Speaker 1: Bloomberg Audio Studios, podcasts, radio news.
Speaker 2: The legendary Wall Street short sellar Jim Chainos also spoke
Speaker 2: out about private credit not so long ago. He said,
Speaker 2: quote now, with the advent of private credit, institutions are
Speaker 2: putting money into this magical machine that gives you equity
Speaker 2: rates of return for senior debt exposure, which again should
Speaker 2: be the first red flag. We rarely get to see
Speaker 2: how the sausage is made. Jim Chanos joins us now.
Speaker 2: He is president and managing partner of Chenos and Company.
Speaker 2: He is here with us exclusively. Good to see you again, Jim.
Speaker 1: It just good to be here. Thanks for having me.
Speaker 2: So you heard what the CEO Barkley said about this
Speaker 2: idea of whether it's one bad actor or some aspect
Speaker 2: of circumstances that leads people in companies to behave a
Speaker 2: certain way. What does your spidey sense tell you?
Speaker 3: Well, I teach a course on the history of financial fraud,
Speaker 3: as you know, and one of the themes of the
Speaker 3: course is that the fraud cycle follows the financial cycle
Speaker 3: with a lag, and the more extreme the financial cycle
Speaker 3: i e. The bigger the bull market, usually more fraud
Speaker 3: is follows thereafter with a leg, so you don't really
Speaker 3: see the large amounts of fraud till after the cycle turns.
Speaker 3: This is early and a lot of consumer credit metrics
Speaker 3: are still kind of holding up. But we are starting
Speaker 3: to get some canaries in the coal mine in subprime auto.
Speaker 3: As you mentioned, the first brand's case is kind of
Speaker 3: mind blowing given what they were hiding, and I suspect
Speaker 3: we'll see more, but I don't think we're going to
Speaker 3: see a tidal wave of it until the actual financial
Speaker 3: cycle turns. Then I think we're going to see a
Speaker 3: lot of it.
Speaker 4: And how extreme is this current financial cycle.
Speaker 1: This one's pretty extreme.
Speaker 3: I mean we're now really sixteen years into a bull
Speaker 3: market in credit inequities, it's getting more speculative. We saw
Speaker 3: a mini speculative blow off in twenty twenty one, we're
Speaker 3: seeing it again in twenty twenty five. Standards get reduced,
Speaker 3: as I like to say, people's sense of disbelief erodes
Speaker 3: over time.
Speaker 1: They begin to believe things. You know they're too good to.
Speaker 3: Be true because there's pressure to put investors' money to work,
Speaker 3: and I think some of that's happening now in private credit.
Speaker 2: So the stock market has barely blinked. With all these
Speaker 2: blow ups, the credit market kind of dismissed them as
Speaker 2: idiosyncratic until Jamie Dimond warned about the prospect of more cockroaches,
Speaker 2: and then that kind of got people's attention just a
Speaker 2: little bit.
Speaker 4: Here.
Speaker 2: At what point does this become something that the credit
Speaker 2: market starts to panic over.
Speaker 1: Well, we don't.
Speaker 3: We haven't seen it yet, as you as you say,
Speaker 3: credit spreads are still almost record lows. So people are
Speaker 3: still partying, you know, it's the punch bowls being taken away.
Speaker 3: Only a couple of people may have noticed it yet,
Speaker 3: but so far it's still it's still partying like it's
Speaker 3: nineteen ninety nine, and the credit markets for the most part.
Speaker 2: What I found really fascinating was that Jamie Diamond didn't
Speaker 2: really target private credit in his comments.
Speaker 4: He kind of just made the comments generally.
Speaker 2: Yet the industry got kind of defensive when he spoke
Speaker 2: up are these firms justified in doing so?
Speaker 4: I mean, you.
Speaker 2: Point out that they have promised these equity like returns
Speaker 2: that raises questions about the economics of their business.
Speaker 1: Yeah, there's two things that bother me.
Speaker 3: The way private credit is being sold to investors, and
Speaker 3: I sit on investment committee, so I see this and
Speaker 3: really it's one of these too good to be true
Speaker 3: type promises. We're going to give you senior debt exposure,
Speaker 3: often secured somehow, but with equity rates of return double
Speaker 3: digit type returns, which makes you wonder about the underlying
Speaker 3: credits themselves.
Speaker 1: That's number one. And then related to that is how.
Speaker 3: Much leverage is being used within the vehicles to juice
Speaker 3: the equity like rate of return. And then the other
Speaker 3: thing that concerning to me is the explosion now in
Speaker 3: captive regulation subsidiaries by the largest largest players in this.
Speaker 1: Area, owning insurance companies.
Speaker 3: And where there really isn't a true arms length difference
Speaker 3: between the people buying the credit and the people selling
Speaker 3: the credit to them, and that is worrisome.
Speaker 1: That's something we saw in the Drexel days.
Speaker 3: By the way, one of the things that got us
Speaker 3: so concerned in nineteen eighty eight and eighty nine in
Speaker 3: the Drexel junk bond kingdom was the fact that more
Speaker 3: and more of Mike Bilkins's clients had regulated subsidiaries like
Speaker 3: savings and loans insurance companies, thrifts, trust companies where they
Speaker 3: were buying the same credit that in effect others in
Speaker 3: the Kingdom were selling without a lot of arm's length disclosure.
Speaker 1: And so that is something to keep our eye on,
Speaker 1: I think, is the.
Speaker 3: Use of captive regulated subs to buy this stuff.
Speaker 4: Yeah, it's your point.
Speaker 2: Private credit has kind of become the a Girl of
Speaker 2: asset classes. Everyone talks about it. Every asset management firm
Speaker 2: wants to be able to offer. Every bank seems to
Speaker 2: want to get in after missing out.
Speaker 1: Sort of like private equity five to ten years ago.
Speaker 2: Exactly, everyone's a stakeholder, so it feels like everyone's kind
Speaker 2: of incentivized to make sure that whatever happens stays an
Speaker 2: idiosyncratic story and nothing.
Speaker 3: More right or hedge funds fifteen years ago. Yeah, look,
Speaker 3: these things are being sold aggressively. It's a wonderful product
Speaker 3: for people that have targeted rates of return needs, endowments,
Speaker 3: pension funds. But again, it's just something that worries me
Speaker 3: when equity rates to return are promised on credit instruments.
Speaker 3: Usually there's something you're not seeing.
Speaker 2: Let's talk about something that may or may not be
Speaker 2: worrying to you, which is what's happening in big tech.
Speaker 2: They are investing tens of billions of dollars to build
Speaker 2: out data centers to boost their AI capabilities. They announce
Speaker 2: partnerships where they take equity stakes in each other and
Speaker 2: buy stuff from each other. Is this so called circular
Speaker 2: funding a problem in and of itself?
Speaker 4: Does it raizor antenna?
Speaker 3: Well, what we've told clients because we went through the
Speaker 3: first time we saw this in ninety nine, two thousand
Speaker 3: and two thousand and one, where there was a lot
Speaker 3: of circular financing and vendor financing. Back then it was
Speaker 3: the telecoms, but the customers that were taking that vendor
Speaker 3: financing from the Loosens and Nortel's of the world were
Speaker 3: predominantly profitable. The Celex raised about forty five billion over
Speaker 3: five years competitive local exchange cares. They had a flawed
Speaker 3: business model, most of them went broke, and then the
Speaker 3: fiber optic guys did build outs and most of them
Speaker 3: had to be restructured or went bankrupt. But we were
Speaker 3: talking about one hundred billion dollars of vendor financing over
Speaker 3: the five years or so that it was happening, which
Speaker 3: was a lot at the time, but it pales into
Speaker 3: comparison with some of the numbers were starting to hear
Speaker 3: about both this year, next year, twenty seven, twenty eight
Speaker 3: for the capital needs of the AI companies, and that's
Speaker 3: you know, that's a red flag.
Speaker 4: It's a red flag.
Speaker 2: I mean, is circular financing funding an unmistakable sign of
Speaker 2: market over exuberance.
Speaker 3: Well, similar to my concerns about private credit owning regulated
Speaker 3: investing subsidiaries, one of the things that has caught my
Speaker 3: eye that is concerning now is we're starting to see
Speaker 3: the advent of so called SPVs, which are entities and
Speaker 3: this comes from the end run era and the global
Speaker 3: financial crisis, entities that are specifically set up to hold assets,
Speaker 3: borrow against those assets, and take it off balance sheets.
Speaker 3: So you just showed an equity investment as opposed to
Speaker 3: the massive amount of debt that's being taken on.
Speaker 1: And that again.
Speaker 3: Is something that worries us because if there's one sort
Speaker 3: of consistent theme that we're seeing amongst the players that
Speaker 3: know this the best in video Microsoft companies like that
Speaker 3: is they seem to now be willing to do anything
Speaker 3: to get the actual equipment off their books and either
Speaker 3: keep it in the footnotes or use innovative financing to
Speaker 3: sell it. And I think they're concerned about depreciating lives
Speaker 3: and some of the accounting on this, as well as
Speaker 3: just the immense capital needs that they don't want to
Speaker 3: put directly on their balance sheets.
Speaker 4: So how do you HYDI against this?
Speaker 3: Look, I mean, it's driving the market right AI is
Speaker 3: the displacement of this cycle. Right If the Internet was
Speaker 3: the displacement idea of the nineties, certainly it's AI right now.
Speaker 3: And if AI goes, there's not going to be a
Speaker 3: lot of places to hide because it's so embedded right
Speaker 3: now in the psyche of investors. So we better hope
Speaker 3: it works, and because if not, there might be some
Speaker 3: disappointment down the road.
Speaker 2: You've pointed out that the AI driven capital spending boom
Speaker 2: we're seeing today is comparable to the Internet build out
Speaker 2: in the late nineties. So when companies start tapping the
Speaker 2: brakes a little bit, pulling back on their spending by
Speaker 2: just a bit, how quickly will that show up in.
Speaker 4: Earnings and margins? Given where we are in this market.
Speaker 3: So the problem in two thousand and two thousand and
Speaker 3: one was basically wasn't really vendor financing. As I said,
Speaker 3: that was all in about one hundred billion dollars over
Speaker 3: five years. The real problem was double and triple ordering
Speaker 3: of equipment, where people put in orders for routers and
Speaker 3: network equipment and capacity and then basically all at once.
Speaker 3: In late two thousand and early two thousand and one,
Speaker 3: they pulled back, we don't need all these routers, we
Speaker 3: don't need all these switches, we don't need all this
Speaker 3: fiber optic gear, and order books just collapsed and S
Speaker 3: and P earnings dropped forty percent from peak to trough.
Speaker 3: The SMP dropped about forty per there was a mild recession.
Speaker 3: GDP dropped about one percent for two quarters. It really
Speaker 3: was not like the global financial crisis or even eighty
Speaker 3: nine to ninety when we had a banking crisis, but
Speaker 3: it was terrible for corporate profits because there was so
Speaker 3: much basically steroidal of profit participation profit margins from all this.
Speaker 3: So that's what we're kind of keeping an eye on,
Speaker 3: is order books and looking for any signs that suddenly
Speaker 3: maybe we don't need all of these router GPUs or
Speaker 3: all of these data centers or what have you.
Speaker 4: And it's not just things tied to AI.
Speaker 2: I look at the fifty five billion dollar takeout of
Speaker 2: electronic arts marking the biggest LBO ever. It's deal making
Speaker 2: like it's two thousand and seven, going beyond the order
Speaker 2: books of the big tech companies. As an inherent skeptic,
Speaker 2: what are you watching for to get a sense of
Speaker 2: how and when the music stops?
Speaker 3: Well again, we want to see the underlying profitability of
Speaker 3: the engine, rightI I come up with a profitable business model,
Speaker 3: because right now, if you think about it, open AI
Speaker 3: is I think seventy roughly two thirds of all queries
Speaker 3: and are open AI. And they're going to do thirteen
Speaker 3: billion of revenues this year, thirty billion next year, you know,
Speaker 3: with capital spending needs and the hundreds of billions of dollars.
Speaker 1: So at some point.
Speaker 3: Someone's got to come up to say, we actually have
Speaker 3: a model that will directly lead to cash flow and
Speaker 3: profits so we can service the debt that we're taking
Speaker 3: on to build the data centers and build the infrastructure.
Speaker 3: And we'll have to see. I mean, what I've said
Speaker 3: is I'd rather be long the companies that are producing
Speaker 3: the magic from the chips than the landlords where the
Speaker 3: chips reside. Right, So, if this is going to truly
Speaker 3: be revolutionary, and it probably will be. I think you're
Speaker 3: going to have to see stuff coming out of the
Speaker 3: hyperscalers and open AI, really interesting applications that can be monetized.
Speaker 3: I think a lot of investors, however, are basically investing
Speaker 3: in the picks and shovels, the data centers, the equipment guys,
Speaker 3: and I think that's at the end of the day
Speaker 3: going to be a commodity business.
Speaker 2: Okay, well, eventually it will be. As of now, it
Speaker 2: hasn't gotten there yet. Jim, stay with us because we're
Speaker 2: going to discuss a lot more, including some of your trades.
Speaker 2: This is Bloomberg. This is Bloomberg Markets. I'm Scarlett Food.
Speaker 2: We are back with Jim Chanos, founder of Chenos and Company. Jim,
Speaker 2: I want to get an update on your bet against
Speaker 2: MSTR Strategy, And to be clear, this is not a
Speaker 2: bet in which you, Jim Chainos, are anti bitcoin. You're
Speaker 2: kind of agnostic on where the price goes. You just
Speaker 2: don't believe that the stock should be trading at this
Speaker 2: hefty premium to the value of its bitcoin simply because
Speaker 2: Strategy owns bitcoin and is raising money to buy weren't bitcoin?
Speaker 4: Where are we at here?
Speaker 3: So you're exactly right. I mean, we're agnostic on bitcoin.
Speaker 3: I have no idea where bitcoin is going or what
Speaker 3: it's worth, but we own bitcoin against.
Speaker 1: The micro strategy short.
Speaker 3: This was an arbitrage and we just as you know,
Speaker 3: we just weren't and aren't believers in this whole concept
Speaker 3: of bitcoin treasury companies trading at premium to the underlying asset.
Speaker 3: And it's interesting, I mean, since we were on last
Speaker 3: I mean the so called m NAB, the premium has
Speaker 3: compressed from about one point nine to one point four.
Speaker 3: But what's really interesting is what's happened to all the
Speaker 3: strategy you want to be companies. Most of those now
Speaker 3: have gone to below one point zero NAV, so they've
Speaker 3: been completely.
Speaker 1: Blown out of the water.
Speaker 3: And strategy is kind of the granddaddy of this and
Speaker 3: is still holding on at one point four. But again,
Speaker 3: we just think that investors are much better suited if
Speaker 3: they're bitcoin believers in buying bitcoin at a dollar.
Speaker 1: Not a dollar forty.
Speaker 2: And you say that m NAV should be at one,
Speaker 2: you advise clients when the m NAV was between two
Speaker 2: point two to two point three.
Speaker 4: Have you covered any of your shorts?
Speaker 3: We have not covered any of our shorts. But you know, again,
Speaker 3: we reserve the right to change our mind. But I
Speaker 3: think as long as micro Strategy keeps selling its paper
Speaker 3: to buy bitcoin, we're going to do the same thing
Speaker 3: that they're doing.
Speaker 2: You mentioned that the m NAV of the copycat strategy
Speaker 2: companies has gone below one.
Speaker 4: Have you did you bet against any of those?
Speaker 1: No, we did not.
Speaker 3: We just kept it to Strategy and it was the biggest,
Speaker 3: it was the most liquid. The premium at two plus
Speaker 3: was at one point I think fifty or sixty billion
Speaker 3: dollars just the premium. It's kind of staggering how big
Speaker 3: the arbitrage was. In my forty years of experience, when
Speaker 3: these kinds of things set up, maybe they're five hundred
Speaker 3: million dollar opportunity of billion dollars a couple billion, you
Speaker 3: rarely see tens of billions of dollars of premium in
Speaker 3: these kinds of trades.
Speaker 1: It was highly unusual.
Speaker 2: Let me ask the obvious question, why do you think
Speaker 2: Strategies and Now is holding up at one point four
Speaker 2: when everyone else has gone below one.
Speaker 1: It's a good question.
Speaker 3: In fact, you know people that like this concept and
Speaker 3: I don't you know, should be buying the other companies
Speaker 3: and buying bitcoin at a discount, but again that's not.
Speaker 1: They can't add to their bitcoin.
Speaker 3: So there are some diehards who still believe that micro
Speaker 3: strategy is adding value by being able to sell securities
Speaker 3: and buy bitcoin. The problem is he's doing that at
Speaker 3: your expense, the new investor, and so the whole thing
Speaker 3: just never made sense.
Speaker 1: It still doesn't make sense, all right.
Speaker 2: I want to talk about carbon as well, because you've
Speaker 2: embarrashed on that for a couple of years, and in
Speaker 2: part because of its reliance on the sale of subprime loans.
Speaker 2: Given the problems we've seen with Prima Lend and Tree Colore,
Speaker 2: subprime auto loans just doesn't sound like a good business
Speaker 2: idea right now.
Speaker 3: It is for them, so they're still booking hefty gains
Speaker 3: on their sale loans. But look, there's just lots of
Speaker 3: red flags at Carvana.
Speaker 1: It's not new news.
Speaker 3: But what really would worry me if I was new
Speaker 3: to this story is the fact that a Carvana affiliate
Speaker 3: services the loans Bridgecrest, And again, we just don't have
Speaker 3: complete transparency as to what's going on. And given the
Speaker 3: news in the subprime model space of default bankruptcies, rising delinquencies,
Speaker 3: the fact that that Carvana seems to be sailing through
Speaker 3: it without with Narus scratch stretches credulity in my.
Speaker 2: Opinion, so your shortest still on right now.
Speaker 1: We're still short Carvana.
Speaker 4: And Eerie Insurance.
Speaker 2: This is something that you've spotted accounting problems at for
Speaker 2: a while, and now there's a legal battle that could
Speaker 2: have ramifications for the broader insurance industry that practices overall.
Speaker 3: This is a really odd one. We wrote about this
Speaker 3: with another firm, my brother's firm, in February, pointing out
Speaker 3: that this company was a real kind of unique animal
Speaker 3: in the US publicly traded insurance space. They had set
Speaker 3: themselves up as a servicing company and had the insurance
Speaker 3: all of the insurance operations, which were massive, I think
Speaker 3: the eighth largest insured the US, owned by the policyholders.
Speaker 3: But those companies have no employees, no directors, and Eerie
Speaker 3: itself handles all that for a flat fee of twenty
Speaker 3: five percent of premium. Well, last week a couple of
Speaker 3: things happened. A lawsuit was given a go ahead by
Speaker 3: policy holders who said they're being raped by the high fees.
Speaker 3: But just as ominously, the National Association of Insurance commissioners
Speaker 3: have now taken notice and saying she We're going to
Speaker 3: set up a working group to study this because the
Speaker 3: incentives are wrong. There's an incentives for you just to
Speaker 3: book business because your revenues come off the top line.
Speaker 3: We point out that the company's earnings are supposedly twelve
Speaker 3: dollars per share, but if you actually consolidated them, as
Speaker 3: you should in our opinion, and as they've done in
Speaker 3: the past post Enron, the earnings would be forty fifty
Speaker 3: percent lower.
Speaker 4: So this sounds like late cycle behavior.
Speaker 3: It's just it's it's a kind of one off accounting
Speaker 3: story that has been under the radar for a lot
Speaker 3: of people.
Speaker 1: And it's just again, this is kind of as simple.
Speaker 3: They control these insurance companies, and the insurance companies have
Speaker 3: very cyclical up and down earnings. They lost a lot
Speaker 3: of money in the last quarter, for example, but Eerie
Speaker 3: has smoothed it out by this construct, and we just
Speaker 3: think it's it's an accounting.
Speaker 4: Game, all right.
Speaker 2: Jim, always a pleasure speaking with you. Thank you so
Speaker 2: much for sharing some of your time with us. Jim
Speaker 2: Chanos is founder of Chenos and Company.