Lessons from a Ponzi scheme in Finland

In Finland, a company called Wincapita operated from 2003 to 2008 in Finland, defrauding more than 10,000 victims – about 0.2% of Finland’s population – of approximately 100 million euros.

Here is a post regarding the study conducted by someone on the scheme, seems like the first of its kind.

Some interesting findings and my views on the same are as under:

  • A specific feature of Wincapita is that investors could join only by invitation from a sponsor.
    • Many fall prey to such a scheme, as “exclusivity” is so tempting that the brain stops thinking.
    • We don’t want to lose out on such an “exclusive” scheme
    • The word “exclusive” along with invitation from someone you knew massages the ego and makes one feel special. Ego is the enemy
  • Rantala studied the relationship of personal characteristics between sponsors and invitees. He found that invitees invested more if their sponsors had higher income, were older or more educated.
    • Higher income, more education and old age are not equal to better financial decisions. I have come across many investors in India, too who think that such traits make one a better investor.
    • The Ponzi scheme operators rely on such behavioural traits of masses and employ employees that look educated, smart and are well-groomed and confident – traits many equate with financial savviness.
  • Rantala said. “When information comes from a friend, it overrides safety mechanisms.”
    • This can’t get more ridiculous
    • Trust is surely built on the integrity, but the other and equally important leg of the same is the ability or skills or competence. The best of the friends may be able to offer an honest opinion without any axe to grind, but will he or she be able to offer an informed opinion?
    • In any financial matter, remember while taking someone’s opinion – you need both integrity and competence.

The book’s chapter titled “The Pied Piper” starts with the following line:

“How easily the masses have been led astray” – wrote Charles Mackay in his 1841 classic, “Extraordinary Popular Delusions and the Madness of Crowds”

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Is it a bubble?

One of the hallmarks of a bubble is that it’s most easily detected after it has popped. Part of this is because there’s a certain logic to high prices at the time.

I have borrowed the above lines from a blog post I read today. I really liked this superb line from this blog post.

Very often, the investors want to know answer to this question in advance. However, very few have been able to correctly predict it and even fewer have been able to repeat the feat.

This is what I wrote in the book on this subject:

Attendee at a seminar: “There are bubbles in the market every now and then. What are the indicators of the next bubble?”

Expert speaker: “The day you stop thinking of this question, that is an indication of the next bubble.”

Enjoy while it lasts.

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Another “safe haven”?

Look at what happened to another “safe haven” investment …

How safe is your PF money?

Very often, investors think something is safe so long as nothing wrong happens. And then, it is already too late.

I wrote in the book the following line: “We do not perceive risks when things go right and by the time we do, it is too late”

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Patience is not just a virtue, it’s a blessing

The willingness to delay financial gratification (actually, instant gratification) is the key to a healthy and wealthy life, research says.

Read the Wall Street Journal Blog here.

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Dhanlaxmi Bank defaults on interest payment on bonds

This is the first time investors in India have had to forgo interest on a bank capital instrument. We view this as a positive development for a system with a high expectation of support for banks and where moral hazard has developed around the assumption that support could be extended to regulatory capital instruments.

Fitch Press Release

In July this year, Dhanlaxmi Bank defaulted on interest payment on its subordinated debt papers.

This is probably for the first time that such an event has taken place in India. This indicates that even the banks could be vulnerable. The so called safe haven is no longer absolutely safe.

The troubles at Dhanlaxmi Bank started a few years ago when first the top management decided to leave the bank after disagreements with the board on the investment required for growth and then some frauds at the bank.


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Real estate investment or loan to builder?

In a recent development, the real estate firm Unitech was asked by the Supreme Court to refund the money to home buyers for failing to deliver the homes as per the schedule.

However, the firm’s lawyer told the Court that the firm has no money to refund to the home buyers. (See the news).

Many home buyers probably wanted to buy a home to live in, but some might be buying the property for investment. Having said that, this was a classic case of not understanding the risk one was taking. While these buyers were buying property, the investment would be considered an investment in real estate only after the said property is constructed, all legal approvals are taken and the possession given to these home buyers. Till that time, it was akin to a loan to the builder. If the broker defaulted on the commitment, getting the money back would take looooong time.

Here is a paragraph from the book:

Investors investing in “under-construction” properties are taking a credit risk by making payments to builders. Very often, they consider the property as their security. However, a property, yet not constructed, cannot be considered as a property. Someone would be required to complete the construction, whereas the builder has already got the money, and the chances are, already used it.

This is evident in the Unitech case going by the argument of their counsel. The company has no money to refund, which means the money the home buyers paid to the firm has been used already.

It is important for one to understand the risks associated before signing the cheque.

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Why bubbles matter to even a cautious investor?

The creation and bursting of bubbles can have direct or indirect impact on the finances of even a very cautious investor.

If the investor is aggressive and has invested borrowed money during a bubble, the results could be disastrous. However, even for a conservative investor, there could be major impact if a large number of big investors have invested borrowed money. Such a situation can lead to severe economic consequences in the aftermath of the bursting of the bubble.

Less than a decade ago, we witnessed such an event, popularly known as the sub-prime crisis. Large banks, institutions, hedge funds and even some Sovereign funds borrowed heavily and invested the money in risky assets. The after effects were felt across the world and by all investors – aggressive or conservative.

I have written the following in the beginning of the Chapter 2.9 – The Sub-prime Crisis:

In early 2014, while referring to the global meltdown of 2008-09, an IFA asked, “How does one explain to a school teacher in rural India that her portfolio value dropped by around 50% because someone on the other side of the world defaulted on his housing loan?”

Think about it. The investor thought that she was conservative and taking least risk. What she did not know was that it was someone else’s action that impacted her.

Read and learn from history. It is a good protection against the stupidity of others and of your own.

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