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