be control of Simon rather than idea generation of me that keeps it that way.


PS. I often run my blog posts through Simon. This one is in praise of the mad-guy (Carson) and the sane-guy (Simon). I think they should just see it when it pops up.

PPS. The best fund managers hire the misfits who work hard, don't belong in suits and often put them in suits to make them seem more reasonable. (We skip the suits.) This famous letter to a job-applicant by Dan Loeb is a gem.

PPPS. John Paulson is a mad genius. His problems at the moment are as much as anything a function of risk control. His positions were too large and when he was wrong (and everyone is wrong sometimes) his wind-down was horrible. He should hire Simon but I am not going to let him!



Pradeep said...

I really liked this part from Susan.

Her Hypothesis (or shall we say conclusion):

I learned early in my career, that when it comes to research, the source, and underlying motivation for any report needs to be taken very seriously. In this situation the source of this report is somebody who seems to have very little, if any experience in accounting or understanding of large publically traded company operations.

Her supporting arguments:

- He is not a chartered financial analyst (CFA).

- He is not an accredited or registered analyst and therefore does not have the same access to corporate management that other analysts do.

-Being an unregistered self employed analyst, he has not pledged to follow the analysts’ code of ethics or disclosures.

-Nor does he need to comply with any rules regarding the provision for full and accurate information.

As long as people like Susan exist, there is always money to be made in the markets

Barbary Coast said...

Nice piece, as usual. Do you realize that Susan Mallin is still blaming the short sellers for the company's downfall. Amazing. People actually pay for that kind of financial "advice."

Although the vast majority of financial "planners" underperform the market, they add in value in preventing clients from doing stupid things that would result in even worse performance. I didn't think Sino was a screaming short, but I don't see how anyone could have recommended it after such revelations. So much for fiduciary duty.

I am not familiar with Canadian securities laws, but is there some regulator that makes sure only qualified people dispense financial advice? People like that reflect badly on the entire profession.

Michael M said...

Dundee Captal Markets looks cheap but I have a hard time estimating how much they will bleed from the Sino Forest litigation. Any opinion?

michael webster said...

I find this fascinating. In Canada, we are tolerate of large scale securities fraud, but completely intolerant of excessive fraud in the banking industry.

The US constantly has bank runs, while in Canada, I don't believe a bank has failed in over 70 years. (Insurance is a different story.)

I wonder why.

Kyle said...

Solid gold. I hope I don't come across as a sycophantic flatterer but the way you think is something I seek to emulate as closely as possible. I hope I don't always agree with you but I do hope to reason like you. You are the first person in the financial realm that I have come across that seeks to keep confirmation bias to an absolute minimum at least to such a regular degree. I hope I'm never on the other side of a trade with you, I don't think it would work out so hot for me. I have followed your postings for quite some time now and hope I'll be able to read them for a long time to come.

John Short ad sinorazum said...

Those naysayers were too concerned with details. Block got inside information that Sino was a fraud. I still remember the standing timber detail that analyst said meant Block was wrong. It just didn't matter, Block had inside information that Sino was a fraud. Any wrong detail in their report just didn't matter.

PennyRoyalTea said...

John -- you operating process embodies the two key principles of critical rationalism (Popper).

1. Be as creative and adventurous in your ideas as you can be. Providing you subject the ideas to the most rigorous criticism, it does not do any harm to have wild crazy ideas.

2.Subject all theories and ideas, your own and other people's, to the most rigorous criticism. Falsify ideas by finding countervailing evidence. Do not become bogged down in searching for confirming examples - if your idea is good, you will find plenty of those in your attempt to disprove the idea.

Bertrand Russell also had as one of his ten commandments: Do not fear to be eccentric in opinion, for every opinion now accepted was once eccentric.


Ken Lorp said...


Unfortunately, the finance industry suffers from amazing levels of group-think. This can be partly explained from remuneration practices and being measured relative to your peers, so people don't like to venture far from the consensus view.

We should celebrate people like Carson, who are prepared to do the basic research and publish their findings. It is only with their research that we can truely see the emperor has no clothes.


Anonymous said...

Sussan Mallin's latest post is laying thick the old straw man argument of "short-sellers conspiring to bring down the system at the expense of everyone else".

Never mind that value investors and arbitrageurs usually wait hungrily on the other side of the short sellers, the absence of whom in this case demonstrates the capitalism has done a faster and finer job than any SEC or like body could ever achieve in unveiling fraud (think Bernie Madoff).

Anonymous said...

In 2007, while working for a Toronto hedge fund I was asked to look at Sino as it seemed liked a good investment. In fact several people in the office placed personal posioins on it based on the "research" of several Canadian sector analysts. I would like to mention an analyst from Deutsche Bank that called this company out early on. Unfortunatley, I don't remember his name to give him credit. But essentially, he nailed it from a fundamental analysis point of view and also questioned the veracity of the company's model. After that I never got comfortable and never made a recommendation. We may have lost out on trade profits but then again never lost any either.
I would like to make one comment point about the "closeness" of the investment community in Toronto. It reeks of insider information and well-placed rumor trading. It is no wonder that all analysts were one-sided on this analysis - they are all attrmpting to share in the ponzi and maybe if their employer is luck to share in the next securities offering by the comapny. There is an old description of how the system works there. On very frequent occasion, one will see a stock price ramp or decline by 15-20% on absolutley no news. This is a result of what is called the "canadian press release". Somewhere, someone, knows something (like maybe a drill result by a mining comapny) and blabs it to their buddy somehwere else and before you know it, the stock jumps. And then after market or the next day, the news release is issued. It's comical.

Gary said...

John Short, you are absolutely correct.

In Carson's report, he accused everyone in the Sino Forest chain to be in on the fraud (Accountants, Subsidiaries and even the banks in reference to the Longtop fraud) but he CLEARLY stated that Poyry, the forestry consultant firm did it's regular duties without being compromised of the fraud.

Secondly, the non-affiliated transactions that Carson stated were in the Yunnan region is probably the same transactions that OSC/ independent committee gathered their information.

Finally, having the stock shorted at almost 90% capacity and hedge fund managers participating or selling their stock considering the huge accumulation suggests that Carson's allegations had to be backed up by an important source. Otherwise considering the events surrounding Carson's open letter to spreadtrum communications, he wasn't privy to the same allegations on top of any significant changes in shorted position. Imagine hedge funds being wrong with 90% short position trying to cover?

The fact that Sino was huge, had a big 4 auditor, analysts from the big CDN banks, loans from China development bank while big hedge and pension funds being invested in this company, people couldn't believe it's another Enron. It was impossible, steps to address blatant fraud would have been found out but now. It just couldn't be..... Well......

John Hempton said...

Susan Mallin has now removed the blog post where she blamed the shorts including an a shortseller she won't name (me) for the debacle at Sino Forest.

John Hempton said...

I repeat Susan Mallin's blog post for posterity:

Monday, August 29, 2011
Is this the end of Sino-Forest….. as we know it?
It is incredible that a company can be whittled down to near zero based on a short seller attack. Rightly or wrongly, it is still unclear that this company has been proven to be a fraud or not. However, the bond market has spoken and will probably stick the final nail in the coffin.

Even though the independent audit review is not even half finished, the company will be hard pressed to financially survive going forward…guilty or not.

Some of the outstanding bonds have “put option’ features on them. In some cases these options allow for full payment of the bonds if the company incurs a change of control. These covenants are sometimes known as a poison pill in order to thwart off hostile takeovers. However, the resignation of Allen Chan could be seen as a change in control which could activate the put option. Another feature on some of the bonds is the credit ratings. If the bonds have significant credit rating declines, the holders can demand payment if it is part of the original covenant. Note: Allen Chan resigned as CEO and Chairman, but has been appointed as Founding Chairman Emeritus due to his connections and relationships within China.

These particular bond covenants may or may not be enforceable under these unusual circumstances. It really depends on the bond holders and their motives and the legal opinions.

If the bondholders come forward to exercise their potential rights, there is a high probability of a default. The cash balance is not enough and asset sales would take time. Nobody really knows who owns the bonds until they come forward. In some instances they are willing to negotiate, but in other cases they can create a defacto bankruptcy. There is a reason for the term bond vigilante. It’s not to say that new flush investors won’t come forward and allow a re-finance. However, under the current circumstances it could come at a steep price.

John Hempton said...

I have learned a lot about short sellers in the past few months. Many operate anonymously and groups back each other up. Although they may seem obscure and “unknown” at first glance, it seems there are definitely deep pockets involved and it looks to me like there are sophisticated rings. There are other short seller reports available that are eerily similar in style, wording, and format to each other, yet they have different authors. It’s like a well built formula.

There is a hedge fund manager, who will remain nameless, who insists that I apologize to Carson Block, the man behind the Muddy Water’s report. I am not going to sit here and say that things don’t look utterly bad right now for Sino-Forest, because they do. There seems to be some evidence of emails between officers that imply unauthorized movements of money. How much, where, and why is yet to be detailed. Whether or not this company is a total fraud has yet to be proven by anybody, but yet it looks more and more like a bankruptcy in the making well before any answers to the hard questions have been finalized. Carson Block has never asked me to apologize, only this hedge fund manager….it makes me wonder the connection of who and how many are really behind the report.

In any case, there is no reason for me to apologize to Carson Block. He and “others” shorted the stock, issued a report with fraud accusations, and seemingly benefited financially from the fall in price. I pointed out the short comings of the report and wrote about some of its glaring errors. This ruffled a few feathers in the hedge world. I always thought that if Carson was right, it would only be by fluke. I also always said that I would believe the independent audit review once it came out. Sino-Forest is now trying to prove to everybody that they are simply innocent victims of a short attack, yet could go bankrupt in the process. It looks like they are running out of time and now… money.

This is capitalism at its worst. Either a company fraudulently steals money from investors in some elaborate scam lasting for years, or a group of short sellers makes allegations of fraud serious enough to create financial havoc and potential bankruptcy and then tell us they have done the world a favour. If someone has evidence of fraud, the proper thing would be to go to the authorities and let them sort it out. But maybe that’s just wishful thinking on my part. I am not against short selling and I certainly think it’s a healthy part of the markets. What I don’t like is that sometimes organized groups can be outright wrong (and have been previously) and yet often create substantial gains from their short trade regardless of being accurate or not in their initial assessment. Then it leaves a trail of disaster behind them for others to clean up. If Sino-Forest survives this, and if they have a clean audit, the recovery will most likely be very long anyway. If it turns out that fraud allegations are proven correct, then I would say congratulations to those who were able to expose this even if I don’t agree completely with the method.

Tom said...

Warren Buffett doesn't operate alone, either. He has Charlie Munger around to talk him down and prevent him from doing stuff.

Nemo Incognito said...

Susan Mallin's comment about needing a CFA to have a view was absurd.

Similarly, her view on the covenants is also ridiculous. This was always a company with high yield docs. The issue is quite simply running out of cash of which very little ls left offshore - hence why the senior debt is trading at 22 cents on the dollar. You can't put bonds to a company based on a ratings downgrade very often these days.

Hypothetically, say you did run a company which required massive, ongoing funding like, ooh, I dunno, a bank. You would think that you would have better disclosure terms and and be able to more readily identify and document intermediaries and transactions like this to keep your creditors happy. Its possible that Alan Chan is entirely innocent of crimes however, its painfully clear that he was far too dependent upon the high yield market and couldn't keep his company records clean and clear enough to be exonerated quickly. I'm not sure I can find much pity for him regardless - its either criminal or its incompetence.

longshorttrader said...

Hey Anonymous (who mentioned Deutsche Bank's Sino Forest report in 2007),

What I don't get is I read that Deutsche Bank analyst's Sino-Forest initiation report too - as part of my personal due diligence post Muddy Water's Sino-Forest report. Having read that, and also having uncovered accusations that another sell-side analyst made back in 2003-2004, I couldn't help but wonder:

What are Wellington Management and Richard Chandler smoking?

I also independently found serious red flags that no one to date has publicly disclosed. For the sake of posterity, I just may eventually make them publicly available.

Anonymous said...

The yin/yan idea makes a lot of sense, but it's not new. It can be traced all the way back to what Mr Graham said. Here is just one example:

"To obtain better than average investment results over a long pull requires a policy of selection or operation possessing a twofold merit: (1) It must meet objective or rational tests of underlying soundness; and (2) it must be different from the policy followed by most investors or speculators." (see The Intelligent Investor, 4th ed revised, p78).

More to the point, you can only short a share profitably if the price is relatively high (compared to it's intrinsic worth), which means that the share must be popular to begin with, which in turn means that short seller will nearly always find himself taking positions contrary to the "average opinion" (as Keynes referred to it).

As for the "Canadian press release", we have something like that down here in Australia too: A big price movement typically triggers a "speeding ticket" being sent to the company by the exchange, followed by an announcement by the company the next day. This is so predictable that I believe the system is sometimes gamed, that is, a rumour is started just to get the company to reveal what is going on (eg, in takeover negotiations). The problem is that, about as often as not, the rumour is confounded by the actual announcement rather than confirmed by it. All you can do is rely on your own work so as to take advantage of favourable price movements caused by rumours (and have the "temperament" to ignore adverse price swings when the crowd disagrees with your view).

Anonymous said...

@John Hempton @ 1:39am
Is this really you (the blog writer?). I'm not American (truly!) but the subtlety of this Australian humour escapes me - either your entry here is in jest, or your previous posts on MW and TRE have an inspired level of sarcasm that is beyond me.
To confess my stupidity: I did not note anything in your previous posts that was remotely as contemptuous of Block's arguments and motives as it seems you intended.

John Hempton said...

I am not at all contemptuous of Carson.

I am quite contemptuous of some of the longs in Sino stock.


Anonymous said...

Hehe John, it's the same story every time. You posted about hedge fund management, only, that's far from exclusive.
- Drive, on the border of recklessness, to try things. Because who never dares never wins.
- Control, which means doing stuff properly. The idea may be wild, but the execution must necessarily be methodical.
- "Be, not look like". Which means, communication style and dress code doesn't matter, working communication and real clue does.
That's first things I check out at any company I advise - manufacturing, retail, oil/gas, anything. Without fail, any problem I'm asked about has it's roots somewhere here - either vision and force of will is lost, control and feedback doesn't work or business processes are so "processed" form long overshadowed function.

I understand you work with listed companies, based on their various official returns which they are obliged to provide. When you've got to evaluate projects on earlier stages or without long history of open accounting data, what do you look for? The team, mostly ("control" part is notoriously difficult to check in interviews and the like, but well, I kinda managed so far).

So what you wrote hardly deserves any special targeting at hedge fund management. What's way more curious is - how everyone and their mothers keep missing this stuff all the time? "I learned early in my career, that when it comes to research, the source, and underlying motivation for any report needs to be taken very seriously." - uh? A proper analysis is scientific - it doesn't matter who says 2x2=4, Newton or Hitler. And when 2x2=french fries, it doesn't matter either. But, well, the whole "form over function" problem just won't go away.


Anonymous said...

Excellent post John, thanks very much. I was re-reading some old Bertrand Russell essays.

He went to prison twice (once for anti WWI pamphlet, once for anti nuclear weapons protest) and lost his lectureship in accademia twice (once for being anti-WWI, once for his views on marriage which offended someone in NY).

And yet I read what he had to say, and most of his views nowadays wouldn't be considered "sounding crazy"... in fact quite the reverse

Anonymous said...


Great post. David Einhorn has both traits in one body, in my opinion.

Keep up good work.

Anonymous said...

I feel rather stupid in my previous post stupid but FWIW: On my browser firefox I see a standalone comment _from you_ that starts:

"Blogger John Hempton said...

I have learned a lot about short sellers in the past few months. ..."

At least at it appears to me in firefox, there is no indication (other than someone who has read you previously and the consequent WTF? moment!) that this is not you yourself speaking in this comment, whereas it is in fact (_now_ I see) continuation of a quote from Susan Mallin.

downtown josh brown said...

another spot-on post, brilliant and well-written

thx John

Anonymous said...

everytime i read a post from you, it always makes one to feel the same -- a disguised self-marketing which is only so obvious if one has an inquiring mind.. I read your original post on TRE CN and it was not that straight other than a few highlights mentioning why it would be a scam, but not as convinced as putting a short on eq right around ~$3 when you posted... ANd now you claim you made money on that short? I say horseshit.. I don't think you have the guts to sit on that while it was going to $6.. But, then again, this is my contrarian side, as you recommend in this very post, if one to listen..

if you had that kind of a mindset, as yours truly, you would have rather put that short on bonds, not equities, where it was trading at 70 cent..

hope you enjoy my mad side,

Anonymous said...

1) Canadian stocks seem to have a penchant for huge fraud. Anyone remember Bre-X? I wonder if Sino-Forest executives will "accidentally fall out of a helicopter" as well? The Vancouver Stock Exchange was one of the most fraudulent in the world.

2) I'm not convinced John Paulson is a good investor. He made 1 good bet, although my understanding is that he did this by manufacturing securities that were designed to fail. Ever since then, people have given his the aura of greatest, but I think it has been proven he stinks at stock picking.

Anonymous said...

Hi John,

An old quote that speaks to this phenomena,

"All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."

Arthur Schopenhauer, German philosopher (1788 – 1860)

Anonymous said...

Re the comment by Anonymous at 11.53 am - I think his/her confusion is because the quote JH is reproducing (the blog post from Susan) goes across two posts. Accordingly, he/she thinks that the second post is JH speaking rather than a continuation of the quote.

To make an analogy between your post (and the role of a second person acting as a moderator on position risk), Richard Chandler used to have his brother for that on a formal level, prior to the split up of Sovereign Global. This role was covered in the Institutional Investor article on the Chandlers (which can be found online at RC's website). No doubt, both still talk, but I wonder if it was idea drought at work (it's not like he was buying the debt).

I coat-tailed RC into Sberbank (he made $700m in the space of two months on that position). He, unlike the other critics you mention, has a LOT of credibility. His track record is Buffett like - $10m invested into $5b in 20 years. At the very least, assuming he is as wrong here as it looks - it is a great lesson in the importance of doing one's own work.

I'm still intrigued - I know that their Indian investments were average - but SinoF seems like a very different situation to the situations where RC made his money (accusations of fraud being the only common thread - SK (it was a different entity to where the fraud was, and different from the Russian investments).

By the way, no surprise you didn't get an answer to your email - he has only ever given one interview!


John Hempton said...

To Mr Anon who thinks I must be lying about the short and if I really thought what I did then I should have shorted the bonds.

1). If you read my blog you will know I always keep fraud shorts small.

2). We kept this small - but roughly double our usual size.

3). We were down hard on it at one stage - it was painful.

4). Yes I should have shorted the bonds - but the only one I really wanted to short were the 2011s because they were trading above 90c. We could not borrow them. This was dumb luck because they actually paid.

5). For the non-US accounts we purchased some put options in Canada. US accounts could not do that.


Anonymous said...

John - I think I remember reading a quote of yours once - one of your finest - when you said something like "people believe what they want to believe, because well, that's what people do..."

What separates the great analysts from the rank and file is an ability to elevate their thinking above their own biases and what they would like to believe. You are exceptional at doing that, and are always seeking to disprove your own hypotheses through critical analysis and research. Ideas are poor things to show loyalty to.

Unfortunately the likes of Susan Mallin are unable to separate their analytical abilities from their emotional biases. She has too much invested now (reputationally) in Carson Block being wrong that she can't bring herself to admit that he was right even at this stage - saying that if he was right it would be merely a fluke! That statement is so ridiculous it needs no refutation.

As for analyst incompetence, once can possibly understand and forgive (although far from admire) analysts for getting it wrong in the first instance - mediocrity is the order of the day in any area of life and not everyone is as smart as Carson Block or Mr Hempton. These analysts obviously lacked experience with detecting fraud and are now being taught a quick lesson.

But to come out and call the report a "pile of crap" without actually critically reading the report and refuting the FACTUAL allegations (as opposed to attacking Carson's motives - the first line of offense that always seems to be taken), as well as relying purely on management pronouncements, I think is much more reprehensible.


Anonymous said...

Just a few thoughts on the "sounding mad" hypothesis - I agree but think in this case Carson Block was also battling against the fact that human beings are by their nature too optimistic and don't like hearing bad news. North Americans are at least as bad as average in this respect - some would say much more so.

I believe one of the reasons that short sellers ruffle up so much more ire than overly bullish reports is that people don't like to hear bad news, and so the instinctive reaction is to shoot the messenger.

People would prefer to believe that the short sellers are wrong, and so - believing what they want to believe - grab hold of whatever arguments their biased brains can muster to refute the allegations. And given that (in this instnace) the facts and analysis are sound, the only arguments at their disposal are to attack the shorts' motives.

Re Buffett - yes he is rational. Also working in his favour, I believe, are that he never overstates his case (as he doesn't have too - his reputation proceeds him to a degree where he doesn't have to be alarmist to get peoples attention); he argues his case always in good humour; he never seems to get too riled up with people disagree or criticise him; and also, he doesn't seem to like to criticise people publicly.

With respect to the latter - it may be partly for carefully calculated PR/political/business reasons, but it is als possible that he is simply a lot more understanding and tolerant than many (including say Grantham - who I also deeply respect) about the failings of others - perhaps he recognises that most people are mere mortals and are not as smart as him, nor have the luxury of spending their whole lives analysing financial markets and human folly in action. Ethical misconduct is another thing of course, but he has a philosophical understanding for incompetence (and never ascribe to malace that which can be adequately explained by incompetence...)


John Hempton said...

LT - I have fallen for the trap of believing what I wanted to believe.

It cost me money. Quite a lot actually at the time.

It is what people do - and we have to fight it.


Nemo Incognito said...

Speaking as someone who did short the bond after talking with John about them - it was a pain. Also, I now have the operational pain of having to decide whether to take part in some class action suit to claim payment on the 11s was a fraudulent conveyance.

Fortunately shorted the 14s after that at 75. SO:

-10 pts on the 11s (-15%)
+50ish points on the 14s so far (+70%)
- Braindamage of class action suit participation

So, it made money with less drawdown but is going to be a lot more irritating with the class action stuff.

Seriously folks, sometimes the obvious thing is the right thing.

Anonymous said...


I know I'm just a random anonymous internet poster, but I hope you'll reply anyway.

Regarding fraudulent, Chinese small-cap companies... here is my hypothesis:

1. Top-4 audtiors aren't very good at spotting frauds (they have been fooled many times).

2. Large investors are often poor at spotting frauds (Paulson, Hank Greenberg, etc).

3. (and here is the good news): There is 1 venture capital firm in the world which has a flawless track record of only investing in non-fraudulent Chinese companies... this firm is IDG Capital Partners.

They have made many Chinese investments over many years, earning an average annual return of 30-40% and several times being voted the top venture capital firm in the world. And they have never had any problems with fraud at any of the companies that they've invested in.

4. Due to their unmatched track record and level of due diligence, if IDG invests in a company, then we can safely invest in that company ourselves without having to worry about the possibility of fraud.

Would you agree with this logic, or am I giving IDG too much credit?

Anonymous Guy

Anonymous said...

Anonymous @1:12pm, how do you design a "security to fail"? If you are short you may HOPE it will and you maybe PRETTY SURE it will but that is not the same as KNOWING it will, especially in a bubble.



John Hempton said...

I think I can answer that. The allegation in the Goldman Sachs/Abacus case is that Goldman Sachs created a CDO to the specifications of Paulson.

Only the sh-t that Paulson thought was bad was put in. It looked like a randomly selected pile of securities but in fact was selected so that the CDO was bad.

The problem with that thesis (and why I think that thesis is not true) is that if it were true Goldman would have themselves be short the security.

They were not - they were long and they lost money on the deal.


Kid Dynamite said...

@NemoIncognito, JH - that full payment on the 2011 bonds is still confusing me... WHY? Why, if Sino is a total fraud, would they pay back these bonds in full?

one possibility: the holders of these bonds were the insiders ? I have no idea - is there any way to tell? I can't think of another explanation.

As for Susan: "he has not pledged to follow the analysts’ code of ethics or disclosures. " that's good for a world class LOL.

Anonymous said...

john, this is OT, but I think it would be instructive to post on the following question:

Do you have a view as to how the Euro debt problems will work out, and how do you think about the problems in Euroland when constructing your portfolio?

Thanks in advance for any response.

John Hempton said...

I have always thought the Euro worked in practice and not in theory... and that one day theory would reassert itself.

However I thought the Baltics would go off the Euro standard (see the infamous hookers that cost too much post) and I was wrong about that.

I suspect that the EU will break down too as I thought the Baltics would.

But I guess that would just make it twice wrong.

I think that European banks are mostly dangerous... but then I suspect most are priced for dangerous. Credit Agricole is pretty darn cheap for instance.

And beyond that it will be OK. Collapses of currency unions work out with a new money in the end.

The losses are largely German.

Anonymous said...

re Paulson & Abacus. IIRC Paulson shorted BBB tranche, GS kept AAA tranche. It's entirely plausible to believe BBB tranche will tank but AAA won't - and if GS bought cheap CDS on it from AIG (I have no clue whether they did or did not), their traders wouldn't care one way or another - they would pocket the positive carry. That GS said they lost money on the position - well, there's lost and lost. I can say I lost money on the position and be quiet about my hedge that worked - it can be more political to do so than to say I had a hedge with AIG that was paid out in full (especially in a fraud case).

Alex Dalmady said...

@Kid Dynamite. I don't understand why you are surprised by the payment of the 2011 bond.. They matured. They were due and Sino had the cash to pay and did. It was only $87 million, since those bonds had been exchanged for the 2014s back in 2009.

The only thing that could have stopped this payment would have been a company collapse or an admission of insolvency (which hasn't happened - yet).

Those who went long on the 2011s made out fine, although there "may" be fraudulent conveyance concerns. (Extremely unlikely, IMO, It will take YEARS before this whole deal begins to sort out).

Jason said...

re: Paulson & Abacus.
I thought Lewis' book, "The Big Short" was instructive on this issue. Lewis is no fan of Wall St. or financial types, but he does present a history of the creation of CDS on RMBS and then on CDO.

Around 2005 or so, there was no such thing as a CDS on RMBS (and no CDOs). People such as Michael Burry (Scion) and later Paulson asked investment banks such as Goldman to write them insurance on specific RMBS securities. Goldman, et. al then got some one else to take the carry and risk.

TO me this seems quite a bit less nefarious than what has been implied. A customer came to a bank and said I want credit default insurance on these debt securities. The bank found people to take the other side of the trade and charged a fee. Seems okay to me.

The idea that Goldman got in some dark room with Paulson and hatched a plan to blow up longs is fanciful. The bad RMBS already existed when Paulson et. al. decided to short them. The amazing part is that so much more money was willing "go long" by buying the insurance.

Phil said...

Yeah, who cares if you lost money on the AAA tranche (which you had to buy to make the deal look good) if your CDS paid out? It's someone else's loss then.

Has anyone has ever asked Goldman whether they had taken out CDS on those securities & if so who was the counterparty?

Sambo said...

As I posted previously on your excellent blog - you bet against Richard Chandler on Sino and his amazing Buffett like track record (probably better as at the same point in time). He is looking right. If the cash balance is real, I suspect they also own a lot of forests. However, I expect that a good amount of the forests they own are rubbish (there was a very good article that I know can't find about Sino F buying forests from villagers who commented that they couldn't use wood from them for even fencing given the poor quality). As RC said, it was a deep value investment. I would expect the internal company controls are hopeless. But RC invested in Gazprom - so he has experience with fraud/messy situations!

Keep up the great work.


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