Treasury Today Country Profiles in association with Citi
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March 2009

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Editorial

Too good to be true?

Warren Buffet once famously said, “You only find out who is swimming naked when the tide goes out.” In other words, it is not until favourable conditions become unfavourable that it is clear who has been covering their back and who has gambled that the high tide was here to stay.

In the financial world the tide has well and truly gone out and swimmers are still emerging without appropriate attire. Bernard Madoff’s alleged $50 billion Ponzi scheme uncovered in December 2008 has so far dwarfed any other scandal, but numerous other schemes of this nature have since come to light. The Ponzi scheme, a concept which has entered mainstream consciousness as a result of the Madoff scandal, can only work for as long as conditions remain favourable, as existing investors are paid returns using funds from new investors. If the inflow of new investors dries up, the scheme collapses. The difficulty is that just as the tide moves in both directions, economic conditions do not continue on the same course indefinitely. Such a scheme has a limited lifespan and few would be able to survive the current global downturn.

While the high tide kept everyone afloat during the boom years, it is now clear that returns that seemed too good to be true quite often were. Madoff’s fund is just one example of a high-yielding proposition that few thought to question. The high interest rates offered by Iceland attracted thousands of European investors until the country’s financial system collapsed in late 2008. In recent weeks, the activities of Alan Stanford have come under the spotlight and investigations are still ongoing as to the nature and extent of his alleged fraud.

One of the biggest lessons of the crisis is that focusing on financial return – ‘chasing yield’ – should not be an investor’s sole priority. Treasurers understand this. The profit centre approach to treasury, whereby profit was generated by trading activities, was abandoned by many in the 1990s in favour of a cost centre model. Rather than exploiting risk for financial gain, treasurers have tended to focus on mitigating risks in order to avoid losses.

Yet even for treasurers, the current conditions have heralded a new age of conservatism. They have also highlighted the importance of asking questions, rather than accepting the word of experts. In the current market conditions it is essential for onlookers to look beyond received wisdom and decide for themselves who is adequately dressed. If the return is too good to believe, there is a reason.