chit funds, crowdfunding and p2p banking (II)

two lessons from history

Thailand

I was just getting acquainted with Thailand when the Ms. Chamoy Thipyaso chit fund scandal broke.  “Mae” (=Mother) Chamoy, the wife of a Thai Air Force officer, appeared to be running a very large chit fund investment operation that was stringing together a sequence of startlingly high investment returns.  She had agents throughout Thailand collecting new money for her.  Money was pouring in.

The fund turned out to be a gigantic Ponzi scheme, however.

The scheme sustained itself for an unusually long time.  It continued to operate even after it had become so large (US$100 million+) it was implausible to think Mae could find enough lucrative “secret” microfinancing opportunities in Thailand.  Several reasons for this:

–people wanted to believe.

–the fund appeared to have the backing of the military, the ultimate source of political and business leadership in Thailand.  This gave an implied assurance that the investment results were real.  Prominent high-ranking Air Force officers invested with Mae, and forcefully urged their subordinates to do so as well.

–investors who thought about withdrawing some of their “profits” were pressured not to do so, with the threat that if they took money out they would be blacklisted and not allowed to invest in the fund thereafter.

Interestingly, large investors in the Chamoy fund continued to urge their friends and work subordinates to plow money into the fund even after they realized it was a Ponzi scheme.  Their rationale?   …it bought them more time.  That extra time allowed them to continue to enjoy a lifestyle they knew was going to end when the fraud was discovered.  And it allowed them to arrange their financial affairs in a way that would minimize the negative impact on them personally.  To followers of the Bernie Madoff case in the US, this must certainly sound familiar.

my thoughts

In my reading about microfinance, it seems that Ponzi schemes have been a constant problem wherever third-party chit funds–not the ones where friends and neighbors lend to one another–operate.  That means virtually everyplace in South Asia and Africa.  There seems to be an especially large amount of study done of the industry in India, which I have no practical experience with (because the stock market isn’t easily open to foreigners–and I think the political environment is particularly unfriendly toward equity investors.)

Personally, I’d worry more about Ponzi schemes in the US springing up among the firms that the JOBS Act will allow to raise equity.  These are the entities that won’t have adequate financial controls or accounting statements for shareholders.

My chief p2p banking concern is a more prosaic one–that the present very low loan loss rates will prove to be more a function of the industry’s newness rather than of the creditworthiness of borrowers.  Time will tell.  And, unlike fraud, this is a risk we can take precautions for.

Taiwan

There was a unique twist to the Taiwanese chit fund industry that I encountered in the mid-1980s.   Chit fund loans were secured by post-dated checks issued to the borrowers by the lenders.  In Taiwan at that time, “bouncing” a check–having insufficient funds in the account to cover payment–was a felony, punishable by the check writer serving time in prison.

The threat of jail time was thought to be sufficient incentive to ensure repayment.  So no one worried too much about the creditworthiness of the borrowers, which–as it turned out–included large publicly-traded companies.  American accountants I met, who’d been sent to Taiwan to break into the auditing business there, told me that they could see the fact of unaccounted-for money sloshing around in potential client companies.  They just couldn’t see how much.  Because of this, they were reluctant to take any engagements.  And they were continually undercut by local accounting firms who charged virtually nothing for “audits.”   American bank lending officers told me the same thing.

The chit fund business received a major shock, during a mild economic downturn, some large companies had made hundreds of millions of dollars in chit fund loans–all unrecorded in the financial accounts–that they couldn’t repay.  Bankruptcies resulted.

my thoughts

This is another potential problem for equity holders in firms crowdfunded under the JOBS Act.  Without audited financials, it’s impossible for an outside investor to determine what the capital structure of a company is.

I also think, à la Taiwan, a legitimate auditor will simply walk away from a suspect company rather than make a public outcry.  Non-disclosure agreements may force it to do no more.  A less fastidious auditor, one nobody ever heard of, might take the business and issue a clean opinion.  After all, Bernie Madoff got one for years, didn’t he?

One response

  1. Mr. King, I am writing in lieu of your category archives: “P2P Lending” series. I think that they were a well informed and thorough pieces explaining the latest trends. Similarly, I thought that you and / or your readers would find the Wall Street community’s information and opinion on the matter of interest: http://www.wallstreetoasis.com/blog/hedge-funds-move-into-p2p-lending. Our community consists of a myriad of users who are aspiring / current finance professionals so feel free to use it as a follow up if you like or as an expansion of traffic and ideas. I hope all is well and keep up the good work!

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