Suddenly finance god John Paulson isn’t looking so omniscient. The New York-based hedge-fund manager was the star of the 2008 subprime crisis, capitalizing on Wall Street’s misrepresentations to the tune of $15 billion betting against U.S. mortgages. Now, fraudsters may have taken him in.

That is, if a June 2 report by Muddy Waters LLC is correct and Sino-Forest Corp. lied about its finances. I don’t know, and neither do investors such as Paulson, the biggest shareholder in the Canadian-listed, Chinese timberland owner. Paulson & Co. said this week that it sold all its stock, which has plunged more than 90 percent in the past few weeks.

Even though Sino-Forest rejects claims that it exaggerated its landholdings, investors are taking no chances. That gets at a bigger issue than short sellers trying to undermine one company. The skittishness of markets reflects the sense that we’re one step away from replaying the world financial crisis.

The global backdrop offers no comfort. Post-tsunami Japan is a mess; the U.S. recovery is faltering; and Europe poses a Lehman Brothers-like risk if Greece’s debt crisis can’t be resolved. The sudden collapse in confidence in some Chinese investments adds to the anxiety for the markets.

Why is it a surprise that some Chinese companies have dodgy finances? One reason we are so quick to assume the worst is that Lehman, after months of vehement denials in 2008, really was a house of cards. Before that, WorldCom Inc. and Parmalat SpA really had cooked their books as Wall Street looked the other way.

So why are markets quick to believe a little-known investor such as Carson Block, the head of Hong Kong-based research firm Muddy Waters, when he questions China? Although few short-sellers make lots of money betting against China, the ranks of Carson and his ilk are growing. That’s partly a reflection of the fear that the great Chinese crash is coming.

One worry is that the first wave of bad loans from China’s huge 2008-2009 stimulus is about to hit. The bigger concern is how growth in recent years left the domestic financial system less resilient. China’s expansion relies on a variety of counterproductive policies: an undervalued, nonconvertible currency, off-balance-sheet arrangements to mask debt and ample credit to politically connected firms that don’t necessarily make the most productive use of capital.

China does have a rather large margin for error, mostly in the form of $3 trillion in currency reserves. Yet it has made little progress toward developing a more transparent and open financial system. That, too, is making some investors more inclined to short China than to bet on continued growth.

China is less of a market-based economy than a vast family-run business controlled by the political elite, says Fraser Howie, a co-author of the book “Red Capitalism.” It’s important to remember that when a company such as Industrial & Commercial Bank of China Ltd. goes public, majority ownership stays with the Communist Party in Beijing. Good corporate governance doesn’t always follow.

Is the new scrutiny of Chinese companies a game changer? “I certainly hope so,” Howie says. “We know China is a difficult and corrupt place to do business, so funny dealings are rife. Certainly small Chinese companies are coming under the spotlight, but will it translate to the big state-owned enterprises as well? That I am not so sure of. I think too many investors will shy away from questioning the big guys.”

It’s important that investors start asking those questions. As potential irregularities come to the surface, they will fuel a broad reappraisal of corporate-governance practices at foreign-listed Chinese companies. As skepticism and activism widen, China Inc. will be subjected to much more intense scrutiny than in the past.

That would be a plus for China’s long-term development. In the short run, the fact that markets are so riled about reports that a small company like Sino-Forest might be exaggerating revenue hints at the broad erosion in confidence over the fate of the world’s major economies.

China is now the second-biggest economy, but there is a growing sense that it is due for a setback. The country has proved it can live without consumers in Japan, Europe and the U.S. for a couple of years. But a third or fourth year as the world heads into an economic soft patch or worse?

Everyone liked having a bright spot amid the gloom after the world financial crisis. Now China’s prospects are becoming as murky as the governance of its companies. There’s a reason Block called his firm Muddy Waters. 

By William Pesek

William Pesek is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.