Jim Chanos: ‘We are in the golden age of fraud’

Harriet Agnew in The FT 

Jim Chanos has been cast as the “Darth Vader of Wall Street”, the “Catastrophe Capitalist” and the “LeBron James of short selling”. The 62-year-old titan of the $3.2tn global hedge fund industry predicted the downfall of US 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. 

I am ensconced at Oswald’s, an elegant London members’ club for oenophiles. It’s the first time I’ve set foot in a restaurant in four months. But where more appropriate to interview the short-seller than an antique mirrored dining room in Mayfair, the heart of the European hedge fund industry? It’s three days before “Super Saturday”, when London’s restaurants and bars can reopen. I’ve been granted an exception and am the sole diner. Social distancing would not be a problem here, however. The round tables are generously spaced apart, designed with discretion in mind. 

I am to have early dinner — Chanos is to have lunch. He is in Miami Beach, where he has been stuck since the start of lockdown in early March. For our encounter, he has persuaded Prime 112 steakhouse, his go-to place on Friday nights, to allow him to use its private room. When he comes on screen, his air is more benevolent academic than pantomime villain, dressed in a white open-necked shirt and blazer. Chanos likes to present himself as a “real-time financial detective who is incentivised 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. A week earlier, one of his largest short positions — the German payments company Wirecard — filed for bankruptcy, after admitting that €1.9bn of its cash probably did “not exist”. This followed a five-year FT investigation into its accounting practices. Chanos’s funds made almost $100m 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. 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 $1.5bn 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”. 

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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 epitomised this — Chanos identified that it was using aggressive accounting to front-load profits and hide debt in its subsidiaries. 

He wasn’t the first short-seller to the Wirecard party. Chanos initiated a short in the German payments company last year and increased the position last autumn, when the FT published documents indicating that profits at Wirecard units in Dubai and Dublin were fraudulently inflated and that customers listed in documents provided to auditor EY did not exist. 

Wirecard’s collapse, when it finally came, was dramatic. But, says Chanos, most fraud is on the edges. And these days, often it is “staring at you right in the face through the use of company-designed metrics” through which they are “gaming the system”. He is referring to creative accounting measures used to flatter companies’ books, notably office-space provider WeWork’s now infamous community-adjusted ebitda. The coronavirus crisis has spawned “ebitdac”, or earnings before interest, taxes, depreciation, amortisation — and coronavirus — where companies are adding back profits they say they would have made but for the pandemic. 

Regulators, he says, could be much firmer in clamping down on metrics “that just are increasingly unmooring themselves from reality”. 

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 US 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 US 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. 

Chanos’s wedge salad and my own starter (a plate of oysters, deliciously juicy, with a glass of crisp white Burgundy) arrive. 

It must take a certain personality type to be a perma-bear, 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 $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. 

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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 US 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 $7bn after 2008, when short-only Ursus gained 44 per cent, net of fees. They have slumped to $1.5bn 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 US, 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 US 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.” 

Chanos declines a second glass of wine, joking that “I don’t want to be drunk for this.” Defeated by his huge steak and salad, he asks the waiter to put them in a doggy bag. On my encouragement, he decides to be a good sport and orders the “decadent” fried Oreos that the restaurant is famous for. My own dessert is a coconut choc ice. 

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.”

New Data on the History of Kashmir

A-level grades to be adjusted downwards

Many students will have at least one adjusted grade to ensure this year’s results are in line with previous years writes Sally Weale in The Guardian 

 

Ofqual said results are still likely to be slightly higher than last year, up 2% at A-level. Photograph: Matthew Horwood/Getty Images


Teacher-assessed A-level grades, submitted by schools in England because exams have been cancelled, will have to be adjusted down by 10 percentage points, though results will still be up on last year.

The exams regulator Ofqual said a substantial number of students would receive at least one adjusted grade – usually downwards – as a result of a standardisation process, designed to ensure this year’s results are in line with those of previous years.

Ofqual said schools and colleges had submitted grades that were higher than would normally be expected, but it was not surprising because teachers had not been given an opportunity to develop a common approach to grading in advance and “naturally want to do their best for their students”.

The regulator also sought to reassure students and their teachers that despite the downward adjustments, results are still likely to be slightly higher than last year, up 1% across all grades at GCSE and 2% at A-level.

The government was forced to cancel all summer exams this year as a result of the Covid-19 pandemic, which closed schools to all but the children of key workers and vulnerable pupils. As a consequence, grades awarded this year will be based on a combination of teacher assessment, class ranking and the past performance of pupils and their schools.

Ofqual revealed that predicted grades submitted by schools and colleges were around 12 percentage points higher than last year’s results at A-level, and 9 percentage points higher at GCSE, with peaks at key grades such as 4 at GCSE which is a pass, and B at A-level which can be required for university entrance.

“Improvement on such a scale in a single year has never occurred and to allow it would significantly undermine the value of these grades for students,” the regulator said.

Ofqual also sought to allay fears that certain groups of pupils, including black, Asian and minority ethnic (BAME) students, as well as those with special educational needs and disabilities (Send) could be disadvantaged by calculated grades. Ofqual said their analysis had found no evidence of widening of gaps in attainment.

Nansi Ellis, assistant general secretary of the National Education Union, said: “It is very good news that results from this year’s extraordinary exams process are broadly comparable to previous years’ results, and that the majority of students will not be disadvantaged by this year’s process.

“A majority of teacher-calculated grades were unchanged by the Ofqual process, showing that centre assessed grades have been as robust as exam grading. This is a credit to the hard work and professionalism of teachers, who have a sound understanding of their pupils’ attainment.”

Economics and Islam

Ideology and the pandemic

Jawed Naqvi in The Dawn

THE niece was in school in the US when she saw Nadia Comaneci live on TV in the 1976 Montreal Olympics. In India, one could only dream of such pleasures although the kindly radio ensured we wouldn’t miss the cricket action at Old Trafford, Karachi or Kanpur thanks to John Arlott, Omar Qureishi and Bobby Talyarkhan weaving magic with the running commentary.

Coming back to Delhi the following year, the niece was greeted with fanfare reserved for people returning from a pilgrimage. She had seen the wondrous Nadia perform her fabled Perfect 10s on the beam and uneven bars. But, uncle, the schoolgirl moved quickly to alert me to a flaw in my eagerness. “Nadia is a communist.” And so? Didn’t we like the Romanian girl’s captivating smile? “Yes, but, you know, communists are trained how to smile.” Probing her reading list in school in America, out came the resolution to the puzzle. George Orwell’s Animal Farm had taken its toll.

The anti-communist primer had come up also for exams at our school in Lucknow, but somehow for most students it was water off a duck’s back. Indeed, the common man’s grip of political reality has remained at variance with, say, Ayub Khan’s, as the dictator turned his hatred of partisans into a bloody mess, or Nehru, who would abandon his fabled democratic instinct to dismiss the world’s first popularly elected Marxist government in Kerala over a disputed school curriculum.

When the Cold War was over, there was a sense of anticipation that the ‘free world’ would tone down the admixture of cretinism and propaganda, which it spewed for decades to describe a communist’s horns and canines. One thought the shrill imagery would give way to a sensible critique of many things that had gone wrong with communist systems.’

Within no time at all, however, the Cold War-era slogan for free democracies turned into an insidious prescription for ‘free-market democracies’. That should have been figured out as early as 1955 when popularly elected Mohammad Mosaddegh was overthrown in Iran by an American-British intelligence-led coup over the prime minister’s nationalisation of the oil industry.

One of the triggers for Orwell’s outburst against communism was his disenchantment with Stalin, though the British writer never reneged on his own commitment to socialism, provided it remained democratic. Much of Orwell’s anger deepened with his experience of the Spanish Civil War where he saw partisans turning on each other, aligning against Stalinists or supporting them.

As the world continued to see in the fable of Animal Farm the turning of an egalitarian dream into a nightmare, particularly for those that led the allegorical revolution, not much was said or discussed of Orwell’s ‘Man’ who symbolised the animals’ class enemy. It was Man in the form of the drunken farm owner, one Mr Jones and his perpetually snoring wife, whose untold cruelties set off the upheaval.

“Man is the only creature that consumes without producing,” the Old Major confided to the secret barn house meeting. The ageing pig was the intellectual fountainhead of the rebellion. “[Man] does not give milk, he does not lay eggs, he is too weak to pull the plough, he cannot run fast enough to catch rabbits. Yet he is lord of all the animals. He sets them to work, he gives back to them the bare minimum that will prevent them from starving, and the rest he keeps for himself. Our labour tills the soil, our dung fertilises it, and yet there is not one of us that owns more than his bare skin.”

Replace Man with Capitalism and it reads like a fine précis of the Communist Manifesto. This critique of capitalism in the very beginning of the book has been lobotomised from popular memory. The Covid-19 pandemic may have pushed it back centre stage again, nudging societies to rephrase their worldview. The millions we saw on the roads in the wake of the badly called lockdown in India were as much victims of a callous state as of a reality in which the rich are the privileged and the poor their grovelling minions.

That equation may have been jolted. The world’s four best friends are definitely in trouble. Benjamin Netanyahu has lost his popularity from 70 per cent approval ratings to around 15. The virus has ensnared Jair Bolsonaro in more ways than one. He has a rebellion brewing. Donald Trump is fighting everything and everyone except the virus. His lack of leadership, when it was most needed to save American lives, looks primed to cost him the election in November. Narendra Modi, according to The New York Times, has used the virus-related lockdown to arrest more critics, indicating he is on the back foot.

The Times mentions the case of Natasha Narwal, a student activist accused of rioting by the New Delhi police. When a judge ruled that she be freed for she was merely exercising her right to protest against a divisive citizenship law, the police slapped fresh charges of murder and terrorism, sending her back to jail.

Vijay Prashad’s Tricontinental: Institute for Social Research has been studying the way in which governments in places like Laos, Cuba, Venezuela and Vietnam — and one Indian state, Kerala — have tackled the coronavirus.

Both Laos and Vietnam border China, where the virus was first detected in late December 2019, and both have thriving trade and tourist relations with China. India is separated from China by the high Himalayas, while Brazil and the US have two oceans between themselves and Asia; nonetheless, it is the US, Brazil, and India that have shocking numbers of infections and fatalities. Asks Prashad: “What accounts for the ability of relatively poor countries like Laos and Vietnam to attempt to break the chain of this infection, while richer states — notably the United States of America — have floundered?” Orwell should have been around to figure that out.

Economics for Non Economists 2 – Quantitative Easing Explained

by Girish Menon

Pradhip, you have asked for an ‘Idiot’s guide on Quantitative Easing and how it affects the economy’. Let me try:

The Bank of England (BOE) has been practising Quantitative Easing (QE) since 2009. The amounts are:

Time	Amount in £ Billions
Nov. 2009	200
July 2012	375
Aug. 2016	435
Mar. 2020	645
June 2020	745

Ref – The Bank of England

What exactly did the BOE do when they said they were doing QE?

The BOE created additional digital money and used it to buy financial assets (especially government bonds) which were owned by the privately owned banks, pension funds and others.

How did they create this additional money?

Unlike you or me who would be arrested if we did this; the BOE has been conferred with monopoly powers to conjure up any amount of money from thin air by typing the necessary numbers into its bank accounts. It’s as simple as saying, ‘Let there be £745 billion and it appears in the bank’s accounts.

Why do they do QE?

Post the 2008 financial crisis there was a liquidity crisis (see below for explanation of liquidity crisis). The BOE by buying the government bonds from local banks transferred cash to them thus enabling them to start their lending activities in the economy.

In 2020 too they have done the same, but this time I suspect that even if the commercial banks are willing to lend there may not be enough borrowers and so this policy may not have the intended effect of stimulating economic growth.

How does QE affect the economy?

The dominant worldview is that debt drives the world. So QE ensures that lenders have enough money to lend to prospective borrowers. Borrowers borrow money to produce and sell goods at a profit; enabling them to repay their loans with interest while creating jobs in the economy.

The above borrower will use his loan to buy machinery, employ labour…. One man’s spending is another man’s income, so the money begins to circulate among citizens in an economy and a positive spiral will push economic growth and create employment.

However, all this theory hinges on the citizens’ confidence about the future. In the current Covid climate, with firms downsizing at will and people worried about their future, I doubt if there will be a critical mass of borrowers to re-start the stalled economic activity.

Pradhip, thus the BOE does indeed have a magic wand to create money out of thin air. You may ask why is it that in a free market I am not allowed to create my own money? Now that question will be considered seditious!

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What Is a Liquidity Crisis?

A liquidity crisis is a financial situation characterized by a lack of cash or easily-convertible-to-cash assets on hand across many businesses or financial institutions simultaneously. In a liquidity crisis, liquidity problems at individual institutions lead to an acute increase in demand and decrease in supply of liquidity, and the resulting lack of available liquidity can lead to widespread defaults and even bankruptcies. (Ref Investopedia)

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