Carson Block's newest short, Singapore-based commodity firm Olam, is near and dear to the Singaporean government's heart.

Temasek, Singapore's sovereign wealth fund, just upped its stake in the company to 18% this week.

It's an indication of what the government, controlled by the unyielding Lee family, is willing to do to ensure that Block's call does not sink the company. Since Block's report, Olam announced it would offer $750 million in bonds and $500 million in warrants. Temasek could end up owning as much as 29% of the company, Bloomberg reports, if it exercises all the warrants in 2016.

So clearly, Temasek is not backing down. And in Singapore that means the Lees are not backing down, especially since Ho Ching, the head of the fund, is Prime Minister Lee Hsien Loong's wife.

Lee Hsien Loong's father, Lee Kuan Yew is considered the founder of modern Singapore and became the country's first Prime Minister in 1965.

In 2008, The Wall Street Journal was fined and kicked out of the country for publishing letters to the editor that suggested there may be Lee family nepotism in the Singaporean government.

Suffice it to say, the Lees don't play.

That said, to understand what Block has got himself into, you have to understand how Singapore and Temasek work in that environment.

As of March 2012, Temasek disclosed that it manages about $161 billion worth of assets — some of their biggest investments being Olam and Singapore Airlines. The fund claims an average annual return of 17% since 1974 when it was created using $289.6 million in government surplus funds.

That sounds great, but Singapore is still one of the most heavily indebted countries in the world. To understand why, Professor Christopher Balding at Peking University, writer of Sovereign Wealth Funds: The New Intersection of Money and Politics, took a deep dive into Temasek and The Government of Singapore Investment Corporation, it's other investment vehicle.

According to his findings, all is not as it seems in the Singaporean investment universe. The individual companies that make up Temasek, for one, simply have never returned enough individually to make up the 17% collective return.

"Just about everyone I know in the finance industry down here... knows things just aren't right with Singaporean finances," Balding told Business Insider, "but no one wants to go toe to toe with the Lee's by themselves."

In a report entitled A Brief Research Note on The Government Investment Corporation of Singapore, Temasek Holdings, And Singapore: Mr. Madoff Goes to Singapore, Balding first compares Temasek's performance with that of the Singaporean stock market.

This makes sense, because Temasek is heavily invested in domestic companies (see the chart to your right).

As you can see, Temasek is clobbering Singaporean companies.

Another strange thing that Balding noticed, is that Temasek's companies have basically no debt, while the the country is up to its ears in it. At the same time, the country says it's running a surplus.

From Balding's report:

...due to the large government budget surpluses and the increased debt, it seems highly improbable that the current numbers published by the Singaporean government and markets can be reconciled either to external data or to each other. If investment returns and public finance data is accurate, there must be an enormous pool of unreported assets controlled by the Singaporean government. If investment returns and public finance data as currently published is inaccurate, this represents a serious problem.

So then the question becomes, how do Temasek, GIC, and the government itself work with this seemingly odd cash flow?

To Balding, the answer lies with something called the Central Provident Fund (CPF). It's like Singaporean Social Security. Citizens pay in and, depending on the account they have, get returns of 2.5-4%. According to government disclosures, 95% of CPF funds go to purchase Singaporean government bonds.

Balding conjectures, however, that CPF funds are being used to finance investments in GIC and Temasek. If the two investment vehicles return well over 2-4.5%, as the government claims, that's fine. If they earn less, the government has to put up the money to ensure that citizens get their returns.

That means digging into government funds. Balding believes that this, at least in part, explains Singapore's massive debt.

More from Balding:

The government of Singapore is subsidizing GIC and Temasek losses by paying their implied obligations to the CPF even though the they have not earned a rate of return sufficient to cover the cost of debt capital. In other words, the government of Singapore is subsidizing GIC and Temasek losses to the amount of the rate of return earned by GIC or Temasek minus the 4% it pays to CPF account holders. Financial losses attributable to GIC and Temasek but covered by the government of Singapore, significantly increase the risk of CPF deposits.

If that sounds totally confusing and opaque, that could because it is.



"One of the things about Singapore is that it's really like putting together a jigsaw puzzle, because even if you go get the data if you don't have context or an understanding of how they set up the system its really tough to understand," said Balding.

Olam's 3 month stock chart, Block announced his position on November 19th Now back to Carson Block. In his report, he accused Olam of being like Enron in that it was hiding its debt on a different set of books. If Balding's research is correct, those books could be the government of Singapore's — the ones that have tons of debt on them.

But that isn't to say Singapore doesn't have the cash (or the will) to shore up their investment, even though Block estimates that it would take billions to keep Olam afloat.

Business Insider asked Carson Block if Muddy Waters was worried about the government's active involvement in Temasek's holdings.

"We are not concerned by the prospect of a continuing bailout of Olam," Block responded. "Such support would either add to a debt load that we believe is already fatal, or substantially dilute the shares. At the heart of Olam is a sick core business and substantial amounts of already squandered capital investment. We do not see Olam ever becoming a bailout success story."

Perhaps not, but that doesn't mean that the Lees won't start a war of attrition. Balding conjectured that Block may be able to win, however, if other hedge fund managers take up the short, find other Temasek companies to short, or start attacking the Singapore dollar.

"If you just look at these companies, if you look into their finances they're fine," said Balding, "but because a lot of this is on the public books it will be interesting to see if people go after the Singapore dollar... if there's a run its probably going to be on the currency."

Olam's bond offering is set to take place in early January. Until then, we'll be watching the Lees, the stock, and Temasek Holdings with much anticipation.