Jim Chanos on Crypto, Tech and the Golden Age of Fraud

goes out the environment. I mean the number of CEOs of various companies who have written some version of like I screwed up, this was all my fault, I misjudged, etcetera. Every day it feels like there's another one. And it is true. When there is a bear market, when there's a downturn, you discover both frauds, and you discover insolvencies, and you discover unsustainable structures. It all comes out right. It is a popular saying for a reason, which is

that it tends to be true. Is kind of amazing me about this particular cycle, is I guess just the speed at which all of this seems to be happening, So you know, it was only a few months ago that we had Jim Chainos, the fame short seller, on the podcast talking about how he thought that there was going to be more pain ahead for a lot of different froth spots in the market, and how interest rates going up basically meant that a bunch of frauds were

going to be exposed. Yeah, and so basically the market at particularly a lot of the tech stocks and a lot of the gig economy, is sharing economy, the arc economy, all these things really have gotten hit pretty hard since we talked to Jim earlier in the summer, and it's still a mess. And so I guess part of the question is, well, what does it look like at the bottom, What have we learned, what are we seeing with the tide going out? And are we any closer to you know,

something that could resemble like a bottom for this market? Right? And then also I guess my question is do fra pick up in this environment or do they get exposed and more difficult to perpetrate. So we're going to be talking about all those things with Jim Chainos. This is an episode that we recorded live at the Berkeley Forum for Corporate Governance in San Francisco. Jim is of course, the co founder of Chainos and Co. Which used to

be called Kinnicos. Here's our conversation. Hi Ji, Hi guys now, Jim, the last time we spoke to you, I think was in June of this year. Fast forward a few months. You are completely correct, froth was blown off the top of the frothy stocks in the market. I don't even have a question. I think I'm just gonna ask you, like, tell us what's going to happen now. Look, we're getting a situation where the various parts of speculation are getting rung out of this market one by one. We talked

a little about them back in June. I think we've waited right in the middle of kind of our second crypto crisis over these past few days. On top of it, you've got the tech complex melting down, and a lot of this is just the byproduct as we discussed of perhaps the most speculative market that I've seen in my lifetime forty years on the street, which was and one by one, whether it's crypto, whether it's n f t S, whether it's SPACs, the poster children for that speculation are

basically being taken out to the woodshed. And disposed of, and the question will be does it spread to something in the markets anyway that's much broader than that, and that remains to be seen again kind of like Tracy, I don't even have a question exactly, but f t X give us, give us the Jim Chaino's take. Well, I mean, I think Joe, you basically are probably better prepared than me to talk about that, because the quintessential moment for me in the whole crypto saga was the

interview that you and Matt Levin had with SPF. I think back in April, where I pointed out he kept saying the quiet parts out loud about how business models were in effect Ponzi schemes. And I think we're gonna look back at that as a watershed moment because the crises in liquidity and the revelations on the stable coins all immediately followed that interview and it was one of

those moments, and kudos to you all. It was one of those moments in the markets that not only went viral on social media, but but went viral amongst professionals and others. Have you seen this interview? Did you see what was said here? And it's very rare you get that aha moment like that crystallized, But that was one of them, and the whole idea, and I've called it

a predatory junkyard. As you know, the whole crypto structure, in my view, was designed to extract fees from really unsuspecting investors and investors that were kind of sold a bill of goods where the bill of goods kept changing. You know, we remember all the use cases for crypto as they kept changing over the past handful of years.

It was going to be an alternative currency, it was gonna be a store of value, it was going to be inflation hedge, and at the end of the day, it was really just a speculative asset and speculative asset class and with an immense cost structure built around it. So the idea really was for the crypto you know community, was how can we extract the most amount of fees from unsuspecting investors. And that's my view and I still hold to it. What happens now for crypto is there

a recovery here or is this so bad? I mean f t X, Sam Bankman freed, and you know, I was there at that Odd Lots interview as well, and we were all sat in the room quite shocked by what SPF had just said. For those who haven't listened to it, we asked him to describe how yield farming works, and he basically says, well, you put money in a box and more money comes out of the box, and you worry about the use case later. All right, So

fast forward to today, it's all falling apart. Can crypto emerge from this and potentially find, you know, a new narrative to sell a new potential use case. Yeah, I'll just add the ultimate irony in the last couple of days is the crypto community talking and sort of begging

and asking where are the regulators? Is really truly the ultimate irony since the crypto ethos was about, you know, really being outside of the regulatory environment and being a separate and independent system um, and now it's begging for

for the same sorts of things. And you know, as I pointed out for a few years, the real problem with anti fiat structures is exactly when you need fiat is the time when people are most afraid and when fear stalks the markets, because governments, through their various different means can not only enforce contracts and adjudicate fraud, but in effect connect as lenders of last resort and or established deposit insurance, which is exactly what everyone looks for

when when people are worried about getting the money back. And it's why alternative currency schemes and by the way, crypto isn't the first. I mean, they've been all kinds of alternative currency schemes to FIAT for centuries now, and they always flourish in bull markets when people's sense of disbelief is suspended and people begin to believe things that

are too good to be true. And crypto and all the other ancillary aspects of crypto, whether it's n f T s or what have you, really were the latest iteration of that. The last time we talked to you said that as well. What's an example of an alternative currency that thrived in a bull market? What's a historical parallel to so, I mean you had you had the various different banking systems that that thrived in the early nineteenth century in the US. That's certainly probably one that

that economic history orients would point to. And we can go back further. I mean the various different currencies that that the father of FIAT, John Law, who I teach in my fraud course, brought forth in the early seventeen hundreds in France. But there have been a number of them. And the problem again is is they rely on a system of trust, whereby the systems that FIAT has developed in the past three hundred years have really been designed to engender trust. It's the offset, of course, to the

downside of FIAT, which is debasement. And so the crypto community pointed out the risks of debasement and UH and all the other risks of sovereign governments getting involved in your currency, but they forgot the good parts and and that's I think the lesson that we have to learn.

Do you worry about crypto drama, what's going on in that industry having a contagious effect on either the rest of Silicon Valley or the wider market, given that they're do seem to be these interlinkages between for instance, crypto players and venture capital firms. Yeah, I mean, to me, this looks this looks a lot more as we discuss this looks a lot more to me like the dot com era on steroids rather than sort of the prelude to the global financial crisis because of the nature of

of the banking system and payments. I don't think this is a contagion effect. I do think it's it's a pretty bad mark to market effect for equity type investors, much like the dot com era. But I don't think it is contagion through the credit markets. I mean, I think, why I saw something this morning that it might even be lower now as we speak. But I think the crypto mark to market for the all the coins out there is something now below one trillion, somewhere on eight

hundred billion dollars. And uh, you know, eight hundred billion dollars is a lot of money. But I'll remind you that until about a week ago, you know, Tesla's market cap was a hundred billion dollars. That's just one stock. So I think the contagion effects are probably going to be dimnimus to the to the payments and credit system. I definitely want to get to like tech stocks and Tesla and all that in one second, but one last question. You know, it's this, as you pointed out, the crash happens,

people say we're are the regulators. This is again, I think a classic part of the cycle that the regulators seem to come in late. What does history say about how far they go? Would you expect to see, for example, criminal charges people in jail as a result of this dot com trading on steroids in crypto. Yeah. So one of the things, one of the things I teach is that not only are are the regulators archaeologists not detectives, but that that asset prices are both the staunch a

defense attorney and the harshest prosecutor for financial fraud. That nobody's out looking to bring the bad guys in when everybody's making money. It's only when people start losing money that you begin to get a public outcry of of, you know, throw the rascals in jail. You know, if we go back again to the dot com era, people were losing money and dot com for a better part

of a year. But it wasn't until the Enron and World Com scandals hit that the federal government really geared up its efforts to uh to look at corporate wrongdoing and and bring on Sarbanes Oxley. So this is gonna be the same thing. I mean, people have lost a lot of money in crypto, a lot of new investors, a lot of young investors, so you're gonna get a political outcry nowdo to to regulate this system and and

bring bad guys to justice. Now. I've also pointed out that it seems to me that there might be a reason why a lot of these crypto entrepreneurs live in places like the Bahamas in Dubai and not New York City, So you know, it might be. And I think there are one or two actually that are technically fugitists from

justice already. So it's gonna be interesting to see see what we see from a prosecutorial as opposed to a regulatory initiative against this, and what kind of wrongdoing that gets exposed if it turns out that there was actual misrepresentations or assets that were claimed to be there, we're not there. On the other hand, it just seems, I mean, people have been warning about this for for now a few years. It's not like the warning signs weren't there

for people to notice. Yeah, there's at least one crypto entrepreneur that has effectively purchased diplomatic community as well preemptively. Nothing has happened to him yet, but he has it. Let's talk about frauds more generally, and you mentioned en Ron, and you've obviously been a player throughout different boom and bust cycles. What generally happens to frauds in a down turn? I'm assuming many of them get exposed, but there must also be incentive there to maybe start new ones and

try to bury some of your problems as they get worse. Well, that is a problem in that that as it becomes more and more difficult to to meet expectations, often the frauds get exponentially worse as they go on. But what I would point out is that the fraud cycle follows

the financial cycle with a lag. So typically broad thrives in a in a in a bull market, and the longer the bull market and the longer the the business expansion, typically the worst the waves of fraud that are subsequently discovered. And then when when markets turned down and people become a little bit more leary, since most frauds require new capital to keep going, they tend to get exposed after the markets turned down and made off in December of

oh eight's a good example. Um, And of course what we mentioned and on in world common tycho and that class in this cycle, I think it's going to be. I think crypto is probably gonna be right up there. Uh, and that has started clearly, But I think the fraud that's occurring is much more subtle, and I think it's

going to be even harder to prosecute. And and that's the abuse of metrics, self described and self generated metrics that now investors have just gotten so used to, which are really, in my opinion, you know, mask over business plans that probably will never be profitable, and and the

amount of adjusted adjusted profitability and adjusted EBITDA. There was one of our shorts reported last night and they said that they expected to be profitable by the end of three on an adjusted basis adjusted for other operating costs. I have no idea what that mean, but you know, analysts dutifully this morning said they expect to be profitable

at the end of three UM. And so the investors have gotten so used to, particularly Silicon Valley, describing profitability as they would like it and not as it really exists, that you kind of wonder will the SEC cracked down on that, Will will Congress crack down on that and and get us back to kind of generally accepted accounting principles as opposed to accounting principles or whatever I want them to be. Well, as you say, the fraud cycle

follows the financial cycle. And of course one way that Silicon Valley companies in particular, all companies, but Silicon Valley in particular, flatters their financials makes profitability look better is you know, substantial share based compensation and you know it's not really a cash expense, but of course still investors are paying it. What happens to this place, Silicon Valley? What happens to share based compensation in an era in

which shares go down? I imagine for employees they're not as excited about getting stocked as they might have been a year ago or two years ago as part of their camp. So talk to us about like how that unfolds, and like what the down cycle of an industry that's so driven by equity issuance two employees? What happens in a down cycle? Well, it was a big issue Joe in posted dot com era, and back then it was stock option accounting that became that went under the microscope

and ultimately had to be accounted for. And now, of course, in effect it's taken out through the use of pro formal adjustments. But what what people found out was that it had just a tremendous pro cyclical effect on things. That is, when your stock price was going up, you didn't have to issue as many shares for a given dollar level of compensation. And now that the stock is down, if your stock is down eight or you have to just issue massive amount of stock, So you're issuing more

stock as it goes down, You're diluting people. So it becomes procyclical to the downside as well, and the numbers are now becoming meaningful. The company I mentioned just a few minutes ago that reported last night it's got run rate share based comp of almost a half a billion dollars and based on their current share count, that means that that the shares outstanding are going to be going up something like seven to ten percent a year just

on the back of share based comp. The other problem is we've seen a number of companies, beginning in the second quarter UH companies like door Dash and Salesforce, dot Com and Zoom announced large share buyback programs to offset the dilution of the share base comp. So you have the you have the silliness of the share based compy excluded from the adjusted profit figures and actually being a positive for operating cash flow and the cash flow statement.

But yet now the substantial share buy back cost is below the line in the cash flow statement under financing. So it's skewed incentived in so many different ways. But I don't it's getting worse. The amount of share based camp for some of these companies is actually going up faster than revenues. So they're on the treadmill, if you will, and I don't know how they're going to get off it.

Why do you think investors have been willing to accept these types of pro forma adjustments in the past, because, I mean, this has been a known issue. I think we had someone from the SEC recently. I think it was an article in the Wall Street Journal. They were talking about this. We used to make fun of, you know, community adjusted ebit DAW and stuff like that. People knew that this was happening, and yet it didn't seem to have that much impact on either the company's share price

or its ability to raise funding. Yeah, until it did, right, And again that that's my view on the pro cyclicality of all these kinds of developments. They make things look much better than they are on the way up, and they really hitch it pretty hard on the way down, and so it just increases the amount of votility in

given corporate assets. There's one other aspect I will mention that your audience might not appreciate, and and we saw it in the dot com bust, and that is if you have a lavish equity issuance culture, and you have a compliant board that basically will agree to almost any management equity issuance plan, then when you issue stock options and various different equity instruments to your management and your employees, if the boards rubber stamp things, well, they will rubber

stamp repricing those equity awards if the stock goes lower, or granting more if the stock goes lower to keep employees happy. And what that means is is that boards are acquiescing to not only call options, but they're granting

put options to the employees and management. And that's a frightening alternative because number one, the black Shoals model is only picking up the cost of the call options, and b you don't really want a management team that has a bunch of puts in their stock as well as calls. And it's something that I don't think a lot of people pay enough attention to on the governance side that I think I think your your audience might appreciate. I

have a really short question. Are you gonna make us look at the look at which companies reported earnings on November eighth and have a half a billion dollar share based compensation run Rader? You're gonna just tell us the name of the company. It's a fintech company, that it's based out where you guys are right now. And uh, and let's say let's say, uh, let's say it's involved in a sector of fintech. Uh that a lot of people have questioned by now pay later. I think that

that that'll narrow down that that should narrow it down. Well, okay, this kind of leads into a process question. But in an environment like this, do you find identifying potential shorts easier than during the bull market? Identifying them wasn't the problem, Tracy. It was where they where the stocks went, that was the issue. Um. You know, some of these business models, I mean to us and others have been questionable from

the get go. Um, you know, take a look at at ride hailing or or food delivery, something we're all familiar with. These companies been around for ten and fifteen years. They haven't found a way to make make profit. Door Dash to single out, one company actually has higher losses per order now then a few years ago, and so they're not scaling. And and that is for companies that are based on digitization and having a platform and using the internet, you had better scale. That's the whole concept.

And you know, so many business models are showing increasing losses as they age, and I just sort of wonder, at what point do do people just say okay enough. And I've been shocked at it. It went on as long as it did for a lot of these business models, so identifying them was not the issue. Having other investors

care about that is really the issue. So I've always found this point that you make to be very compelling that it's like, Okay, if these right hailing, sharing economy whatever companies couldn't make money during the boom, during the good times, then when were they ever going to make money? The counter that we've heard and we didn't interview not long after the last time we talked to you with the VC Jason Kelly canvas. He's like, yes, that's a

good point. On the flip side, investors were encouraging all these companies to grow at any cost, and they were not being rewarded for profitability. They were rewarding for growth. And so it's not fair to say they can't make money because they just weren't incentivized to. There was no reason why they would have when the games were all too growth. When you look at these models, why can't in your view, they turned the dial? Because that is

the big question, right, can they cut costs now? Can they sort of like finally like right size and make money. We've seen these big stock price to clients. In many cases we see management going into cost cutting, layoff profitability mode. Why don't you think that they can now turn the

dials and get to positive cash flow? We'll see and and so far they haven't and and so uh, maybe they're not losing as much money, but if you look at the operating metrics, a lot of them are still inherently unprofitable at suitably high up in the income statement,

whether it's operating income or gross profits. But what we're really looking for as short sellers and looking at these business models is for the companies that have stopped growing and are still losing money, Because if they've stopped growing and the losses are still considerable, then the whole idea. While we were investing for growth through investing for future capacity, investors you know, didn't care as long as our top

line was growing. But if you're structurally unprofitable as you slow down or stopped growing, then you have a problem. And that that's why the things like the door dash metric I mentioned to you, you know, the loss is per order become important to judge whether or not what your guests said is true or not. We've made it twenty five minutes without actually mentioning Elon Musk, although we did mention Tesla, so I don't again, this is one of those things. I don't even have a question, but

Tesla Elon Musk, Twitter, Jim go. Look, you know the Twitter saga is one for the ages, and I'm an interested observer like everybody else. We're focused on on Tesla the car company, and I would just keep pointing out to people that Tesla the car company is not only the most profitable car company, which certainly we didn't never thought it would be, but is also you know, going away still with the stock down almost is still the most expensive automobile o EM in the world by a lot.

And uh, I think we're looking at a company that that's training now right around thirty times gross profits thirty times gross profits is is you know, their software is a service stocks that would kill for that and basically sells luxury cars, right he sells fifty and sixty and seventy thousand dollar cars that you know have immense gross profit margins where the rest of the industry is lucky

to get fifteen or we don't think that's sustainable. Um, we think that the number one the luxury car market is a much smaller than people think. And number two, even though the o E other o E m s have been slow on the uptake, they are coming and competition will increase and most cars will be e v s by the next five to ten years. And it's a tough business. It's a low return on capital business.

It always has been. He caught the sweet spot to his and his shareholders benefit and to the short sellers detriment. But now he's got to maintain it. And I think that's increasingly difficult because his investors are still looking for forty growth for the next you know, decade, and that means that pretty much he's going to be the entire car industry, you know, by by the early twenty thirties. And we just don't think that's going to happen. Are

you short Tesla right now? We are because I wasn't sure because I where you're so obviously the stock has come down a lot has gotten hammered over the for a while now. But you're just even at the current levels unsustainable. Yeah, And I would be remissed if I didn't point out that people have now lost more money in Tesla than they've made. It's like crypto, I believe. Think about that, Yeah, yeah, exactly. And when do you

think about Twitter? Does that distract from Musk's role at Tesla? Well, remember he's also the CEO of a couple of other companies, not just Twitter and Tesla. So you know, it's I don't understand the value age, I don't understand the price he paid, um and and it's to do with what he wants. And I believe in private property and free enterprise, and you know, I'm kind of scratching my head at some of the initiatives, But um, we'll see how it

plays out. I don't think it was worth four billion dollars. I think he thinks it probably wasn't worth forty four billion dollars, And it'll be interesting to see how how that plays out. But I think it's probably gonna take a disproportionate amount of his attention over the near term. So we just have about a minute and a half. So just like really simple, you know, like when you've seen the end sides of many bubbles in your career, does it look like we're close to the bottom here?

And also what do you what would be the signs that we are close to something that you would call a bottom. Again, market timing is not my forte but um, if it was a bottom, it would be the most expensive bottom probably in modern financial history. I mean, most bear market bottoms have basically bottomed out somewhere between nine and fifteen times the previous peaks of earnings. And because normally the earnings are depressed at the bottom of a

bear market. But but if we think that roughly, you know, earn things are peaking right now, and they may or may not be, but my guess is they're pretty close nine to fifteen times would be eighteen hundred two three thousand thirty one on the SMP. We're a long way away from that, so, you know, I saw it for

the first time. Facts that was saying that SNP earning estimates are coming down for the fourth quarter, are gonna be down you over year, So we might be at peak earnings right now of two hundred and five or two d ten dollars. You know, we were where were we the other day? So we were at nineteen and a half times that number. That's a pretty rich number to be a stock market bottom. All right, Well, Jim Chanos,

it was lovely seeing you again. We look forward to maybe catching up with you in like another four months and we'll just ask you we'll just say you were right again. Thanks guys, I appreciate that. Well, that was our conversation with Jim Chainos at the Berkeley Forum on Corporate Governance. Tracy, it's always a pleasure to talk to Jim, of course, you know, I thought it was actually interesting.

Obviously we're in this sort of like fraud exposure cycle, but the other sort of pro cyclical element besides discovering all this bad activity, it's just what we see about financing and what he talked about with share based compensation and this sort of compensation structure coming home to roost, right, and also the idea that those sorts of share based compensation schemes can be an amplifying force for stock prices on the way up but also on the way down, right,

Because you know, when when it comes to uh, you know, Silicon Valley, you know, and we think about leverage, we we sometimes don't think of tech companies in that because they don't have any debt per se. But when you think about like how crucial share based compensation was, and if you think about it in terms of almost rowing from your own investors in order to pay employees and so forth so that they'll keep working at the salaries it expects, it really is like a form of financial leverage.

It's just not a credit leverage. Share based capital is the lower tier two capital of Silicon valid I like this. That's good. That's good. That's yeah. Shall we leave it there. Let's leave it there. Okay. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway, and I'm Joe

Wi isn't, though. You can follow me on Twitter at the Stalwart, follow our guest Jim Chanos He's at Wall Street Cynic, follow our producers Carmen Rodriguez at Carmen Armand and Dashel Bennett at Dashbot, and check out all of our podcasts under the handle at Podcasts and I wanted to let you know about a special event that we're holding for listeners. My co host Tracy Alloway and I will be speaking with past guest Josh Younger, as well as Columbia law professor levmanand in a special live episode

of The Odd Lots podcast on November nine. We're gonna be holding it at Bloomberg h Q, and you're welcome to come mingo join. We're gonna have cocktails, canapas and other stuff on that day along with the live recording. So if you're interested in attending a live episode of the Odd Lows podcast as well as meeting me and Tracy, as well as meeting our guests, and as well as meeting other Odd Lots listeners, go find the rs VP. Both Tracy and I have tweeted about it. It's also

on Bloomberg dot com. Slash odd lots. Sign up and join us in New York City at bloomberg Age Q on November twenty nine,