SHORT-SIGHTED

U.S. SHORT-SELLER JIM CHANOS SAYS TROU­BLE IS COM­ING. ‘I DON’T KNOW WHEN, BUT IT’S COM­ING.’

National Post (National Edition) - - FINANCIAL POST - HARRIET AGNEW

Jim Chanos has been cast as the Darth Vader of Wall Street, the Catas­tro­phe Cap­i­tal­ist and the LeBron James of short sell­ing. The 62-yearold ti­tan of the US$3.2 tril­lion global hedge fund in­dus­try pre­dicted the down­fall of U.S. energy gi­ant En­ron al­most two decades ago, mak­ing a for­tune in the process. But the course of true riches, it seems, never did run smooth. On the day of our en­counter, Tesla, which Chanos has bet against for the past five years, over­takes Toy­ota as the most valu­able car­maker in the world, leav­ing him nurs­ing heavy losses. But more about that later.

Chanos likes to present him­self as a “real-time fi­nan­cial de­tec­tive who is in­cen­tivized to root out fraud’” Or, more pro­saically, a “foren­sic fi­nan­cial state­ment junkie.”

To crit­ics, short-sell­ing rep­re­sents the scourge of mod­ern cap­i­tal­ism. Whereas so-called value in­vestors such as Warren Buf­fett try to buy shares in com­pa­nies that the mar­ket is un­der­es­ti­mat­ing, short-sell­ers such as Chanos seek out over­val­ued com­pa­nies. They borrow shares and then sell them, hop­ing to buy them back later for less. In short, “they are profit­ing when oth­ers are los­ing money,” says Chanos — and this makes some peo­ple un­com­fort­able.

Chanos is buoy­ant. Re­cently, one of his largest short po­si­tions — the Ger­man pay­ments com­pany Wire­card — filed for bank­ruptcy, after ad­mit­ting that 1.9 bil­lion euros of its cash prob­a­bly did “not ex­ist”. This fol­lowed a five-year Fi­nan­cial Times in­ves­ti­ga­tion into its ac­count­ing prac­tices. Chanos’s funds made al­most US$100 mil­lion from the trade, according to an in­vestor. He laughs: “It’s bit­ter­sweet, Harriet, be­cause short-sell­ers put up with weeks and months of mis­ery, and you feel good for hours and days.”

Even its de­trac­tors ac­knowl­edge that short sell­ing, in a nor­mal en­vi­ron­ment, helps the mar­kets to ques­tion con­ven­tional wis­dom. But a sharper com­plaint, usu­ally heard from tar­gets, is that short-sell­ers act­ing to­gether to sow FUD (fear, un­cer­tainty and doubt) about a com­pany’s ac­count­ing or fi­nan­cial po­si­tion can become a self-ful­fill­ing prophecy. In the past, in­vestors such as Chanos have moved mar­kets just by re­veal­ing a bet against a par­tic­u­lar com­pany.

Chanos hap­pily con­cedes that he talks fre­quently to other short-sell­ers. He shorted Luckin Cof­fee, once touted as China’s an­swer to Star­bucks, after Car­son Block of Muddy Waters en­cour­aged him to look at it. (The com­pany is now be­ing in­ves­ti­gated for ac­count­ing fraud.) But it’s “a myth” that short-sell­ers act to­gether, he tells me from Prime 112’s pri­vate room.

“If there were con­spir­a­cies, we’d be in some­thing much more prof­itable than short sell­ing.”

I men­tion Cana­dian in­surer Fair­fax Fi­nan­cial Hold­ings Ltd. It sued a group of hedge funds, in­clud­ing those run by Chanos, Dan Loeb and Steve Co­hen, for al­legedly driv­ing down its stock un­der a short-sell­ing scheme. “That was the per­cep­tion, but it wasn’t true,” says Chanos. “The case was thrown out (in 2018) on ju­ris­dic­tional grounds. Our al­le­ga­tion was that the com­pany was over­stat­ing their earn­ings, and dur­ing the process they re­stated their earn­ings.”

Chanos’s hedge fund man­ager Kynikos As­so­ci­ates is named after the an­cient Greek word for “cynic”. His pitch is that he can iden­tify cor­po­rate dis­as­ters-in-the-mak­ing. The New York-based out­fit em­ploys 20 peo­ple and has US$1.5 bil­lion in as­sets un­der man­age­ment. Chanos also teaches a course on the his­tory of fi­nan­cial fraud (“how to de­tect it, not how to com­mit it”, he quips) at Yale Univer­sity, his alma mater. The syl­labus stretches back to the 17th cen­tury. To­day, he says, “we are in the golden age of fraud”.

Chanos de­scribes the cur­rent en­vi­ron­ment as “a re­ally fer­tile field for peo­ple to play fast and loose with the truth, and for cor­po­rate wrong­do­ers to get away with it for a long time.” He reels off why: a 10-year bull mar­ket driven by cen­tral bank in­ter­ven­tion; a level of re­tail par­tic­i­pa­tion in the mar­kets rem­i­nis­cent of the end of the dot­com boom; Trumpian “post-truth in pol­i­tics, where my facts are your fake news”; and Sil­i­con Val­ley’s “fake it un­til you make it” cul­ture, which is com­pounded by Fomo — the fear of miss­ing out. All of this is ex­ac­er­bated by lax over­sight. Fi­nan­cial reg­u­la­tors and law en­force­ment, he says, “are the fi­nan­cial ar­chae­ol­o­gists — they will tell you after the com­pany has col­lapsed what the prob­lem was.”

All in all, it’s “a heady witch’s brew for trou­ble”.

A waiter ar­rives to take his order. Chanos knows the menu by heart and picks a wedge salad of ice­berg let­tuce, ba­con, toma­toes and Ro­que­fort dress­ing, fol­lowed by a strip steak (medium) with a baked potato. He doesn’t nor­mally eat or drink like this at mid­day but says he will make an ex­cep­tion for Lunch with the FT, and or­ders a glass of Caber­net Sau­vi­gnon.

At Oswald’s, the gen­eral man­ager Michele greets me with a glass of cham­pagne and ex­plains that the chef will prepare his own se­lec­tion of dishes for me. I’m out of prac­tice with or­der­ing, so this comes as some­thing of a re­lief.

Chanos’s mis­sion is fo­cused on un­der­stand­ing a com­pany’s business model and then as­cer­tain­ing if its fi­nan­cial state­ments re­flect it. Cer­tain themes crop up time and again in his hunt for short po­si­tions: tech­no­log­i­cal ob­so­les­cence, con­sumer fads, sin­gle-prod­uct com­pa­nies, growth via ac­qui­si­tions and ac­count­ing games. No­tably he looks for “le­gal fraud” — where com­pa­nies ad­here to the ac­count­ing rules and reg­u­la­tions but there’s still an “in­tent to de­ceive”. En­ron epit­o­mized this — Chanos iden­ti­fied that it was us­ing ag­gres­sive ac­count­ing to front-load prof­its and hide debt in its sub­sidiaries.

Grow­ing up as the son of Greek and Ir­ish im­mi­grants who ran a chain of dry-clean­ing shops in Mil­wau­kee, Chanos says he was in­ter­ested in stock mar­kets at an early age. After Yale, he worked for an in­vest­ment bank in Chicago and then re­tail bro­ker­age Gil­ford Se­cu­ri­ties, where he be­gan writ­ing re­search on in­di­vid­ual stocks. He had a bap­tism by fire: “The first ma­jor com­pany I looked at and wrote up turned out to be an im­mense ac­count­ing fraud.”

Bald­win-United was a piano com­pany that had mor­phed into a fi­nan­cial su­per­mar­ket. Chanos’s re­search pointed out in­con­sis­ten­cies with its num­bers and rec­om­mended that in­vestors sell the stock. It went bank­rupt the following year, in 1983, at the time the largest-ever U.S. cor­po­rate bank­ruptcy. Bald­win’s col­lapse piqued the in­ter­est of Gil­ford’s hedge fund clients who fol­lowed its stock rec­om­men­da­tions, no­tably Ge­orge Soros and Michael Stein­hardt. “What else does the kid not like?” they asked, Chanos re­calls.

Soon af­ter­wards, he joined Deutsche Bank in New York. It was a short­lived af­fair. In September 1985, The Wall Street Jour­nal ran a front-page in­ves­ti­ga­tion into the “ag­gres­sive meth­ods” of a net­work of short-sell­ers that it al­leged was driv­ing down the shares of U.S. com­pa­nies. The then 27-year-old Chanos was por­trayed as an en­fant ter­ri­ble at the centre of the net­work. “Peo­ple think I have two horns and spread syphilis,” he quipped in the ar­ti­cle. Deutsche fired him and his boss. “The post­script is that nine of the 10 com­pa­nies men­tioned (in the ar­ti­cle) ei­ther went bank­rupt or were pros­e­cuted for fraud,” he says.

It must take a cer­tain per­son­al­ity type to be a per­mabear, I ven­ture.

A long time ago, Chanos be­lieved that go­ing short was just “the mir­ror im­age of go­ing long.” He has changed his tune on this, how­ever, “be­cause there is a lot of be­havioural fi­nance at work in the mar­kets.” On Wall Street, he says, “the bull case is ev­ery­where” — op­ti­mistic man­age­ment pro­jec­tions, takeover ru­mours that boost tar­gets’ stock prices, and com­pany earn­ings es­ti­mates re­vised up­wards.

“So I think that it does take a cer­tain pe­cu­liar per­son­al­ity — and I’ll leave it at that — to say ‘OK, here’s my facts and here’s the con­clu­sions I draw from my facts, and that’s why I think there’s an op­por­tu­nity on the short side here.’ ”

Many can’t stom­ach it. Less than a year after the 1985 launch of Kynikos — amid “the rip-roar­ing bull mar­ket” of the time — Chanos’s business part­ner de­clared that he wasn’t com­fort­able with the pure short-sell­ing side of the business. He said his ac­coun­tant had ad­vised him to sell back his stake to Chanos for a nom­i­nal amount of US$1. “And I paid him right there on the spot out of my wal­let,” says Chanos. “It was the greatest trade I think I ever did,” he adds with a chuckle.

Chanos has put the re­mains of his salad to one side to make way for the steak. I’m de­lighted by my main course: deep red toro tuna carpac­cio, gar­nished with av­o­cado mousse.

My guest has one of the best track records in the hedge fund in­dus­try. The Kynikos Cap­i­tal Part­ners fund, a long/short eq­uity strat­egy, has gained 22 per cent a year on av­er­age over the past 35 years — double that of the S&P 500 in­dex. In the same pe­riod, against the back­drop of ris­ing eq­uity mar­kets, its U.S. short-only Ur­sus strat­egy — named after the Latin for “bear” — has lost 2 per cent a year.

The past decade has been a dif­fi­cult one for short-sell­ers in gen­eral, as tril­lions of dol­lars of cen­tral bank stim­u­lus have lifted prices of as­sets in­dis­crim­i­nately across the board. How do you trade that? “Very care­fully and painfully,” he says.

Fundrais­ing has been tough. Kynikos’s as­sets peaked at around US$7 bil­lion after 2008, when short-only Ur­sus gained 44 per cent, net of fees. They have slumped to US$1.5 bil­lion since then. This year Chanos sold a mi­nor­ity stake in the man­age­ment com­pany to bou­tique in­vest­ment firm Con­lon & Co and the fam­ily office of Richard M. Da­ley, for­mer mayor of Chicago.

Pro­longed pe­ri­ods of quan­ti­ta­tive eas­ing — most re­cently to ease the eco­nomic pain of the coro­n­avirus cri­sis — is “adding to in­equal­ity” by ben­e­fit­ing the peo­ple who own fi­nan­cial as­sets, says Chanos. He be­lieves that the Fed­eral Re­serve ought to cut credit card rates for con­sumers, which are still 15-18 per cent in the U.S., and sees a po­ten­tial po­lit­i­cal back­lash against the cen­tral banks for their part in how “the rich have got­ten much richer and the vast ma­jor­ity of peo­ple have not”.

Po­lit­i­cal risk is one of the rea­sons that Chanos is short­ing gig econ­omy com­pa­nies such as ride-hail­ing apps Uber and Lyft and online food-de­liv­ery plat­forms Grub­hub and Just Eat Take­away. Not only are they los­ing money, but he be­lieves that there is go­ing to be a greater po­lit­i­cal fo­cus on low-wage work­ers, which poses an ex­is­ten­tial threat to their business mod­els.

Chanos sits on the fi­nance com­mit­tee of U.S. pres­i­den­tial hope­ful Joe Bi­den, who is supporting a new Cal­i­for­nia law to strengthen le­gal pro­tec­tions for gig econ­omy work­ers. A Bi­den ad­min­is­tra­tion raises the prospect of higher taxes. “I think it’s fair that rates of tax­a­tion on cap­i­tal prob­a­bly should go up, rel­a­tive to rates of tax­a­tion on earned in­come. I know that makes me a com­mu­nist on Wall Street but I’ve al­ways felt that.”

I return to the sub­ject of Tesla, whose shares have surged around six-fold in the five years since Chanos be­gan short­ing the com­pany. What is go­ing on here? “I think Elon Musk has per­son­i­fied the hopes and dreams of this bull mar­ket,” he says, setting out his bear case against Tesla, which he sees as un­prof­itable, highly lever­aged and fac­ing in­creas­ing com­pe­ti­tion. Tesla “bur­nishes its re­sults through ag­gres­sive ac­count­ing”, in his view. He also de­scribes it as “a cul­ture of de­cep­tion” be­cause it is sell­ing self-driv­ing to con­sumers, which as yet “doesn’t ex­ist”.

What, I ask, is Chanos’s main mo­ti­va­tion: to be rich or to be right?

“I want to do this un­til they pull me out of the seat,” he replies. When Wire­card filed for in­sol­vency, there was “an elec­tric­ity” that ran through Kynikos. “That keeps you go­ing.” And so, he says, does his be­lief that “this mar­ket is setting up to be one of the great short op­por­tu­ni­ties of all time”.

“Trou­ble’s com­ing, I don’t know when, but it’s com­ing.”

I THINK THAT IT DOES TAKE A CER­TAIN PE­CU­LIAR PER­SON­AL­ITY — AND I’LL LEAVE IT AT THAT — TO SAY ‘OK, HERE’S MY FACTS AND HERE’S THE CON­CLU­SIONS I DRAW FROM MY FACTS, AND THAT’S WHY I THINK THERE’S AN OP­POR­TU­NITY ON THE SHORT SIDE HERE.’ — SHORT-SELLER JIM CHANOS

MISHA FRIEDMAN / BLOOMBERG FILES

Jim Chanos, the 62-year-old hedge fund in­dus­try ti­tan and renowned short-seller, presents him­self as “real-time fi­nan­cial de­tec­tive who is in­cen­tivized to root out fraud,” Harriet Agnew writes.

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