Episode #479: Jim Chanos & Bethany McLean on Regulators, Enron, Earnings Adjustments, & The Golden Age of Fraud
Guest: Jim Chanos is the founder and managing partner of Kynikos Associates. As the largest exclusive short selling investment firm, Kynikos provides investment management services for domestic and offshore clients. His celebrated short-sale of Enron shares was dubbed by Barron’s as “the market call of the decade, if not the past fifty years.”
Bethany McLean is a contributing editor at Vanity Fair. She is also a columnist at Yahoo Finance and a contributor to CNBC. Her two books are The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron and All the Devils Are Here: The Hidden History of the Financial Crisis.
Date Recorded: 4/19/2023 | Run-Time: 1:15:13
Summary: In today’s episode, Jim & Bethany cover all aspects of fraud. They share where we are in both the financial cycle and the fraud cycle, why we continue to see frauds since they first connected about Enron over 20 years ago, and the thin line between a visionary and a fraudster. We discuss the anti-short seller rhetoric that pops up every few months, the impact of social media on the rise and fall of companies, and the impact of stock-based compensation and adjusted earnings.
As we wind down, Jim shares his concerns about the commercial real estate sector, and Bethany gives a preview of her book releasing this October.
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Meb:
Welcome my friends, we have a truly special show for you today. Our guests are Jim Chanos, Hall of Fame short seller, and generally one of the nicest guys around. Also happens to have an encyclopedic knowledge of market history. And Bethany McClain, contributing editor at Vanity Fair and the author of multiple books, including The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron. In today’s episode, Jim and Bethany cover all aspects of fraud. They share where we are in both the financial cycle and the fraud cycle, why we continue to see frauds since they first connected about Enron over 20 years ago, and the thin line between a visionary and a fraudster. We discussed the anti-short seller rhetoric that pops up all the time in media, the impact of social media on the rise and fall of companies and the trends in stock-based compensation and how companies try to hide them with adjusted earnings. As we wind down, Jim shares his concerns about the commercial real estate sector and Bethany gives us a preview of her new book releasing this October. Please enjoy this episode with Jim Chanos and Bethany McClain.
Meb:
Jim, Bethany, welcome to show.
Bethany:
Thank you.
Jim:
Hi guys.
Meb:
This is going to be a lot of fun you guys. We’ve had a lot of short themed shows over the years, which is impressive because there’s not too many shorts left this day and age. I see that the famous chart, short selling funds by year. We may have had a brief reprieve last year. We’re going to talk about a lot of fun stuff today.
Jim, are you deep in your spring class right now? As a professor, do you have your professor hat on? We’re recording this mid-end of April.
Jim:
Yeah. And special guest lecture, Bethany McClain is coming to speak on Monday on Enron.
Meb:
Well, I know you feature one of her frameworks in your class. Can you guys give us the main, I think you say five types of ideas you’re looking at from the short side, and Bethany can talk about hers as well.
Jim:
Well, I mean the five models are systematic models of fraud and one of them derives directly from Bethany. But we try to teach the students to think about the concepts of financial fraud systematically. And then we use a historical narrative in cases to drive home the points. But we have a macro model, what is the overall milieu and the idea of being that this fraud cycles follow the financial cycle and business cycle with a lag. And the longer the expansion, the longer the bull market, typically the more evidence toward the end of the cycle you get a fraud as people begin to believe things that are too good to be true and fear of missing out replaces healthy skepticism.
Then there’s a micro model on how frauds are allowed to be done in the C-suite. And then we have a governance model, which is derived from Bill Black’s great book, The Best Way to Rob a Bank Is to Own One, in that he makes the great point that modern fraud uses the corporation as both a weapon and a shield. We have a checklist on fraud from Maryanne Jennings, Seven Signs of Ethical Collapse that most frauds adhere to. And last, and certainly not least, we have Bethany McClain’s concept of legal fraud, which really applies to almost all modern day financial fraud, whereby everything that’s done by the corporation committing the fraud is actually legal, yet there’s an intent to deceive. And certainly Enron fit that description in spades, but really, most modern frauds now have things signed off by boards and outside advisors, and yet still you can be deceived.
Meb:
I want to hop over to Bethany, but one more question about the class. What is the interest in the attendance been like over the years? My thinking, you had this bananas environment, 2020, 2021-ish. We’re students become more or less interested in what you had to say during this period, or is he just, he doesn’t know what he is talking about anymore, he’s not on Reddit, or are there any takeaways you can make from that?
Jim:
So the class has been taught since the Global Financial Crisis. I think our first year was just 2010 or 11. And interestingly, so I teach it at Yale in the spring and at the University of Wisconsin every other fall. We had a pretty consistent class size of around 40 students for years at Yale, but this year we’re over 60. So this year there was definitely a pickup. And I think a lot of it has to do with a lot of things we saw happen in 2022, particularly in the spaces of crypto, NFTs and other things that have a lot of younger students and MBA students intrigued. Two years ago I had a fair number of the class exploring careers in cryptocurrency in 2021, and so that was interesting, but we definitely had to pick up an interest this year in New Haven. We’ll see about Madison in the fall.
Meb:
Bethany, I went back and read your fortune piece from 2001, and so it was a little bit of a blast of the past. So I graduated university in 2000 and was very much in the thick of it. I probably would be all in on crypto today if I was a 19-year-old, 20 year old, but was deep into internet stocks, CMGI, Lucent Technologies, all these good things. But I was smiling not just because you were talking about J-Lo and Kate Hudson who are still relevant today, I just want to say, but you mentioned Enron. And the title of the piece was Is Enron Overpriced? And it has a line where it talks about Enron being 55 times trailing earnings, and I smiled. I said, that’s quaint. 2020, 50 times earning might have been a value stock that year. But anyway, I want to rewind a little bit. I never thought I would see anything like the late ’90s again, and it feels like we have, there’s been a lot that’s happened in the following 20 years. Give us a little perspective, Bethany. Why haven’t things mellowed out? Why are we doomed to repeat all these problems we do as humans and investors?
Bethany:
Well, I think Jim’s framework on that front is really interesting. When you have periods of incredible bull market, they are followed by periods where you realize that there was fraud taking place. And the last 20 years since Enron’s collapse has been a period of free money, I think, unlike any other in history. Jim will correct me if that’s wrong. But when money is free, it breeds all sorts of craziness because people both think that they can get away with things and people have to try to get away with things in order to try to get yields. So in that sense, both in a historical framework and then put in this historical anomaly of free money for such a long period of time, I don’t think it’s strange that we’ve seen boom and bust and collapse and craziness. But I also think it’s human nature.
I remember when I wrote about Enron, I really thought Enron was an exception. I thought this thing called the market was this perfect policing that mechanism and oh wow, Enron’s the exception that proves the rule. And it really wasn’t until the Global Financial Crisis came along that I began to get a little bit more cynical. And a little more cynical as well, which I think is another part of the answer to your question about the ability of regulators to fix this because it’s really fun, if fun is the right word, to compare the speeches that George Bush gave when he signed Sarbanes Oxley into law in 2004 in the Rose Garden, and then the speech that Barack Obama gave when he signed Dodd-Frank into law in the Rose Garden in 2010. And in both cases it’s made the world safe. We’ve fixed all these problems. Investors no longer have to worry. Everything is great. We’ve got it all under control. Of course, that didn’t work. Regulation is inherently backward looking and regulators are people too. And while I don’t think regulators are explicitly corrupt, Jim may disagree, I think they are implicitly corrupt, meaning they buy into the times in which they’re living in the people with whom they surround themselves and don’t see coming that witches coming down the pike.
Jim:
I remember getting a phone call from a reporter from a major business daily right after Sarbanes Oxley was signed and she said, “Well, what are you going to do for a living now?” And I said, “What do you mean?” She said, “Well, fraud’s been outlawed.” And I said, “Well, it always really was, but I’ll take that under advisement.” And I think Health South got into trouble I think about a few weeks later or a month later and showing us that fraud was still alive and well, but I agree.
And one of the themes in the course by the way, is the backlash to these waves of fraud that follow revelations in bear markets. And in some cases you see massive, massive outrage leading to political solutions. So the ’30s would be a good example of that where FDR came in really on the back of what happened in the crash and the ensuing depression and with vow to clean up the money changers temples. And we saw in the first a hundred days following the Pecora hearings, Senate Banking hearings ‘in 32 and ’33 sweeping legislation. ’33 and ’34 act, we still work under those laws.
And then you have really the Global Financial Crisis where despite Dodd-Frank, there was a collective shrug like, well, what are you going to do? Everybody was in on it and therefore nobody was in on it. And so it really depends. I mean, I joke that George Bush Sr. put far more bankers in jail than junior in light of what happened in the S&L crisis and that banking crisis and waves of fraud that we saw in S&Ls than in the GFC. So it just depends. There was certainly a bigger backlash following dotcom than there was after the GFC too. So we’ll see how this all plays out, but every cycle is different.
Meb:
Yeah. As we look at cycles, my only slight surprise is that the great revealer or disinfectant being the internet as people still feel comfortable perpetuating some of these ideas in frauds, to me it seems like that is a very obvious risk to have thousands, millions of people that can uncover, but people don’t seem to mind.
Bethany:
Can I have something to say on that front?
Meb:
Go. Let’s Hear it.
Bethany:
I’ve thought about this because it is so interesting how different the world we live in now is from the world when I wrote about Enron. Jim was quiet, there was no place for short sellers or anybody else to put contrarian views forward. The only information that was really publicly available was what Wall Street wanted you to know what the Wall Street analysts were saying. Everything else, every bit of skepticism about any company, not just Enron, traveled in these really closed circles. And so, fast-forward to now, if you think of Tesla, maybe it is or maybe it isn’t an interesting contrast to Enron. You can learn anything you want to know on Twitter, you can find the smartest shorts out there telling you why they don’t believe in Tesla. And yet people’s response is not, “Thank you for the great information let me factor this set of facts into my investment decision such that I make a smarter decision.”
It is, I shouldn’t use words [inaudible 00:13:37] on this podcast, but it is basically as insulting as it can possibly be to anybody who dares to put forward something contrary to the narrative. And so I think what that tells you is that human nature doesn’t change. People want to believe what they want to believe, and when people see a chance to make money, they want to make money. And anything that gets in the way of that possibility. And I’ve never been able to understand that, but I marvel at it. I would think too that a world with all this information available to people would be infinitely better. And it’s just not because people don’t want to hear it.
Jim:
We did see a preview of that in the dotcom era, Meb and Bethany though. The advent of the internet brought forth the Yahoo message boards and a number of things that short sellers and hedge fund people and retail investors interacted on. And I remember that the level of discourse on those Yahoo message boards in ’98, ’99 was probably not a whole lot different than in Reddit and WallStreetBets meme stock 2020. It’s just magnified by a factor of 10X today than back then.
And so, there were a number of well-known soon to be famous or infamous investors on the Yahoo message boards interacting with people pointing out, you shouldn’t be buying Iomega at $80 because it’s a commodity product and the pricing is already down and blah blah, blah, blah, blah. And it was pretty much the same thing as you would get today in a conversation about AMC movie theaters or GameStop or Bed Bath & Beyond. Screw you shorty, we’re coming to get you. And so I agree with Bethany, human nature hasn’t changed. It’s just that better technology has amplified everything. It’s amplified the ability to get information, which is a good thing, but it’s also amplified a lot of the stupidity that we see from time to time in markets.
Bethany:
Yeah. Or maybe another way of saying it’s amplified the ability to get information, but it has not increased anybody’s ability to listen. In fact, it’s probably decreased people’s ability to listen.
Meb:
You guys are going to find this funny. Talking about changing their opinion, I got into it. I’ve long been a supporter of short sellers. I think they’re a national treasurer. We just had Bill Martin on last week who was talking about Silicon Valley Bank on Twitter back in January. But he famously, if you guys remember, started Raging Bull. So, one of the original Yahoo message boards, the Reddits of the ’90s. Anyway, I’m going to read this tweet from 2012 and see if you can identify the author. He said, “That said, even though they cause me grief, I would defend the right of shorts to exist. They are often unreasonably maligned,” none other than Elon Musk.
Jim:
I was going to say, it sounds like Elon.
Meb:
Fast-forward to, he replies to the tweet six years later, “The last several years have taught me they’re indeed reasonably maligned. What they do should be illegal,” which seems like a bit of an about-face opinion.
Bethany:
But it’s no more of an about-face than Wall Street executives celebrating the market all the way up until the collapse and celebrating everything they could do to make their own brilliance for being able to make money in the market all the way up until the fall of 2008 when all of a sudden it became, ban short selling, government tax taxpayers to the rescue, this isn’t our fault. So it’s amazing how a little bit of, what’s that old saying? You can get a man to believe anything as long as his livelihood depends on it. So maybe the modern version is if you’re getting rich or fear that you might not get rich, that just affects your ability to listen.
Jim:
But we see this in arenas other than finance as well. I mean it’s offered easier to hold an extreme view when you couch it in terms of being opposed to another group. I mean, let’s just look at the state of politics in the United States right now where both sides of the political spectrum seem to get crazier by the day because it’s a defense against the other bad guys. And so short sellers have been vilified like that forever for centuries. But it seems particularly bizarre at market extremes to blame short sellers for the banking demise in ’08 when short sellers were covering stocks in ’08, and pointing out to regulators the problems in ’07, I know that for a fact. And conversely more recently in the meme stock run up and some of the silliness that we saw in 2020 and 2021, where short sellers were pointing out that maybe you shouldn’t be paying 50 times revenues for a fake meat company that’s losing money or what have you. And being vilified again for being against innovation. And so yeah, this is his old markets, it’s just been amplified with modern technology.
Meb:
And more importantly, Beyond Meat, I am convinced you make their hamburgers, if you’ve ever cooked one they smell, and Bethany, I know you’re big animal owner, you got some cat, it smells like cat food to me. It is the most disgusting foul smell. Impossible, I think is okay. Now I’ll just say that, but Beyond Meat. But I’m laughing because when you said that you said 50 times revenue, which goes back to our old comment on Enron and I was like, we’re going crazy about 50 times earning, this is 50 times revenue, which is-
Jim:
Well it was. It’s not anymore.
Meb:
It was. It was. Well, I mean there’s an amazing chart and we’ll put in the show note links listeners, that Leuthold Group did, which was another Upper Midwest located company. I know you guys both hail from that area. But it shows it was price to sales ratio over 15 or 20 companies both in count and market cap and it’s like flat and then it shows an Empire State Building run up and run back down in 2000, and then it bumps along all the way until 2020, and then it just goes absolutely straight up again and then straight back. And I never thought I would see anything like this again in my lifetime, forget 20 years later. Has the world gotten much more sane since COVID guys? Have things settled down are things totally back to normal? All the frauds dissipated?
Bethany:
I don’t know that there’s any such thing as normal. But a quick note on about what you said earlier, this in some ways the days of Enron do feel laughably naive, both that we thought 50 times earnings was a big deal, there were earnings for there to be multiple of not that was true across the dotcom universe of course, but at least there.
Jim:
There might not have been an Enron.
Bethany:
There might not have been. Good point Jim. I remember writing that story though and not writing about these partnerships that Andrew Fastow ran because the accountants had signed off on them and the board of directors had signed off on them. And I thought, oh, well I guess I must just be missing something because of course if the gatekeepers have signed off on it, then this must mean that it’s all okay. And I think wow, was I naive. But then I also think, wow, and shouldn’t I have had a right to that naivety? And isn’t it a far worse world that we all know that you don’t have a right to that naivety?
But back to this idea of normal, I don’t know, I was at a presentation yesterday and the guy who was speaking was saying, and Jim, I’m sure you this well, that at the peak of all of this, private companies would go out to raise money and you’d be told you had 48 hours basically to get back to them. And most people just didn’t do their due diligence because FOMO, God, just put the money in and I don’t know what’s going to happen now, the point that the speaker made was that a lot of places, as valuations fall, their allocations suddenly to private equity and venture capital are going to be way, way, way overweight and they’re not going to want to put money into these falling portfolios. And so what that’s going to mean for a private company’s ability to raise money going forward? I think that’s going to be another really interesting area of shakeout. So I don’t think there’s going to be anything approaching normal anytime soon, but again, I don’t know if normal exists. Jim, what do you think?
Jim:
I agree with you on private equity by the way. I’ve been concerned about that on the investment committees I’ve sat on for a while and I’m still concerned about it. I think expectations are way too high and I think that investors continue to not understand that they own levered equity. And in a world in which most declines in equity values have been short and sharp over the past 40 years, really, we had a two-year bear market in 2002, we had an 18-month bear market in ’07, ’08, and then we’ve had selloffs that have lasted literally one to three months since then. And so in all of those, when you’ve had V-shaped recoveries, you never have really seen a problem in the ability of private equity to mark their portfolio in a meaningfully way down for multiple years. If we go back to an environment, say ’66, ’82, which is the environment I came into Wall Street on. Where you had 16 years of down markets, and at least as it relates to the Dow, down 80% in real terms over 16 years, private equity returns will be devastated.
And the plug number that private equity fulfills for a lot of large pools of capital 10 to 12% returns with low volatility, will be a thing of the past and everybody will wonder what happened. But that’s not now and that’s not been in the recent past but may be in our future.
I have a bigger concern as it relates to our discussion about the 50 times earnings for Enron or 50 times revenues for Beyond Meat, and that is where the real rubber hits the road today on Bethany’s concept of legal fraud. And that is the just insane overuse of proforma metrics by corporate America to present their results and investors getting very used to now valuing companies on alternative metrics which may or may not make any economic sense. And so the adding back, particularly in Silicon Valley, of just insane amounts of share-based compensation to the P&L, we’ve just employees as well as investors to attune that we’ve never seen before with the idea that it’s not a real expense.
And it’s one area where I would shy the SEC for falling down on, because technically companies are not supposed to lead with these metrics. Adjusted ESP, adjusted EBITDA, what have you. And yet that pretty much is now how almost all companies lead in their press releases and how financial journalists report results. It’s always the non-GAAP adjusted number. And take a look at a state company like GE. GE’s last report press release, a fourth quarter 2022 press release, had I think 14 pages of adjustment, 15 pages of adjustments, just the adjustments. I mean its mind-blowing now on how corporations report their results and what they exclude and what they want you to exclude. And I think that that makes the valuations even more excessive today than they appear on the surface.
Meb:
It seems like to me there’s certain items, and this I put in one category that seem like an obvious thing for the regulators politicians to focus on and fix. That does not seem unreasonable in any sense of the word. If you’re thinking about governance, if you’re thinking about, oh, I heard a stat the other day, and Jim, you probably know better than I do, but someone was saying that tech, whether it was last year or two years ago, stock-based comp was like 20% of revenue across the industry, some just astonishing number. But it seems like that’s something that not a lot of people would be against. Of the percentage of companies that are doing the proforma, I would think it’s a minority of the total, maybe I’m not, but it seems like something that would be like the administration listening to this podcast be like, okay, let’s just fix that. It’s not a big deal. What’s the hurdle?
Jim:
It depends on the sector of course, but in technology it’s very high, in more basic industries it’s not, but it’s still now a meaningful difference. I think the difference last year, if I’m getting my numbers off the top of my head, the S&P 500 on an operating basis made $197 and I think the GAAP number was 160 something, 160, two a hundred, it was a meaningful total S&P 500 earnings and it would certainly be much, much bigger in certain sub-sectors. And for some companies it just makes their business model unpalatable. Coinbase had, I think 80% of revenues was as share-based comp in the fourth quarter. I mean, your business model is just not profitable. If 80% of your costs are share-based comp and then you just add that back, and by the way, they still lost money with that. So it just depends. But I think that the ability of investors to do that and for companies to do that, investors to swallow it has gotten people very lazy.
Their companies, one of my favorites is reporting tonight as we go to do this podcast, IBM, I mean I B M has been taking restructuring charges every year for years. Literally they’re in the business of restructuring. So at what point did you just say that’s an annual cost? That’s not something you should add back.
Bethany:
I was thinking when you were talking Jim about another one of our favorite companies Valeant because that’s a company whose business was doing deals and yet the way they presented their numbers was to exclude all of the costs of doing deals. And if that was how they got their pipeline of drug products and that was actually the business they were in, then you don’t get to say, but these costs don’t apply. And I think to your point about laziness, the problem is that there isn’t a hard and fast rule. For one company, it may be that the cost of doing an acquisition actually should be excluded because it creates a misleading picture if you don’t, because they only do one acquisition every five years or every 10 years. But then for another company if they’re a serial acquirer, then it doesn’t make sense to include those costs. And so I think people have to do their own homework and understand the dynamics at work in each particular business. And during a bull market, nobody wants to do that. It’s much easier just to take the numbers presented at face value or say, oh, it’s acquisition-related costs, of course those should be excluded. But to Jim’s point about IBM, if your business is restructuring, if your business is doing deals, can you exclude the cost? Not really.
Jim:
Well, I mean Valeant is the example. And to amplify your point. I mean Valeant was in the business of buying drugs that other drug companies were happy to get rid of because their patent [inaudible 00:28:52] was coming up. So these were drugs with very short shelf lives, typically three to five years. And we did at the top of the market, Valeant was trading at $260. We did an analysis of their portfolio and the weighted life of their drug portfolio was about six to seven years. At that time, they were presenting a proforma cash EPS number, and I think when the stock was two 60, the trailing number was $13 and the forecasted number going forward was $20. So the stock was trading at 20 times, trailing 13 times this proforma cash EPS number. And I believe at a trailing four quarter basis, Valeant was trading at $260 was actually losing money on a GAAP basis during that period. So again, yeah, they simply told you to add back the acquired R&D amortization. And in fact, at 10 to 11 years, which is what the SEC mandated them, their amortization was too low, it should have been six to seven years. And so it really was a poster child for all that’s wrong with proforma reporting and metrics.
Meb:
How much of this is, it’s a bull market phenomenon? And what I’m thinking of is that the accounting shenanigans, the proforma, it feels like eventually the free market creative destruction comes for these companies if they continue to not have the resources, they continue to lose money, particularly in time of rising interest rates, it gets higher costs to actually fund the business. Does it just delay the inevitable or are the regulators not focused on this just because they’re like, well, eventually these companies are going to go the way the Dodo and they’ll get what’s coming to them? Or is it more egregious than that? What do you guys think?
Bethany:
Well, back to Jim’s comment about private equity. I worry that private equity has succeeded in making itself too big to fail. I mean, the lesson from the financial crisis seems to be that if you’re big and you’re going to fail, make sure you’re going to take the little people down with you so that then you can’t be allowed to fail. And so that was the case with the banks in the financial crisis and that was the case with Silicon Valley Bank. The venture capitalists were able to go to DC and say, you have to save us because in the end you’re going to crush portfolio companies and they’re not going to be able to put to pay their employees, and that’s going to be the end. And so it ended up being a bailout of wealthy venture capitalists because you couldn’t afford to let the little people fail.
And I worry that’s going to be the case with private equity and that where, to use Jim’s phrase, where the rubber’s going to meet the road again, is when private equity returns or the lack thereof start showing up in pension funds. And that’s going to exacerbate what’s already a pension fund crisis and it’s going to add to a lot of pressure on the Fed to cut interest rates. I don’t know if we can let private equity fail, and I don’t know how that political pressure plays out. So I think that idea of the free market allowing things to fail is really sweet and quaint, but I don’t think that that’s how it works in modern day America. Jim, am I too cynical?
Jim:
Well, again, I mean that’s not the way it’s worked in recent past. So we’re all guilty of recency bias, but there has been a change in one thing that makes me wonder if all the paradigms we’ve been operating on over the past 40 years are about to be turned on their head. And that is for the very, very first time, excessive fiscal and monetary policy brought the inflation genie out of the bottle. And remember, central banks have been rooting for inflation for the last 20 years. They literally rooting it on, we need inflation. And then suddenly when we saw the advent of massive fiscal stimulus coupled with monetary stimulus unleashed the genie, now we’re wondering, oh-oh, what do we need to do? And that’s what happened in the ’60s, by the way. I mean I’d say there is an analog for this. Excessive fiscal policy around the Vietnam War and great society coupled with a very easy monetary policy in the late ’60s unleashed a 15-year inflation genie.
And if that’s happened, then a lot of what we’ve gotten used to, Fed put, short sharp declines, bailouts for everybody, that playbook’s not going to work. And so I hear you, and that’s most likely what will happen, but there is a right tail possibility that in fact the ability to throw money at things just makes the other problem that we haven’t seen for 40 years worse. And it’s not just happening in the US, we’re getting global inflation.
Meb:
Some of the places in Europe are printing double-digit and if you know anything about Europe is they have a very painful history with inflation. And it is front of mind for sure. But when you think about the macro and thinking about my Silicon Valley friends wailing and going crazy a month or two ago, I was laughing because I was like, they’re all complaining about the Fed now, but how many of them for the past 10 years we’re saying a lot of our investing results, by the way, interest rates coming down, they’re being like, “We would like to thank the Fed”? I said, well, zero.
And the funny thing about these environments that you touch on, Jim, and this reminds me a little bit about ’08, ’09, because to me that felt like as a market historian, it was an environment that the vast, vast majority of professional money managers hadn’t been exposed to in their career. So GFC looked a lot like to me, some of the things of the Great Depression, the last 40 years to me has looked a lot like one environment, which is declining interest rates. And all of a sudden, you have this environment that most people weren’t managing money in the ’70s is very different on a macro backdrop, whether it’s yield curve, real assets, higher inflation, I mean historical equity multiples when inflation’s where it is now are usually about half of where they are today. It just feels like a lot of people are unprepared for that type of environment.
Jim:
Well, a lot of people don’t know. And I got on the Street in 1980, I started interviewing ’79 and people were laughing at me as to why I wanted to go on Wall Street. But what everyone forgets is that not only was there a vicious, vicious long-term bear market from ’66 to ’82, but that I believe the number was employment in the securities business dropped 75% over that period. Literally three out of four people lost their jobs because volumes dried up and the public just put their money in money market funds and didn’t buy stocks and bonds. And when I got on the Street again, the S&P was trading at six and seven times earnings and rates were 14% and that finally broke inflation. But that was in my lifetime, and I am not saying we’re going back to that, but the reality is that when you price things for perfection and you see a regime change, you have to be mindful that alarm bell should be going off somewhere in your portfolio that maybe insurance is not the worst thing in the world or being out there on the risk spectrums, maybe not the wisest thing in the world.
If we get back to two and 3% inflation targeting, which is what the market thinks, I’m bemused that the 10 years still trading at 3.6%. 3% inflation in the past usually means you’re looking at five to 6% 10 year governments. So again, we’ve got just gotten so used to that zero interest rate policy and ultra ultra low interest rates, we assume that that’s now baseline. And if that baseline is not a valid assumption anymore, then I think lots of things are going to change.
Meb:
Yeah. We could spend so much time on this topic. We had a Twitter thread during the craziness of it’s getting so long ago, 2020, when was it? January 2020 that things went really nuts, but it’s called What In Tarnation. My mom is from the South. It’s 30 charts of just the craziness of that period. But one of which was the sentiment, normally they ask the polls, people expect about 8% stock returns. As it got up to 2018, 2019, 2020, a lot of the polls got to mid-teens, 17% I think was the peak of the individual investor expectations, which mirrors a poll in ’99, by the way.
But the other crazy part to me was the percentage… And my followers are mostly probably professional investors because I talk about a lot of boring quant stuff. So you can’t be a hobbyist really and follow me because you’ll, you’ll unsubscribe. But ask question, do you own stocks? Everyone owns stocks 95% or whatever it was. Said would you own stocks if they hit a long-term PE of 50, which is higher than they’ve ever been in history, they hit talking about 10 year P/E ratio, they had about a 45 and 99. And three quarters said yes. And I said, would you continue to hold him with had a P/E of a hundred? And it was I think half said, yeah, I would just continue to hold them. So this cult of own stocks in any price, was at that point at least firmly ingrained, maybe we’ll have to do the poll again.
I want to shift real quick. Bethany, you know, wrote this piece on Enron 20 years ago plus now, you talked about the it girl, J-Lo, Kate Hudson. I have a potential new lead for an article for you, and we’re talking about 2023 now because one of the crazy parts of this year, to me, there’s been two big stories, maybe there’s more, but FTX, was that even this year? And Silicon Valley Bank and everything going on with the banks.
The crazy thing to me about FTX was the laundry list of professional investors that have hundreds of analysts, VCs on and on that essentially I said they had to have done two things, done due diligence and just gotten it completely wrong, or just admit they’ve done no due diligence. And I was like, you got to pick one or the other because you, there’s no C option. But there’s a big news story came out this week, I don’t know if you read it, but it said Taylor Swift was offered $100 million sponsorship on FTX and they did due diligence and said, no, these are unregistered securities, we don’t want to be involved in this. So your potential it girl for the FTX saga, when you write the definitive piece of the 2023s, I’d just love to hear your input on people. And it’s not even a one person shop, but it’s people that have reams of teams. When does the due diligence go out the window and why? It’s something that is astonishing to me with these giant red flags. What do you guys think? And is Taylor Swift the it girl?
Bethany:
Well, I have a 13-year-old daughter, so obviously Taylor Swift is the it girl. I mean, come on. If I were to say anything negative about Taylor, I might get kicked out of my house. But seriously, that makes me her even more. Go Taylor for saying no to this. As to why people don’t do their due diligence. I think there are a bunch of reasons. I think there is this widespread fear of missing out that you think would not reach into the levels of the most sophisticated investors, but it absolutely does. There’s this fear of looking stupid that I noticed for the first time with Jeff Skilling and Enron, where so many people just didn’t ask him the basic question, how does Enron make its money? Because they didn’t want Jeff to think they were stupid. And I will dare say that men in particular fall victim to this more often than women do, were used to people not thinking were very smarter underestimating us, but smart men can’t bear to be thought of as not smart. So if they’re put in a room with a founder who everybody thinks is brilliant and they don’t really get it, that smart man is highly unlikely to say, “I don’t really understand this.” Instead, they’re going to try to be one of the cool kids and pretend that they get it even when they don’t.
And then there’s another thing that I think is an interesting phenomenon, which is due diligence by proxy. People look at something, and this was certainly the case in Valeant and say, oh x, y, z smart investor has signed off on this. Why do I have to do my homework? And so in Valeant, you had some of the smartest investors out there, ValueAct this San Francisco-based activist investor, Sequoia [inaudible 00:41:10], and they were all wrong and they were wrong for different reasons. ValueAct actually had its money out of Valeant and didn’t really care what happened to the company after that. So everybody has different motivations, but the underlying thing is really smart people can get it wrong. And so if you ever outsource your due diligence to somebody else who’s smart and try to ride the back of that, you’re taking a big risk. They may have different motivations than you do, and they may simply be getting it wrong.
Jim:
FTX is such a special great example Meb because, so it was one year ago, I think off by a week or two that I was sitting in the Yale School of Management cafe having my pre-class coffee and my trading desk flagged me on a story that had just dropped on Bloomberg with Matt Levine and Joe Weisenthal and I think Tracy Alloway interviewing SBF and in a now infamous interview. And in this long rambling interview, Sam Bankman-Fried basically said the quiet part out loud five or six times. About how these are all basically Ponzi schemes and a lot of these token schemes and whatever are just scams and totally greater fool things. And I’m paraphrasing of course, but I think you both remember that interview. It was stunning.
And I remember rushing up to my AV people, the same people that are going to be hooking Bethany up on Monday and saying, I’ve got this interview on my smartphone, can we upload this and can we add this to my presentation deck at the beginning of class when we talk about current events because I need the class to read this with me. And they were able to obviously do that. And so, for the first five, 10 minutes of that class, we literally went through this interview that Sam Bankman-Fried did on Bloomberg, and I said, it’s very rare guys in this class that we teach about fraud that we are going to see a better real-time example of an industry luminary completely explaining his industry as just a cesspool of fraud and let’s go through it. So that was April.
And SBF and FTX had a conference with numerous luminaries, I think in May or June in The Bahamas. And it wasn’t until after that, we now know six months after that, that everything came apart at the seams and he had raised lots of money from well-known investors. All you had to do was read that interview and realized that there was nothing, literally nothing there. But to Bethany’s point about smart people and following particularly charismatic CEOs, charismatic CEOs have answers for everything, even when the evidence is when smoke is coming out from underneath a door and the door handle is red-hot as is the door to touch, and a CEO is saying, “Why would you think there’s a fire in there that’s not a fire in there, that’s normal.” People will believe them because it’s very hard human nature to have someone you admire and respect look you in the eye and lie to you. But it happens all the time. And we see it in CEO behavior today, 10 years ago, 20 years ago, 40 years ago. It’s as old as human nature. It just happens in different guises at different eras.
Meb:
Yeah, I mean, Bethany, I know you’ve been involved in overstock and just thinking about some of the CEOs that react so vehemently just have such a strong reaction to short sellers. To me it’s always been a curiosity. I scratched my head say, hey, maybe these are helping improve our business. And almost always like you see, you have the crazy reaction. It’s almost like the Grinch when he smiles really big, it’s like, oh, we know we’ve uncovered here or something because this is very clearly a visceral reaction to something that they probably know is somebody’s… Is like catching a kid with their hand in the cookie jar or something, they know better.
Jim:
Look at one of our most admired CEOs right now, the fellow who you tweet you quoted from 2012. I mean the number of things that come out of Tesla that are just simply not true, but you will get the response when you point out the latest whopper from that corporation that, “Have you ever landed a rocket bro?” And it’s this false equivalence that a lot of investors look at when confronted with obvious lies and material misstatements and omissions, they’ll point to something that is clearly a positive and say, “Well, okay, but what about that?” And of course the risk of loss when you have deception in a corporation goes up dramatically. And when you can routinely see evidence of that deception and then have it explained away, usually you’re in a pretty bullion market when that happens. And that’s certainly been the case for the last few years. That’s why I’ve called it the golden age of fraud.
Bethany:
I also think, speaking of that point of false equivalence, one thing that’s interesting, maybe this was always true, but it seems to me like a laziness that is exacerbated today or peculiar today, which is this belief that if somebody is smart in one field, then they must be smart in another field. And so, people look at Elon Musk’s unquestionable successes and say, well, let’s quote him talking about Federal Reserve policy or let’s assume that because he did this, he can run Twitter. And the reality is one thing has nothing to do with the other. There’s this great anecdote in this book I just read by, it’s by an MIT economist named Daron Acemoglu and it’s about something else. But he recounts this great episode of the building of the Suez Canal and this French genius visionary who persevered through the building of the Suez Canal named Ferdinand de Lesseps. And then Ferdinand went to build the Panama Canal and tried all the same techniques and it was a miserable failure. And so just because somebody who is brilliant and charismatic and amazing succeeds at one thing does not mean they’re going to succeed at the next thing, but we want that intellectual sloppiness today.
I also think per your other point, there’s a very interesting hypocrisy at work lots of times that I find true more often than it is not where people only believe in the market if it’s going their way. So we believe in it’s the bank CEOs and the run-up to the financial crisis. We believe in the market until the market tells us we’re wrong and then we don’t believe in the market anymore. So anyone who believes in the market should believe in short sellers. If there are people who are buyers of your stock, there should be people who are sellers of your stock. Why can’t you tolerate that? Except they don’t actually really believe in the market. They only believe in a market that gives them what they want and tells them what they want to hear and makes them richer.
Jim:
The opinions about facts are what set prices. And so I’ve said that for years. And only hearing one set of opinions may give you a very misguided view of facts and ultimately prices. And so I think that you ignore short sellers and skeptics at your own peril. But yes, you’re right, that particularly when the market is going one way, everybody believes in the market, when the market’s going the other way, intervention and something needs to be done typically at the public’s expense is the general human cry. So capitalism works great on the way up, it has its issues on the way down as we know.
Meb:
I was laughing and you’re talking about Musk talking about the Fed because in particular, I don’t know what it is about this cycle in particular, but this cycle of the last couple of years tending to be a lot of my venture capitalist friends, but we have a special phrase reserve, and it’s called macro bullshitters, but it’s like people that have no business talking about macro, all of a sudden becoming central bank experts. And I have that domain, if you guys want it, you can use it for something. I don’t know what I was going to use it for when I got it 10 years ago, but it just drives me nuts. I mean, I laugh in a way.
I wonder how much of this, a lot of CEOs, megalomaniacs, they’re very overconfident. We all have these behavioral biases. The podcast actually dropping today is with Professor Thaler who talks a lot about all of our behavioral biases, although we’re talking about the NFL draft, so it has nothing to do with investing markets. But I do a lot of angel investing. And one of the things we talk about is we say every person who starts a company startup knows that there’s the stat that’s something like 80 or 90% of startups fail. And yet every one of those has this naive optimism and belief that they’re going to be the one to make it. And then you have this massive survivorship bias. So the 10% that do make it, they’re like, ah, I was brilliant, maybe it all is true. And then they graduate to private funding public markets. And then you have these people out there… I was laughing at one in particular because he said on Twitter, “I know more about real estate than anyone in the world.” And he has a public company that stocks now down, I think 90 some percent.
Jim:
Oh, he commented to me on that company’s numbers back a year and a half ago in 2021 when we were short it, you’re speaking about Opendoor. And it was quite clear that that was not the case, that he did not know more about real estate than anybody else. And he certainly didn’t know lot more about his own company that he had founded or funded than other people did either.
Meb:
Well, the number one lesson in markets for those who have been through a cycle or two, we always say the number one compliment you give anyone is survival. Hey, you made it, you’re still alive. But those of us who have enough scars, you know that hubris is like the number one thing the markets Gods do not reward and they immediately take you to the woodshed in any scenario, I can’t think of an example ever where it’s really actually worked out where people grandstand or have a large amount of hubris and it continues. I don’t think I’ve ever seen it.
Bethany, I want to talk about this one question is one of the trends we’ve seen over the past decade is this merging and private markets, public markets, companies saying private longer, companies getting funded on the private side, these huge valuations. Is it easier to get away with some of the shenanigans as a private company? And does some of that perhaps lend itself to then when you become public emboldened to behave poorly? I mean, I’m thinking of Theranos, I’m thinking of a number of companies that on the private side, or is it just the same spectrum?
Bethany:
I don’t know. It’s really tempting to say yes because it seems logical, and I think I have said yes in the past because it seems inherently logical to believe that a company being private would allow it to get away with more shenanigans as you put it, especially without short sellers to provide some honest assessment. But yes, you have Theranos, it was a private company, then you had Wirecard that was a public company. And so I just don’t know in the end. And you had Wirecard by the way, with, what was it, Jim? Practically a decade of people warning and saying, this is a huge problem and trying to expose this. And just nobody was willing to listen until they were willing to listen. So I’m not sure systematically, I don’t know that there would be a way to study that because a lot of private frauds you probably don’t even find out about.
But as appealing as that logic is. I actually wonder if it’s true. And I think maybe it’s not true that human nature is the determinants in both private markets and public markets. And if there are enough people who think they might get rich and think they are getting rich, then the discovery of whatever is going on is just going to be on a delayed timetable. And look, I’ve said this before, I firmly believe that there is a fine line between a visionary and a fraudster, and some fraudsters never get found out because they’re just able to keep raising capital through the period of the fraud. And then, aha, it all worked. And then everybody looks back and says, “Oh my God, what a visionary you were.” But the reality is, if the music had ever stopped playing and they’d been unable to raise capital, they might have gone down in history very differently. So I’m even a little cynical about what the line between those two things might be.
Jim:
So I think the two great barbell examples on this, one you mentioned, one I will mention. As it relates to private companies, so I have an investment conference that we hold every year since 1998 called Bears in Hibernation and Bears in Hibernation in ’03 or ’04, someone mentioned Bernie Madoff in his returns and how great they were. And there was a participant in our group who walked literally a room for 40 well-known investors why Madoff was a fraud. And this was before Harry Markopoulos wrote his letters to the SEC. And it had to do with the amount of volume in the options market doing reverse conversions that Madoff claimed he was making his money on. And this fellow pointed out, they had done work, they had a big options trading operation, and it was very clear that you could not do the type of volume needed to make these returns even in these large cap stocks that he was talking about.
And I think one participant said, “Oh, you mean like Charles Ponzi didn’t have enough of the international reply postal coupons to do what the actual arbitrage that he said existed did exist. It just, you couldn’t scale it. Right?” And this fellow said that that’s the same with Madoff Securities. And boom, five years later we find out that was true. And the question would’ve been if Madoff Securities was public, would people like the people in that room have said, “Aha, this is crazy.” And brought it to people like Bethany to say, you got to look into this? That’s one example of how a private company I think, benefited from it being private.
The flip side is Wirecard. I think it’s a wonderful example because we got tipped off to look at Wirecard I think in 2016 or 2017, and it wasn’t until the FT did, its two pieces in 2019 that we ended up putting a position on. But what really amazes me in the Wirecard story, I now teach the case in our class, is that in October of ’19, the ft, its follow up piece also included a document dump. And if you remember, the document dump had literally smoking guns in it. In that that admission that what the company had denied in February was in fact true regarding some of the operations I believe in Dubai, Singapore and the Philippines.
And what’s even more incredible was that the company then hired an auditor, a special auditor, KPMG to review all these allegations. The head of the supervisory board resigned a few months later. KPMG in April of 2020 said it couldn’t get enough cooperation from the company itself regarding the special audit. And yet the company still traded for two more months at about a hundred euros per share after KPMG said the company wouldn’t cooperate before they themselves finally came out and said, “Oh yeah, there’s missing money.” And then the stock went from 100 basically to zero in a handful of days. And so there evidence was the fraud was hiding and played in sight for nine months. Proof of the fraud was there in the public markets through the FT document dump and then enough other things you could infer. And yet the stock traded, I think in a range of 80 to 140 euros over that nine month period before the company itself admitted the fraud.
Meb:
Crazy thing about the Wirecard, which is an amazing story, there’s a couple fun podcasts, listeners we’ll put in the show notes. But it’s one of the examples where the story keeps getting crazier and crazier. There’s some that are just like, okay, here’s the one issue, one element of this story, which is, but then it’s almost like reading a novel it. I’m like, you can’t make up some of the actors and it’s worthy of a movie, right? This is a giant company.
Jim:
I remember the morning of the revelation in June telling my guys, I hope they’re taking passports. And sure enough, I think within 24, 48 hours, the number two guy who was apparently the real brains behind the operation fled Germany as a fugitive. And even the basic law enforcement fraud 101, make sure that nobody leaves the country and makes sure that everybody sticks around was violated in that story. Now there seems to be enough evidence that there was state actors possibly involved in this one. Intelligence services and real bad guys. So it’s quite the story. Yeah.
Meb:
Jim, I’m going to ask you where you’re doing the most digging today. Is it commercial real estate? Coinbase and crypto? China? All the fun stories. Where are you finding the most nuggets underneath the surface today?
Jim:
We still find, despite the selloff in 2022, and by the way, the markets aren’t down that much from 2021, which was the peak of insanity. So for all of the unpleasantness of 2022, I mean they’ve only worked off maybe half of the May, not even half of the insanity from 2020 and 2021. There’s lots of business models that just don’t make sense. That were funded, came public either via IPO or SPACs. And just simply the business doesn’t work it. I mean when you boil down to unit economics, it just doesn’t make any sense and constantly loses money. So I’m talking in our more recent past of the Carvana’s of the world, the Affirm Holdings, and there’s still a number of these where just simply you’re losing money. You mentioned Coinbase. I mean we keep pointing out if not now, when? Crypto prices are up 70% in the first quarter and it looks like Coinbase is going to lose a lot of money again and still is overcharging their retail customers. So again, that to us is a business model that you have to ask yourself, does this business model work? And there’s a lot of those around.
Meb:
The amazing thing about the Coinbase, and I’ve said this about Robinhood, I was very public about talking about Robinhood. I said, look, I don’t think history’s going to judge this company kindly because when you treat your in-customer so poorly, and we have some friends that talked about the percent of the account Robinhood extracted from their clients on all these different measures, option trades being the most egregious, the customers don’t survive. And if they do, they survive for a little while, they hate you, they’re balanced goes and they leave. And it reminds me of the old FX brokerages where they would have to disclose in the filings, like what percentage of their customers made money? And it was like 99% lost money. It was just like they just churned until they died. And the math, it’s like Vegas, it’s like the 11 you bet on the craps table. It’s like it’s terrible on every single time they trade and they trade a million times.
Robinhood still draws my ire to this day because they’ve claimed many, many times in public to me on Twitter and on various TV stations that most of their clients are buy and hold investors. And I said, there is zero chance what you just said is true and you’ve claimed it 10 times and it is so infuriating. I can’t even. And the problem is if you’re not a buying hold investor, you’re getting churned and then eventually your account code is zero. Anyway, sorry.
Jim:
So to that end, Coinbase, based on fourth quarter numbers, Coinbase’s cost structure was 10% of annualized of customer AUM under the umbrella. And their revenues were 5%. Now we think with depreciation of crypto, their cost basis is somewhere around 7% of customer AUM. So think about that, in order to break even, they have to basically charge you 7% annually of your AUM if you’re a retail customer of Coinbase. Nobody seems to bother if crypto’s going up 30% a year, but that 7% or 10% is a pretty big vig on AUM. Charles Schwab doesn’t charge that. And so I mean it just goes right to the cost basis of the model and just how fee extractive it’s dependent upon. And ultimately you kill your customers. And they charge customers 3% round trip, retail customers, 3% round trip on a trade.
Meb:
Not a good business model to kill your own customers. That’s like finance 101.
Jim:
Commercial real estate has been on our radar since the pandemic offices first and now more recently data centers, which we think legacy data centers are liabilities, not assets. They actually burn cash unlike even office buildings. But what happened was a double whammy of what… Zero interest rates brought real estate prices to insane levels where mundane properties we’re trading at 3%, so-called three and four and five cap rates, which is simply gross cash flow divided by asset value. And it misses all kinds of capitalized costs, particularly in areas like office where it costs you a lot of money to replace a tenant now with rent concessions and build-outs and whatever. And that’s not reflected in the numerator NOI number, it’s capitalized over the life of the lease. So the free cash flow of a lot of property companies now is really much worse than the so-called NOI. And this gets back to accounting metrics.
And then when you couple of putting big multiples on that phony number, you get valuations that make no sense to a private buyer and certainly don’t make sense if interest rates have gone to five or 6%. And so there’s lots of real estate now beyond offices that just doesn’t pencil out anymore. And it’s going to be interesting to see how it all plays out. I don’t think it’s going to be a banking crisis, however, because the banks by and large, even the bad aggressive banks only lent 60% on deals. And so it’s the mezzanine guys, it’s the private equity guys and it’s the equity holders who are going to get killed here because their equity is worthless.
Meb:
People forget just how volatile the REITs are. I mean, I think in GFC they decline like 70, 80% as an index. And what’s funny to me is that you guys are talking about the marks earlier and Cliff Asness has talked about this being volatility laundering, which I think is such a great phrase. But I still continue to this day, we’ll get presentations or forwards from marketing people on the private REIT space and they’ll say one of the reasons investment private REITs is they have a volatility of four. And I’m just like, I swear to God, if you just say that with a straight face, everything out of your mouth that comes after this is going to be a lie or just false, you cannot honestly believe that, like my God. Anyway. So REITs can be extremely, extremely volatile depending on what’s going on in the world.
Jim:
And then we have a lot of idiosyncratic names that we think benefited from the greatest one off of all time, which was COVID stimulus spending and zero interest rates. So people went out and they bought five rooms worth of furniture with their COVID checks and you could just see it in all kinds of companies where they had a regular growth curve. And then 2020, 2021 and early 2022 revenues just went parabolic as did profits. And people are still extrapolating that out despite all kinds of evidence now that that’s normalizing. And so there’s a number of oddball shorts we have where there’s big multiples on 2021 and 2022 results that I think we’re going to see what was just a confluence of literally one-off things, people getting checked, sitting at home and spending that money on a variety of durables and other things, meals at home, what have you, that I think it’s going to be hard to replicate.
Meb:
Speaking of COVID, somebody’s got a new book coming out this fall, Bethany, can you give us a little preview of what you’ve been writing about the last couple of years?
Bethany:
Sure. So it’s a book I’m working on with Jon Nocera who’s a longtime colleague. We wrote a book about the financial crisis called All the Devils Are Here Together. And he edited my original story in Fortune on Enron just to tie it all together and edited The Smartest Guys in The Room as well. So it’s a book about the pandemic, but really about how the pandemic exposed some of the flaws in capitalism. And to me that’s one of the biggest issues, as you mentioned about European inflation, the economy is society and economy is going wrong can have really, really, really devastating consequences. And I think there’s a lot of skepticism of capitalism in our country now and for a lot of good reason, and I think government is in many cases failing to set the right rules for markets to function because in the end I would argue there’s no such thing as a free market. It’s all predicated on the rules that we set to allow the market to function.
I think the pandemic really did expose the many ways in which the market is really, really skewed and often to the benefit of the already well off, whether it’s Federal Reserve policy or healthcare. And so that’s essentially what the book is about. And that to me is just the huge issue for us going forward. I think confidence in our system, maybe it cracked beforehand. Enron was the first cracks, the Global Financial Crisis was another big crack and the pandemic has been another huge one. And so I worry for all of us. I think the stakes are very high in get getting this right.
Meb:
I’m just ready for a nice quiet period. I mean post pandemic, [inaudible 01:07:10] everything’s just chill out. Can I just get one summer where we can just hang out on the beach and just like things not be going bananas?
Final question guys. So we normally into the podcast for first time guests with a question called, what’s been your most memorable investment? Now it can be good or bad, but it’s just burned into your brain. Bethany, since I know you don’t do as much in the investing world, smart girl by the way. That’s a positive mental health attribute. What’s your big biggest memory from all this reporting for the past two decades? A moment where you just like, it’s either where a story unearthed itself where somebody gave you a manila folder under a park bench in Central Park, whatever it may be. Jim, we’re going to go to you first. What’s been your most memorable investment over the years?
Jim:
Well, in honor of my fellow guest, I would say it’s certainly the most memorable thing that people associate with us was Enron. But Enron was one of the easiest shorts we ever had.
Meb:
Is there such a thing by the way?
Jim:
In the pantheon of shorts, great shorts, we put Enron on at 60, it went to 80 right when we were speaking to Bethany about it in January of 2001. And then pretty much went straight down and evolved and revealed itself within the course of a year. And as some of these shorts go, I’ll our Wirecard discussion, whatever, that’s relatively quick.
Meb:
I mean that almost never happens. Usually as a short seller, you get one massive face ripper that at least sticks like a knife in your side first before it goes down.
Jim:
At least what happened for about a month and then stopped and then it was all over. My most memorable though was the first short I ever did when I was a young analyst in 1982 in Chicago was Baldwin United Corporation and it was a real eyeopener as a brand new securities analyst and it turned out to be a massive fraud and the largest corporate bankruptcy in US history up until that time. And it literally was an eyeopener because, and we discussed at the beginning of the broad podcast, that things that people took for granted just simply weren’t true. And by looking at public documents like insurance filings and letters in the state insurance department, you could actually prove that they weren’t true. And yet people were recommending the stock. And despite all the criminality that was going on there, and as a young analyst, I was banging my head against the wall because I literally was holding onto documents, smoking gun documents that were saying that what Merrill Lynch and others were saying about this company was just simply not true. And that was my eye-opener to the inefficiency of markets in these kinds of situations. And I generally believe markets are mostly efficient, but there can be moments, particularly in my world where you just simply know something that is true that the rest of the world thinks is not true.
Meb:
Bethany, what a memorable moment from your journalistic forensics over the years?
Bethany:
This one isn’t even necessarily mine, but it was during the Enron trial and it wraps the conversation back to the note of legal fraud because it really could have gone either way. And back to our discussion about charismatic figures. Jeff Skilling, he testified in his own defense, which very few people do, he really had the jury eating out of his hand. And I really think that trial could have gone either way, but for a moment where he had originally told the SEC that he had only sold Enron stock because of 9/11, and that was the only reason he had sold, I think 15 or $20 million worth of Enron stock. “9/11 was the only reason all my money was in Enron. I was terrified. I sold only because of 9/11.” And the prosecutor unearthed this tape of Jeff Skilling calling Charles Schwab on, I think it was September 7th or 8th, trying to sell his stock.
And the broker at Charles Schwab says, but you can’t do this because we’re going to have to disclose it. And Skilling says, “No, no, no, I’m not an officer of Enron anymore. I’ve resigned.” And Charles Schwab says, “Well, you have to get us the paperwork showing that you’ve resigned.” And by the time Skilling got Schwab the paperwork, it was after the close of the market that Friday. And of course the market didn’t open that Monday. And so by the time the sale went through, it was whatever it was, September 16th or 17th, and you could have heard the proverbial pin drop in that moment in the courtroom because suddenly it was clear that he was a liar. And I’ve never seen such a moment of belief turn to sudden skepticism. I’ve never seen a look like I saw in Jeff Skilling’s face because I think he had convinced himself of his own story such that when he was called out on this, he couldn’t even remember that it wasn’t true anymore. So it was this fascinating moment of all the things that most interest me from self-delusion to charismatic figures and the way we believe in them and the way they can convince us of things, and it was that rare moment of a total unmasking. Anyway, so I think about that a lot.
Jim:
I’m going to hope you’re going to tell that story again to my class on Monday.
Bethany:
[inaudible 01:12:13].
Jim:
It’s such a great one. It’s such a great one.
Meb:
That’s a perfect way to put a bow on this. End it today, Jim. Bethany, thanks so much for joining us today.
Bethany:
Thank you for having us.
Jim:
Thank you for having us.
Meb:
Listeners, if you enjoyed this episode, check out the link in the show notes for our episode last year with another legendary short seller Marc Cohodes, where he shares what led him to call Sam Bankman-Fried the Best Short on the board on August 1st, 2022.
Podcast listeners will post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.
