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Nelson Mandela

Detecting the Scam

 

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Common Sense:
seeing only what we want to see

One of the biggest obstacles in detecting the scam is that we sometimes see only what we want to see. What makes matters worse is that we don’t get much help from the experts. For example, many of the folks we depend on as financial analysts to analyze suffer from the same malady, as do many of the folks we rely on in the financial media to shine a bright light on whatever is weird in the financial markets.

The Madoff and Enron sagas offers great examples of this…

Applying the principles of The Duck School, Enron’s revenues defied common sense. In noting that Enron had apparently doubled its reported sales between 1999 and 2000, Dan Ackman, wrote this for Forbes:

“In its creation of revenue, if not profit, Enron was truly the corporation from another planet… Before it declared bankruptcy, Enron said it was on track to double revenue again… Had it done so, it would have become the second-largest corporation in the world in terms of sales.”

Something was weird. He asked how, in less than 18 months, the company could have gone from a relatively obscure energy-trading company to one of the largest companies in the world by revenue? And how could a company that was reporting such large revenues have no cash? In the first nine months of 2000, Enron had negative cash flow. How could a company operate without cash? Its debt was rising. Something was wrong…

Dan Ackman offered his take on the company’s numbers by using the analogy of an Olympic track coach:

“An uncritical reading of Enron’s inscrutable reports indicates it was running so much faster than everyone else. If an Olympic coach heard a report that an unknown runner had broken the world record for the mile by two seconds, he might be skeptical or wonder if the runner was on drugs. But if he had heard that the runner had run a mile in three minutes flat, 45 seconds faster than everyone else, he’d refuse to believe it. He’d say it was impossible. Or he’d say the watch was broken. When Enron made equally unlikely pronouncements no one seems to have asked a question of thought twice.”

Sadly, until it was too late, nobody took much notice of Dan Ackman and others in the financial media who shone a light on the wackiness that was Enron…

As for Madoff, as I’ve already been noted in an earlier post, Barron’s magazine smelled something in the air way back in 2001. In an article that year, Barron reported that it asked Bernie Madoff how he accomplished compound average annual returns of 15% for more than a decade. This made no sense. It was inconceivable to them how he could perform so consistently year in and year out. The 2001 Barron’s article describes how three option strategists for major investment banks just didn’t buy this. For them and for others, Madoff’s split strike strategy was not the whole story… Sadly, nobody paid attention.

What’s the moral here? Firstly, if something seems too good to be true, it might not be true… Secondly, don’t assume the so-called experts have done their homework, they might not have… Thirdly, trust yourself. If the explanations you hear make no sense, you might just be right. Don’t accept the inexplicable…

Go back to Common Sense home page.