The Devil's Excrement

When financial markets experience turbulent times, like those we have witnessed over the last year, institutions with shaky foundations or suspicious business models begin to unravel and it is difficult for those managing them to continue hiding behind high growth or questionable practices. This is what happened with the now well known Ponzi scheme of Bernie Madoff which managed to divert some US$50 billion out of people’s pockets. (For a fairly comprehensive coverage of the Madoff affair check out clusterstock).

Since the Madoff affair, there have been quite a number of smaller cases discovered and in Venezuela it gave rise to fairly entertaining blog in Spanish called Venepiramides, which has been covering this subject in detail.

Then last week, Veneconomia, in its monthly issue (of which I am a collaborator), carried an article called Duck Tales, (in Spanish here) written by our friend and sometimes reader Alex Dalmady in which Alex analyzes Stanford International Bank (SIB), an Antigua based financial institution with some US$ 8 billion in deposits mostly from Latin America and an estimated US$ 3 billion from Venezuelans. Another blog in English, Caracas Gringo, has already reviewed most of Alex’ findings.

What Alex does in a very entertaining style, is to ask what you should ask yourself if you are trying to find a “Financial Duck”, that is, a financial institution which like Madoff, it’s too good to be true, nobody can match what it does, like the Madoff pyramid it is run by a very small group of people and with no single institution having the incentives to uncover the fraud.

After analyzing SIB, Dalmady concludes that SIB has feathers, quacks, waddles and has webbed feet. That is, all of the tests that Dalmady could come up with, point to SIB looking a lot like a financial duck and people should be more careful of not placing their money with something that looks like  a duck.

For many years, I have been hearing stories about SIB. When most banks paid 3% in deposits, SIB paid 6-8%. No amount of digging or understanding would clarify what it was they were doing, much like Madoff did in the US, where he managed to trap some very smart people. In fact, looking at its financial statements, I realized a while back immediately that SIB looked more like a hedge fund (half the banks investments were in stocks every year) where investments were made with depositor’s money, but those taking the risk were compensated with fixed income rates of return. As long as markets were fine and growth continued, nobody would notice, but as Alex analyzed in his report, the question now is how much did the bank lose last year and how can anyone really find out?

In fact, while Dalmady found a transaction between SIB and a company called EMAG that was delayed in December and which may represent a warning sign, I found a second one last week which has already played out: A company named Elandia had an agreement to receive a loan of US$ 28 million but terminated it it last Friday. Because of this, Elandia has canceled 16.5 million of its own shares previously owned by SIB. As a result, SIB has lost control of Elandia. While there may be a reasonable explanation for this, it seems surprising that a bank with US$ 8 billion in deposits would lose control of an investment because it could not deliver US$ 28 million.

Thus, this represents another surprising feature of the taxonomy of this financial animal, which we are all exposed to. In fact, I have found so many people near me exposed to it, that I am simply amazed about how easily people trust their money to financial institutions without much transparency, just because of the promise of more yield. It is in the end greed that drives the whole thing.

The same greed led many Venezuelans in 1994 to deposit their money in the local banks that paid the highest interest. They paid dearly for it. Will they once be caught by another Anatidae financial bird?