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This week we have an extra special bonus episode live from future Proof. My conversation with Muddy Waters Carson Block really a fascinating conversation, not only about how he developed an interest in shorting fraudulent equities and companies, but how his firm has evolved into a comprehensive research shop and a long short hedge fund. I thought the conversation was fascinating, and I think you will also, with no further ado. My conversation with Muddy Waters Carson Block live at Citywide
future Proof Miami. I'm so fascinated by your career, what you've done, what you've built.
I first kind of became aware of you. I don't know.
It seems like it was a long time ago with the reverse Chinese mergers and Sino Forrest. Then wait, China is doing what. I don't understand any of this. Tell us how you kind of fell into that aspect of markets and how you ended up becoming an activist short seller.
I will try to nutshell this, but I grew up in investing. My father was an equity analyst and was working with him from ninety nine to two alongside covering microcaps. And we were just getting lied to incessantly by these managements. And back then they had forty five days to file their forms for so let me take them on non deal roadshow to meet institutions. Stock would go up and
let me'd find out later that hit the bid. So this is the same time that you had the largest companies in the world like Enron, WorldCom Health South Hidelphia blowing up an accounting scandals. So my my realization around two thousand and two, I was really demoralized. It's like, look, I want to be an investor, but this is this market is riddled with financial predators from top to bottom.
How do I protect myself against that? So I went to law school with just this amorphous idea that that would give me some tools, and you know, fast forward, decided to practice law, ended up in China. Jones Day left to start the first self storage business in mainland China. I don't recommend it, and anyway, I was just sort of, you know, keep trying to keep that business from failing.
In two thousand and nine, when my father got really excited about a bunch of these Chinese companies that had had gone public in the US via reverse merger, and like I had my own problems, I wasn't really that interested. But he asked me to look and he asked me to look at this first one called Orient Paper. And the first thing he told me he'd been at a conference that these guys had gone to, and you know what he's hearing is, oh, you know, chairman Leo, he's
different from other Chinese company chairmen. He doesn't smoke, and he doesn't chase women. And you know, my father's telling me this woman, you know, late night in Shanghai, and I'm like, I'm sure neither of those things is actually true. But the fact that this is making its rounds at the conference, somebody is trying to game Western investor psychology.
So that got my attention. Early twenty ten, went up to see the company and it was a Potemkin factory, Like I never believed that such a thing could exist, where at the time it's market cap is one hundred and fifty million, had just reported one hundred three million dollars in revenue and the real revenue two to five million dollars that it was these empty box So I
exposed that with the thirty some ond page report. And the only reason I did that was I felt like I was stuck in my business in Shanghai, like a few hundred people who are leaving their stuff.
In my facility.
The industry did not exist because it's a bad industry to be in in China, and I don't know, there's like a power and feeling like you have nothing to lose. So I just threw the ball as far down the field as I could wrote that report.
It went viral.
Quickly found out this was systemic, and one year later Bloomberg's like, oh, he's one of the fifty most influential in global finance with Ben Bernanki and Warren Buffett, and it was like, well, yes, of course that's the natural path from self storage.
That's every thirty page analyst report tends to lead to that. So it's funny because you and I kind of came of age in the markets similar period. The dot com implosion was certainly fundamental to my view of both markets and short sellers, and then the financial crisis. How do you look at how the markets have changed over the ensuing decade, as between QE and zero interest rate policy, and more recently the Cares Act and the mascul fiscal stimulus.
I grew up thinking short sellers were the ones who kept the market honest and responsible. That seems to be a minority of you these days.
Yeah, well, I've come to the view that there's an inverse relationship between interest rates and the amount of dishonesty in society. So the lower your rates, the more easy money is, the more dishonesty you get in society. And so the emergency monetary policy outlived the emergency. And you know what I felt is that just each year I've been doing this, that investors are more and more anesthetized
to Now. The flip side of that is that behaviors that were once really only present in microcap land will those bubble up to MidCap land because of the inflation of market caps. So on one hand, my business has gotten harder because unless it's something really really egregious, like
people don't care. But then yes, you'll find that type of behavior now even in mid cap companies, and you know an environment where and just to be clear, it's a small minority of companies that are frauds the world's bigger problem is the gray zone, right, the things where yeah,
nobody's gonna get convicted. Tech you know, lawyers have signed off, the auditor is okay with it, and that gray zone behavior whereby you can significantly misrepresent economic reality that is almost maybe the norm in many respects.
So this secret is to corrupt the attorneys and the orderers and then it's home free.
Wait, corrupt the attorneys.
Right, So you mentioned microcaps, small cap mid caps. I read a note of yours not too long ago talking about the big caps and the megacaps, where so many people have been calling this a bubble, and so many people have saying, gee, I'd like to shorten video.
You kind of went out of your way.
To say, hey, maybe one day there's a downside play here, but this freight train is really difficult to step in front of. What are your thoughts on on the hyperscalers, the megacap tech companies?
Three things?
Number one, there are easier better shorts out there than in video. Number two. The reason why I was making those comments is that flows have driven so much of this, Like you have obviously the passive bid, and it squeezes floats and by squeezing floats. It's not a linear impact on stock prices. It's a parabolic impact on stock prices at least of the winners. So the idea that something is overvalued, that's a reference to its fundamental value. But
I think you have to consider its technical value. And that's what everybody fails to say when they're criticizing these things on a fundamental basis.
It's like, well what are the technicals of this? Now? That's my second point.
My third point is up till one month ago, I was completely sanguine on the on SMP and markets in general and the economy. And my view has one eight And I think the wrong question is well what do you think of the valuations or stock prices of XYZ of these AI companies? And the right question is what is about to happen to society and to the market as a result of AI. And I and like I said on this like a month ago, I wouldn't even refer to these models as a I had this rule.
These are large language models. They are not going to create new information. They merely process information that's already out there. Don't call it AI, they're lllms. But I call it AI now.
Right, they're neither artificial nor intelligence. They're something else. But given that, and given this one eighty but we're going to dive right into AI in a minute. But since you built your reputation before the firm is pivoted into a full service research shop, both long and short, you've criticized SPACs, crypto thematic ETFs, NFTs. Where has there been the biggest destruction of investor wealth in that group?
Well in that group, Okay, so it's a little bit in vogue. I think to point toward private credit right now, and the reality is like who knows, right, there's there's no data.
It's really opaque.
My concerns there, and I recognize that data is not
the plural of anecdote. But in the past few months, some of the research we've done, I've looked at some abs issuers and this is not private credit, but I was really surprised to see as I went down the rabbit hole of abs issuances that a lot of the paperwork that should be done to basically show release of lians of loans that are being securitized and filed publicly, that paperwork is not being filed publicly and at first, I thought, oh my god, we've got these guys on fraud.
They're selling off loans that are still encumbered. And I spoke with a couple of securitization attorneys and they said, no, no, no, that's market practice. The warehouse lender just provides a letter saying that the lians are released. It doesn't get filed publicly. And so I asked each of them, well, what's to stop the sponsor of the securitization from forging the letter because he thinks, like, look, the loans are, the ABSs
are already over collateralized. I can double pledge these, you know, because if the warehouse lender, if it's not public, the warehouse lender wouldn't know if somebody forged it.
Huh yeah, that's a good point.
And so I when I see that the largest financial institutions are not dotting eyes and crossing t's.
You know.
I've a conversation with somebody recently who gave me data point from a private equity firm that's doing a lot of clos The conversation from somebody who's on the p side going to the CLO guys is like, hey, so what do we know about the performance of the underlying loans, like how are they performing?
Huh? Why did we track that we don't service them? Like this is.
Reminiscent of right out of the Yeah, this is reminiscent of some of the behaviors and credit. So then okay, I combined again, it's not data, these are anecdotes, but I combine that with also what I noticed starting a few years ago. You know, every time I talk to an allocator, you know, because we're actually we run a fund. We're a hedge fund, so you know, we're talking to
allocators all the time. And you know what do you guys investing in everybody all of a sudden starts saying private credit, private credit, private credit.
You know.
That also reminds me of the Internet bubble, because the way I used to think about that as it was happening is there's too much money chasing too few investable companies. So I don't think if there are problems in private credit, Like my first bet is not that it's at Apollo, But I also know we have looked at the insurance industry, and so I know a lot of these insurers have been bought by smaller pe firms. I mean they're basically
using these things to finance their deals. The Ft did a great article a few Alphaville a few months ago on the credit ratings agencies. I mean, it's not even SMP in Moody's. The number one is Egan Jones. So corporate headquarters is like an eight bedroom house in suburban Boston literally, and I think they did like two thousand deals last year that they raided. I mean, if you lived through the GFC and we're paying attention, you know,
like starting to see some dots connect. So that does have me worried also, and if that does intersect with what I think could happen in the labor markets from AI job displacement, you know, like I know you want to pivot back to it, but I'm just going to put it out there. I think it's not unrealistic to say fifteen percent of knowledge work jobs in the US in three years are gone. And if it's not three, it's going to be five. But it might not be fifteen,
it could be twenty twenty five percent. I mean, that's and I can work through how I got there.
Let's dive deeper into AI. It's both an investible asset a shortable asset, and a tool that you're using to run a business. So I want to hit each of those things, starting with how are you using AI as a tool to manage a business to identify long and short opportunities? What is true AI not just lms me for your daily work?
Well, I mean in the past again, since finding religion just a few weeks ago. I mean, this is something I've been hammering. Most of my employees have worked for me for over ten years. We're an old firm for a hedge fund. I mean I used to joke that this is probably true that if you look at trips and falls per dollar of AUM, we maybe are the highest in the world. And that was kind of funny to say until I started saying, guys, why are you literally taking months to put together one hundred and fifty
page slide decks to discuss something internally? Stick it in the machine. And so one of my analysts, my longest serving employee, ex ex auditor, super bright, but al we struggled with communication. I mean one of my skills was over months, weeks or months, many many hours trying to draw out of her the patterns that she sees. But
she's just unable to elucidate. Now she's just pumping out the memoranda from Claude, and I'm like, wow, this is I mean, Cindy, this has saved us, like, you know, probably five weeks of you know, like frustrated conversations in the conference room like this. So from that perspective, it's helping, I think hurting a little bit. You know. I've always felt that we have an edge as active as short sellers over our competition in terms of how I write and communicate.
Like that edge has gone.
I mean, you can go to Claude and say, hey, you know, write this up as a short report in the voice of.
Carson Block, and you know it's not bad. I mean, i it gets you a lot of the way there.
So so let me flip the question on you and ask how has AI changed the fraudster's toolkit? What can Claude do for a fabricated document, deep fakes, fake video, fake voice, fake docs, fake everything. Has it just become an arms race between the good guys and the bad guys?
Well, look, I mean the tools for forgery never really needed to be that sophisticated. I Mean one of my favorite examples of that was the Peregrine Financial That guy had a post office box and an ink chat and that's how he forged his auditor letters. And you know that was a few hundred million.
But Bernie Madoff did not exactly use the most sophisticated technology.
Yeah, I think the thing that will get to be more interesting is if you're a company CEO and you know you're kind of you know, like you're pumping your stock price, you're monetizing it and hitting the bid. I think the more interesting thing is querying it. You know, if I were the CEO of XYZ company, what would a short sellar focus on?
You know, like what should I do about that?
So I think that we're going to get in this cat and mouse game of preemption and reaction. But I mean, at the end of the day, I mean, if you're you know, if you're just ramping your stock price and mortgaging your future, and I think as active as short sellers will still get there, but you could at least dig a wider moat around your you know, around what you're doing if you use these AI tools.
So I always think of short sellers like Jim Chainos and the original guys who who really pioneered forensic accounting as being so deep into the documents. How useful are tools like Claude Cowork as a forensic accountant to help either identify patterns in every SEC filing or honing in on a specific company's filings and seeing what doesn't smell right for me.
That's a little TBD. I don't know yet.
I mean, I'm not sure that you can just upload a ten and say, oh, you know, what's dodgy about this? I mean, first of all, one of the one of the secrets. It's not a secret, but of what we do is we obtain documents from places people never look. So again, like we're you know, we're pulling UCC files to look at asset securitizations. We love companies that have overseas subsidiaries because most overseas jurisdictions there are publicly filed financial statements.
So we'll pull those and upload them.
And then also, I'm sure it could really help connect the dots with people. I mean right now or up till now, we've had to rely on memory, like oh wait, yeah, this dude. You know, we've looked at fifty eight entities. This dude was in that entity. Oh interesting. So the AI is going to get rid of it's going to make that part easy. But you still have to go out and do the legwork. And you know, a lot of times you have to send people in person to
do document retrieval. So I don't think it's as simple as you know, Hey, I woke up today and I want to be an activist short seller, like you know, which you know, claude, which company should I write about? And you know, what's my thesis? Like, you have to still do a lot of leg work. But the accounting stuff your claude has demonstrated internally again, turning my you know, my accounting analysts, the former auditor, turning her poorly expressed
thoughts into actual words, you know. And of course she's iterating with it. No, no, no, that's not what I mean. But it's got real accounting knowledge. Oh well, according to ASC blah blah blah, and this does not meet the definition of the da da da N wow.
I mean, that's it's really interesting.
I mean, look, I think at the end of the day, part of the edge of being an active as short seller is the willingness to be sued, or the tolerance for being sued. So I'm not worried that a bunch of people are going to run out and like commoditize this. And and I think at the end of the day, also having a brand where if everybody can produce skeptical you know pieces, it's also knowing when the model is kind of bullying you, right, like no, no, because that
happens too. I mean, these things are sickophantic, like wow, that's brilliant. Of course it's a fraud person, you know, no.
To say nothing of double checking for hallucinations. And a bunch of lawyers who have been using AI keep getting into trouble because it's citing cases that don't really exist, and the judge's clerk, also using AI, discovers these cases don't exist. But you mentioned a word that's really fascinating.
You mentioned edge. If all the participants in the markets long and short are using the same tools, is there any edge to be found that had there or is it really about how you're applying these tools where the edge comes from.
That's an interesting question.
I mean, look, on the on the short side, you only make money if people care, right, And so I think that's been the problem that most so since the GFC. Almost everybody who is running money principally focused on short strategies has gone out of business. I mean some you know, they rode off into the sunset. You know, I made
a bunch of money, most carried out, you know. I think the problem that a lot of the short sellers have had and I had this too, you know, and have if I have to actively correct for it is you try. You tend to view the world the way it should be, not the way it is. And so that's the problem. Like when people short you know, Tesla because you know Elon Musk this and that, like nobody
cares right and that that's that's the thing. So I think you to be good on the short side, you have to understand why people are buying the stock, and you have to have a view that goes directly against that or that undermines that thesis. And I think so much of the time that doesn't happen. So I don't know. I think the I don't know that this erodes the edge of just of judgment when it comes the longside
or short side. And then on the long side, I mean kind of buy what the smart money is buying seems to have worked like I hate to say it, but you know, again, technicals versus fundamental value, the technical value of something. You know, I don't know that AI helps tongue with that right now, but it certainly can.
Let's talk about AI pretenders, and I'm pulling something else you had written a while ago, and there's a little bit of a rhyme with late nineties every company edit a dot com and their stock would see a pop. What are you noticing amongst the fake AI stories, the fake pivots, the companies that really have nothing whatsoever to use to do with AI other than two or three people who work for the company have a Perplexity app on their phone. Tell us about the narrative of AI pretenders.
Well, I look, I think if all of a sudden the company has started talking. So I first did this shortly after I started on the short side. Cloud became the thing, right, and so then I saw some companies that had just done a global find and replaced, like, you know, find this, replace it with cloud. And so if you see that with AI in a company's filings and in their statements, then yeah, I mean they're they're probably a pretender. I mean, I think it's pretty clear.
You know, AI, real AI requires scale. I mean, whether you're on the process on the hardware side, or you're you know, or you're actually producing the AI models. So I don't know everybody who's like AI enabled it, And look, I'm out over my skis here because I don't really understand the technology. But everybody who's AI enabled, it's like, well, what's what's the foundation? You know, if you are an AI enabled this, what are you running? Are you running perplexity,
Claude chat GPT? And if you're like, well I made it myself, like no, man, like I'm not going to buy that, you know, like these things have cost way too many billions of dollars to develop for you to be able to vibe code.
You're short Sellers are always looking for a downside catalyst when you start thinking about the megacaps, the hyperscalers, or anybody else that's really blown up in value and in price that's created a little bit of an air pocket. Has that catalyst come in yet or is there something off in the future that's gonna lead people to say, hey, this has gone too far, we need to take something off the table.
Well, if you take my view that a lot of these names have traded based on their technical values as opposed to fundamental. Then you need to get into okay, like what are the underlying technicals here. So I'm a fan of a guy named Mike Green, So I think Mike is going to prove to be really prophetic. And so what he's been saying since maybe eighteen or nineteen
is that so passive has broken the market. You know, don't disagree, but that when the flows, actually the buying from the target date funds tapers off and then you get net outflows, that's when you get as he calls it, or was calling it nineteen twenty nine magnitude crash at you know, filling the year, you know, filling the blank
with the year speed. And that's what scares me about AI because you know, like I said, if I if this thesis is correct, that then three years or a few years, fifteen percent of knowledge workers have lost their jobs. It's not like they're going to find new jobs. It's not like you know, fiscal or monetary stimulus creates new knowledge work jobs. They are going to and they all have college debt, mortgages, car leases. Eventually they're going to start hitting up their four oh one k's and so
first they stop contributing as they're laid off. Then they need that money and they start taking early redemptions. And so if Mike Green is correct, when that happens, there's nobody there to catch the falling knife, and the technicals have basically for you know better, since the GFC just created this tremendous amount of air, that's when it's really time to panic, because that that's what I think, that's what's going to make his thesis. That's what's going to
test his thesis. And if you asked me five weeks ago, you know, did I think that we're in any danger anything on the horizon in terms of seeing you know, reversal of four oh one K flows and rise significant rise in unemployment, I would have said no.
I was.
I was completely sanguine five weeks ago, and I've, like I said, I've won eight So.
I can't leave on that much of a downbeat note. So for the last question, you run along short funds. If that's the downside of AI, if that's the negative we're seeing in the world of why collar work, what's the long side of the portfolio, What looks attractive through and on the other side of whatever happens with either the AI thesis or Green's thesis.
Well, okay, the tough thing is there obviously are going to be companies that benefit from AI, right, and so they're the hyperscalers. But if you have but if they're in the index, which they all are, and they're major parts of the index, and you have index fund flows, well the bull cases that over the long term they're going to be you know, there's gonna be a great buying opportunity. So I'm not sure that's where you hide out.
I mean, what we've been doing for the past month is creating a set of what I think are highly convexed trades in the book, especially basically shorten credit. So it's not like the lead up to the GFC there's not you know, deep CDs market, but I think, I mean, credit spreads are stupidly tight and credit ball is stupid Lee Love. So to me, you want convexity and there are lots of ways to pay it where you're capping your potential loss. That's how we're that's how we're approaching it.
So like and look, I hope this doesn't play out. I mean, I be cause I don't have like a plan B or C after AI takes, you know, like my job. But you know, at least as it does play out, we're we're positioning for it.
That was my conversation live at future Proof Citywide, Miami with Muddy Waters Carson Block. If you enjoy this conversation, well check out any of the six hundred we've done over the past almost fourteen years. You can find those at iTunes, YouTube, Spotify, Bloomberg, wherever you get your favorite podcasts from. I would be remiss if I didn't thank the crack team that helps put these conversations.
Together each week.
Alexis Noriega is my video producer. Anna Luke is my regular producer. Sean Russo is my head of research. I'm Barry Ritolts. You've been listening to Masters in Business on Bloomberg Radio.