JACK FARLEY: We've got another treat for you today from the Real Vision archives, this one with Jim Grant and legendary short seller Jim Chanos. Short selling, as Jim Grant in this interview calls it, is the subtle art of selling something before you own it. Now, that can be quite a dangerous ordeal, but Jim Chanos has managed to be successful in this throughout his entire career. And Jim Chanos shares, in this interview, his philosophy that has made him successful. So without further ado, please enjoy this interview with Jim Chanos and Jim Grant.
CREW: Could you state your name, your title, and company?
JIM GRANT: Yes. Oh, I should do it!
CREW: Oh, please.
JIM GRANT: Yeah.
I'm Jim Grant. I'm the editor of Grant's Interest Rate Observer. And what I do for a living is write.
I want to interview famous people, but who are famous, perhaps, for reasons that the public is not fully aware of.
I hope to elicit from them new thoughts, frank admissions of things that they had not previously admitted to, and I want to get them to laugh once or twice. I'm Jim Grant, and I am going to sit down with Jim Chanos who, as you know, is the foremost short seller on Wall Street, the longest-lived short seller, the most successful practitioner of that very dangerous and interesting art of selling stocks before you buy them.
Jim is a renowned analyst of companies, the author of the truth on such situations as Enron and Valeant Pharmaceuticals. So please do join us, Jim Chanos, on Real Vision, just one moment.
Well, I am Jim Grant, and this, my guest, is Jim Chanos, James S. Chanos, proprietor , chief cook and bottle washer, founder of Kynikos Associates, leader of the financial resistance on Wall Street, eminent long-lived short seller. Jim Chanos, welcome.
JIM CHANOS: Glad to be here. That bottle washing thing might come in handy, by the way.
JIM GRANT: Well, everyone needs a real skill.
JIM CHANOS: Exactly.
JIM GRANT: Yeah. A conference that Grant sponsors a couple of years, many years ago. Chris Davis, a very good investor in financial stocks was talking, and he was quoting his grandfather, Shelby Cullom Davis.
JIM CHANOS: Sure.
JIM GRANT: And he said, you know, my grandfather always said that the short sellers, they always sound smarter. What could he have meant by that?
JIM CHANOS: [LAUGHS] I think there seems to be a collective wisdom on Wall Street that since stocks have tended to go up over time-- or so I've noticed-- that anyone who's on the short side must be a little bit of an intellectual crank. But the fact of the matter is that while the indices have gone up over time, most companies don't. And most companies actually either fail or are merged out of existence.
And so one has been, I think, well served to be long the indices, but it can be very, very difficult to be a stock picker over time. And I think that that statement expresses not only the wonderment of being a skeptic in a rising environment, but maybe also the difficulty of being a bull in a rising market.
JIM GRANT: Well, that line of Chris Davis has got the most rueful and knowing laughter, I think, ever at a Grant's conference in more than 30 years. Maybe it's time-sensitive.
JIM CHANOS: Well, consider the audience.
JIM GRANT: Yeah. But speaking of 30 years, we have known each other for, I think, about 33 years. We met in 1984.
JIM CHANOS: We did.
JIM GRANT: 1884-- 1984, it was.
JIM CHANOS: [LAUGHS]
JIM GRANT: And it was dinner at Crisella's, which is a great steakhouse. I think no longer with us, but it was certainly great in its time. And Bill McGarr, another short seller, and you and I sat down together, and we had it figured out.
As I recall, we had it figured out that the Drexel Burnham was not for the ages, that Caterpillar tractor was a kind of a Fandango, and that people didn't have enough to read. That was my view of the world. If only I could supply them with a few thousand words every two weeks. So the three of us had the world figured out. What went wrong?
JIM CHANOS: [LAUGHS] I remember that our mutual friend, Bill McGarr, was railing at the fact that Caterpillar had scaled the lofty heights of 12 times earnings after a two-year economic recovery, as I look at it today at 30 times earnings.
JIM GRANT: Yeah.
JIM CHANOS: I think it worked out pretty well for the three of us, all things considered. But boy, I mean, it sure seems to have taken a bumpy road to get there.
JIM GRANT: Yep. Well, speaking of getting there, you grew up in Wisconsin. You went to Yale. You were a premed student. And to this day, some of your early friends and no-longer-young friends call you doc, which is an allusion to a one-time ambition.
The science hill turned out to be a very steep climb. You chose to switch majors. You were on the crew team, were you not?
JIM CHANOS: I was. They call me "Doc" sort of as you call a fat guy "Slim," because I was premed for, I think, five days.
JIM GRANT: Right, so you made the summer slide by during your college career by working in a steel mill.
JIM CHANOS: I did.
JIM GRANT: And earning $14 an hour, which I gather was a munificent rate of pay, at least in comparison to your first Wall Street job. Where did you start on Wall Street, and how did you get from that job to Kynikos Associates, in 25 words?
JIM CHANOS: [LAUGHS] So my first job, I went back to Chicago after graduating. And I'd always actually had a fascination with the stock market. My dad was a stock market investor. So while everyone else either went to the commercial banking world or on to grad school from my class, I decided to send my resume out to some of the big investment banks in Chicago. And I got an interview with a fellow from Blyth, Eastman Dillon. And midway through our interview, he said, look, I'm going to hire you, but why the heck do you want to work on Wall Street?
JIM GRANT: This was 1980.
JIM CHANOS: This was 1980. Interest rates were 14%. We were in the midst of, basically, the 1966-to-'82 bear market, which, in real terms, was as bad as the '30s. And people just weren't making a lot of money.
You mentioned my last summer in 1979, I worked 2 and 1/2 months in a steel mill, and got extra shifts, and took people's weekends and holidays, and I made more in that 2 and 1/2 months that I made my first full year on Wall Street. So a little bit of the difference between labor and capital back then-- labor was ascendant, capital was on its back. And then it, I think, changed a little bit.
JIM GRANT: So tell us if you would, please, about your first big analytical project, having to do with a conglomerate called DH Baldwin.
JIM CHANOS: Yeah, the wonderful Baldwin United. So I moved in 1982 over to a little firm in Chicago called Gilford Securities. The head of Gilford had been the head of retail sales at Blyth, and we became friends. And he told me one day he was starting this firm-- office in New York, office in Chicago-- and they needed analysts.
And I actually was still far more enamored with the stock market than I was doing deal books for McDonald's. And so I took the leap and joined Gilford. And the first stock I was asked to look at was a company called Baldwin United, which was a rapidly growing conglomerate, the old Baldwin Piano. It was run by a CEO that had basically made his chops selling pianos door-to-door.
JIM GRANT: Morley Thompson.
JIM CHANOS: Morley Thompson. And if you think you can sell pianos door-to-door, you could pretty much sell anything, I suspect. But they had more-- they were buying MGIC, the Milwaukee-based mortgage insurer run by Max Karl. And we had clients that owned MGIC stock. And it was basically a risk arbitrage analysis, because there was a wide spread on the deal. People were questioning Baldwin's ability to pay for it.
And as I delved deeper into it, I began to realize that Baldwin was not what it appeared to be. And thus, I put my exquisite-- sense of timing that I've kept through my entire financial life-- I put my first sell research report out on August 17, 1982, which some also might note was the beginning of the intergalactic bull market to the day.
JIM GRANT: Good call.
JIM CHANOS: Exactly. [LAUGHS]
JIM GRANT: So tell us the price of Baldwin United at which you put out your sell, and the price at which it reached its-- what's the word-- apogee?
JIM CHANOS: Yeah, so again, this was something that I think I wanted to start a tradition in. So it was-- I put my sell and sell short report out at $24.00. And it--
JIM GRANT: So $25 was the top, then?
JIM CHANOS: Well, it immediately went to $20, and then, of course, almost tripled, [LAUGHS] and I think got to about $55, $56 in the space of a few months.
JIM GRANT: Tell us all what that experience was like and whether somebody came to you-- you were, what, 23 or 24, 25?
JIM CHANOS: Yes, I was 24, 25.
JIM GRANT: OK, so somebody must have come to you in the firm and said, you know, Jim, what an exquisite job you did on this analysis. You must have gone to Yale, it reads so well. But let's-- shall we just kind of reverse this, because it's really not working out?
JIM CHANOS: Yeah, it actually, sadly, was a little bit worse than that, because the New York partner wanted my head on a plate. [LAUGHS] And my boss in Chicago, the great Bob Holmes, said no, I've seen the kid's work. We're staying with it. And--
JIM GRANT: Now, was the firm short?
JIM CHANOS: The firm's clients were short, and I think the principals were short. I don't think the firm's capital was short. And we put out a second report in early December of '82, which basically, in effect, doubled down on the idea but put out more information--
JIM GRANT: At what price, about?
JIM CHANOS: I think it was about, $50, $52, something like that. And there was more public information out, and quite a bit-- we were getting the files from the Arkansas State Insurance Department, which were public. And in it, the consultant for the department, who was a former New York State insurance superintendent, Stewart, was basically outright saying, you are insolvent. We need more capital. And that's, as we call it, a little bit of a smoking gun.
But the company, Baldwin, was selling its annuities through Wall Street. So it had this amazing choir of supporters who just loved it no matter what. So I guess as a short seller, it might be a better education to have the first one double on you than, maybe, work out right away. But it did work out.
JIM GRANT: So that was the early '80s-- '82 or so. We first met in '84, and by that time, another great theme was playing on the organ of Wall Street, which was junk bonds.
JIM CHANOS: Yeah.
JIM GRANT: Through the support and sponsorship of Drexel Burnham Lambert. Tell us about how you got involved with that.
JIM CHANOS: So I got involved-- I moved to New York in and joined Deutsche Bank, and as a sell-side analyst. And one of the companies I started work on was a company called Integrated Resources, which was the great real estate syndicator of the '80s. And Integrated was financed by one Michael Milken at Drexel Burnham Lambert.
And as I began to look at why they would finance this company-- which ultimately failed-- I began to look at some of the other companies that he was financing. And a pattern emerged. It became very clear to me that one of the geniuses of what Milken was doing was that a lot of his clients had regulated financial subsidiaries-- savings and loans, insurance companies, or banks. And one of the side benefits of him financing the various different parent companies was that they bought each other's bonds. And in effect, it was a way for money to be upstreamed from the regulated subs.
And I think that was basically the underappreciated aspect of the Drexel money machine. The problem was, of course, it made the whole thing far more interconnected than anybody dreamed, and that if one or two of those companies should fail, you would have a possible domino effect-- which is, indeed, what happened.
JIM GRANT: So the dominoes began to tumble in 1989, '90.
JIM CHANOS: Yeah.
JIM GRANT: So let's see. There's 1984, '85, '86--
JIM CHANOS: [LAUGHS]
JIM GRANT: '88.
JIM CHANOS: Yeah.
JIM GRANT: So tell us about the intervening five years between perception and the world's recognition. Emotionally and intellectually, how do you persist in these themes? And how-- I want to get around to risk control as well, let's just stick with the analysis and with the emotional problem of sticking with something in the face of relentless negative reinforcement.
JIM CHANOS: Yeah, so the negative reinforcement is the issue. And as I've said for the last number of years, I think it's one of the reasons why I now believe that short sellers are born, not made. I think you have to have the temperament.
The research should be the same. The work do should be the same. But you have to basically take your positions in the face of almost always overwhelming criticism of it from the other side.
Whereas on the long side, all of those people are the heavenly choir. It's the muzak of the investment business. It's always on. It's always there supporting you.
So you have to have a willingness to stake your position out based on the facts, and your reading of the facts, and how you see the opinion trading on those facts. And look, it's not always easy, even if you've been doing it for a long, long time. But I do think that that quality is what separates people who have-- at this point, I guess survived on the short side, versus the people who sort of flirt with it from time to time.
JIM GRANT: Well, there are very few survivors.
JIM CHANOS: Yeah, I think both of us are kind of [INAUDIBLE].
JIM GRANT: Right, yeah. So tell me about how-- so that's the analytical side, the emotional side of it.
JIM CHANOS: Yeah.
JIM GRANT: Tell us all, please, about the risk management side. Let's say you get an idea. Let's call it a $50 stock.
JIM CHANOS: Right.
JIM GRANT: And there's no doubt, this stock is a goner.
JIM CHANOS: Well, there's always doubt, but yes. [LAUGHS]
JIM GRANT: Right. Well, I'm going to interrupt myself and you to quote you. This has to do with banks. I guess the year must have been 1990, and banks were all going down in a vast heap. It was going to be 1932 again. And somebody said, this is like shooting fish in a barrel. And you said, knowingly, yeah, but the fish shoot back.
JIM CHANOS: [LAUGHS]
JIM GRANT: Getting back to risk management. So it's a $50 stock. The case is pretty clear. It goes to $60.
JIM CHANOS: Right.
JIM GRANT: It goes to 80. It goes to 102, as these things do.
JIM CHANOS: Yes.
JIM GRANT: How do you trade around this?
JIM CHANOS: Right.
JIM GRANT: How do you persist? Seth Klarman will say, if he's long a $50 stock, and he is persuaded by the case-- really convinced by the case-- he will buy in scale, buy more as it goes down. And you can't do that, exactly, on the short side, can you?
JIM CHANOS: No. So of course, the short side-- there's lots of asymmetries, but the biggest one is the psychological asymmetry of a stock can only go to zero on the downside but can go up infinitely on the upside. And I always point out, I've seen more go to zero than infinity.
But having said that, it is people also tend to think far more discretely about their short positions than their long positions.
JIM GRANT: "Discretely" meaning?
JIM CHANOS: Meaning that they isolate the price movement of one stock in their portfolio and disproportionately worry about it because of that, that fear. So remember, we ran a portfolio. And so globally, 60 stocks; domestically, 40 or so. And so every position, basically, averages 1 and 1/2% to 2 and 1/2%, something like that. So you always at least position your portfolio from a risk point of view that being wrong either permanently or temporarily can never carry you out.
So we were famously and disastrously short America Online in the late '90s. I think we started shorting at $8 and covered our last share around $80. And we were short it on accounting reasons that played out fabulously from 2000 to '02, which made us nothing.
But during that entire period, that 10-bagger cost us a few percent, because we were never short more than a 1/2% to 1% of the fund in AOL at any given time. So you have to learn to size positions based on a variety of different factors. And some of that is the secret sauce of what we do.
There's one other important point to make, and that is, beginning in the '90s, we changed fundamentally, strategically, the business to basically, in effect, be long the market for most of our funds. So we get paid, even in our short-only business, by how much alpha we provide. So we are, in effect, long the market, short our stocks.
And this changed the business for us dramatically, because it basically put us in the insurance business, not the market speculation business. And I think that was one of the things that has enabled us to survive and, occasionally, prosper-- that we really don't care that the market's up 30%. We just don't want our stocks to be up 40%.
JIM GRANT: Yeah, you care.
JIM CHANOS: [LAUGHS]
JIM GRANT: Oh, it can be brutal, but there are bright lights. Speaking of the 1990s, please tell us about Enron.
JIM CHANOS: Yeah, so Enron was one of these situations. And people always doubt me when I say, Enron was actually one of the easiest shorts we ever had. We put the position on at about $60. It skyrocketed to 80 over the course of a month or two, which is a given.
JIM GRANT: As they do, yes.
JIM CHANOS: And then rolled over, and never-- pretty much went straight down with a few short rallies in the succeeding 11 months. And in the world of short selling, it probably doesn't get a whole lot easier than that.