Capitalisn’t: Is Short Selling Dead?

Jim Chanos: People’s willingness to believe things that are too good to be true and look closely when everything is working, and everything is making you money, gets eroded in a bull market.

Bethany: I’m Bethany McLean.

Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?

Luigi: And I’m Luigi Zingales.

Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.

Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.

Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?

Luigi: And, most importantly, what isn’t.

Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.

Bethany: Luigi, did you know that in 1609, when a merchant contracted to sell shares in the Dutch East India company in the future, that sent the company’s share price into a plunge? A year later, the authorities imposed what people think is the world’s first ban on short selling.

Luigi: Actually, I did not know that, but I’m not that surprised because authorities don’t like short sellers, and they have been blamed for every financial crisis since the Dutch episode. During the US stock-market crash of 1929, President Hoover actually condemned short selling in 1932.

During the 2008 financial crisis, we saw bans on short sales. We’ve seen CEOs of big Wall Street firms lobbying to have bans on short selling. One declaration that I love is that short selling is un-American. It’s not clear why, but it’s just an indication of how much these people are hated.

Bethany: It’s probably worth spelling out what short sellers do, for those of you who aren’t versed in the intricacies of finance. Short sellers borrow shares from a broker and sell them in the market in anticipation that the price will fall. They then, if it works out, buy the shares back at the lower price, returning them to the broker, and they make a profit on the decline in the stock price.

Luigi: The argument is that short selling creates a downward pressure on stock prices and, therefore, can become a self-fulfilling prophecy. But it’s a kind of chicken-and-egg type of argument. Short sellers will say that they get involved because the stock is overvalued or because they suspect fraud. And if the stock declines, it’s not because they sold the stock short. It’s because the stock was overpriced to begin with, or the underlying business had some problems.

And, by the way, short sellers even point out that when a stock has declined, they provide stability because they have to step in and purchase the shares that they had sold short. And so, that action of buying the shares provides stability to provide a bottom to the prices in the end.

Bethany: My view of short sellers is, of course, informed by my history. When I started at Fortune magazine as a young reporter back in the mid-1990s, I was routinely . . . I’m going to use the word assaulted by people who were long stocks who wanted to see a stock go up.

At first, I wasn’t skeptical, and I would write about the company taking the information I’d gotten from them, only to sometimes see the stock go in exactly the opposite direction.

Sometimes, my phone would ring, and it would be somebody who had been short the stock or who was short the stock saying, “You idiot, don’t you realize you’re helping this management team inflate the stock and then sell their stock options and cash out? And don’t you realize this thing is a fraud?” And I started to think, huh, I need to understand the other side of the story.

That’s how I got to know a guy named Jim Chanos, who’s one of the most well-known short sellers. He’s been around for decades. That’s what led me to write about Enron back in 2000 because Jim was short Enron stock. And so, I’ve always thought that short sellers provide necessary discipline and truth telling in a market where most people are incentivized to see stocks go up.

The detestation of short sellers makes no sense to me because it’s supposed to be a market. There are supposed to be buyers and sellers. And, yes, short sellers can be manipulative and can put a story out there because they want to see a stock go down. But people who are long a stock can be manipulative and put a story out there because they want to see a stock go up. That’s what makes a market. I’ve never understood why one side should be more detested than the other side. But Luigi, as an economist, what do you think?

Luigi: If you ask what I think as an economist, I think that you’re absolutely right, and all the evidence suggests that there is an important value provided by short sellers. But let me tell you a different story that might explain why short sellers are so hated. As a little kid, I was reading a good curated version of Virgil’s Aeneid, which is the Latin version of the War of Troy.

In that story, there is a story of a priest who, when he sees the Trojan horse, recognizes that it’s a danger and warns the Trojans, and terrible things happen to him. Two snakes come out of the sea, and they first devour his children and then kill him.

As a little kid, I was terrified by that, and I went to my mother, and my mother had always told me that you have to be honest, blah, blah, blah. I said, “Wait a minute, why did the gods punish somebody who was telling the truth?”

This stuff did not register with me, and I did not understand this until I was much, much older. Then, I realized that, as in all the Greek myths, they represent some psychological phenomenon, and this is the phenomenon of denial. We don’t want to hear the bad news, and so, we really shoot the messenger.

Bethany: Funny timing, as we were recording this episode, the China Securities Regulatory Commission vowed “zero tolerance” against what they called malicious short sellers, according to Reuters, warning that those who dare to flout the law will lose their shirts and rot in jail.

Essentially, the CSRC, as the China Securities Regulatory Commission is known, is putting in place measures that are basically meant to shut down short selling. Once again, it’s an example of when a market is plunging—I think the China securities market just hit a five-year low—regulators immediately turn their ire toward short selling and the belief that somehow, if we can stop people from saying it’s bad, then maybe it won’t be bad.

What’s funny is that the language that’s being used, maybe it’s a little nastier than we saw in the US, but it’s not really any different than we saw in the United States during the financial crisis in the fall of 2008, when even CEOs of Wall Street banks were asking the US Securities and Exchange Commission to shut down short selling.

There does seem to be this attitude at work that as long as everything is going well, and we’re making tons of money, it’s capitalism. But if anything is going wrong, and people are betting against us, then you have to stop it because the market must be malfunctioning.

Luigi: Yeah, I think that it sounds like the quote at the beginning of our podcast with Bernie Sanders, socialism for the rich and rugged individualism for the poor.

Bethany: There is no question that the last decade has been a very tough time for short sellers. The Federal Reserve’s low-interest-rate policy helped make investors very, very bullish, which meant that even questionable stocks only went up, and so, short sellers could short something that seemed overvalued, and the stock would just continue to go up.

Stocks obviously crashed in the pandemic, but that was really short-lived. The continuation of the Fed’s policy meant that, at least for a few years, even post-pandemic, literally, stocks only went up, and we seem to be back in that world a little bit today.

Last fall, Jim Chanos abruptly closed his hedge fund. As one person wrote, “Wall Street’s best-known bear is going into hibernation.” That’s what the Wall Street Journal wrote, and they noted that his firm managed less than $200 million today, down from $6 billion in 2008.

Data tracker HFR noted that, overall, hedge funds that focus on bearish bets manage $5.3 billion, down from $6.2 billion in 2012. The business has shrunk. And so, the question is, is short selling dead? We thought the best guest we could have on to answer this question is, of course, Jim Chanos.

Jim, the idea for this episode came from one of our listeners, someone you know, actually, who wrote in an email to me: “What does it say about capitalism if Jim Chanos can’t find enough investors willing to profit from its frauds, fads, and failures, not to mention the competitive forces that are necessary for a functioning market? Is short selling dead?”

I wanted to start by asking you that question. Do you think your decision to close your fund says something more broadly about the state of short selling and even capitalism?

Jim Chanos: Well, I don’t know about that. Increasingly, our clientele, we realized, has the ability to do a lot of what we were doing for them through their own back office, their own risk-management protocols.

Having said that, a lot of exhaustion has set in among investors. To your questioner’s point, when is this ever going to matter? If markets are ruled by liquidity and positioning, will fundamentals ever count on the short side? The traditionalist in me says, “Yes, of course it will.” It may take time; it may take a cycle. But if that doesn’t happen, then we can ask much broader questions about markets as a whole, in all aspects. If you just say one side of the market isn’t working, I think by definition, then you have to worry about many sides of the market not working.

Luigi: One could take an optimistic view that the reason why you are retiring is because there is no more fraud, and you have no business because there’s no fraud. Tell me why this optimistic view is wrong.

Jim Chanos: Luigi, this is not the first time that I’ve gotten that comment or question. I got a phone call after Sarbanes-Oxley was passed from a Wall Street Journal reporter who said, “What are you going to do for the rest of your career?”

I said, “What do you mean?” He said, “Well, they’ve just made fraud illegal.”

I said, “I think I might still be busy, but who knows?”

As you know, I teach a course about this, and the longer the cycle goes on, not only does the crazier it get from a pricing point of view, but more egregious aspects of corporate malfeasance occur and get accepted.

Now, I thought that we saw the peak of that in 2021. 2021 was hard to beat in terms of the combination of speculation and absolute nonsense being funded and outright fraud. But late 2023 and 2024 seem to be giving it a run for its money again. I noted that Donald Trump’s SPAC is up 300 percent in the last week or so.

Bethany: Oh, good heavens. That could be an interesting way to track the progress of the election, to track Donald’s . . . Oh, I had not thought of that.

Jim Chanos: Right, and we’ve seen the resumption of the crypto ecosystem that has come back to life. People are talking about going to the moon again, and you would have thought that the stake through that heart occurred in 2022, but it doesn’t appear so.

Bethany: How much of this is driven by the increased reliance on Federal Reserve policy to dictate what happens in the market, and is there a parallel in history? Or for the last, I don’t know, since the financial crisis . . . have we been in uncharted territory, in terms of the way in which the Federal Reserve’s interest-rate policy appears to shape market dynamics really broadly?

Jim Chanos: I think, undoubtedly, things really got going again recently, when Powell signaled what the market had already been pricing in since last summer, which was an aggressive cut in interest rates in 2024.

Actually, the market’s been pricing in cuts in interest rates since the summer of 2022, but having the Fed at your back is wonderful. We’ve gotten positive reinforcement from a recency-bias point of view. I still think what the Fed did in December of 2018 was insane. The S&P had dropped 20 percent in the fourth quarter going into Christmas. The Fed, which had been gradually hiking interest rates, did an about-face, and economic growth was fine. We grew 2 percent in the fourth quarter. We grew 2 percent in the first quarter of ’19, but the Fed did an about-face because the equity markets forced their hand and then started cutting aggressively pre-COVID.

That, more than anything, got what we saw in 2020 and 2021 going. The markets want that again. I think the markets were up 30 percent, 20 percent, and almost 30 percent over those three years. That’s about 100 percent in three.

So, of course, the markets are hoping we’re going to get a replay of that and are trying to price it in accordingly.

Luigi: Sorry, Jim, there is a difference between aggregate and . . . Of course, I know you know, but I want to understand why, in this conversation, you mix between aggregate and individual. I understand the market being overinflated, but my understanding is that when you short something, you at the same time invest on the other side in stocks, so that whether the market is going up overall or going down overall shouldn’t affect you too much, except for the specific case of fraud. Or am I wrong here?

Jim Chanos: We’re trying to isolate the idiosyncratic risk of a short portfolio and take out the systematic risk, which is that markets go up over time. All things being equal, on a simple basis, that should be your alpha. The problem is that alpha has a beta, in that the alpha contracts and expands with the level of speculation.

People will flock to the fraudulent companies, the aggressive companies, the companies with crazy accounting and silly business plans, no matter what you might think they’re worth, for reasonably long periods of time. It is what it is. It’s part of the game. And so, you can take the systematic risk, but the idiosyncratic risk can still be reasonably large. The waves of speculation in the frauds and the scams and the hypes have a cycle all their own.

The longer the expansion and the longer the bull market, the more intense the speculation at the end of it is. People’s sense of disbelief gets eroded, and their skepticism gets eroded the longer things go on. They begin to realize that traditional metrics of value don’t count. It would have kept me from making all this money that my next-door neighbor made. And so, you begin to believe things that are too good to be true at the end of cycles.

I look at NFTs in 2021. For months on end, people were bragging about their digital apes being worth $500,000, $600,000, millions of dollars. And why? Because someone else was willing to pay it. It was patently absurd and led to tears, but you couldn’t tell anyone that at the time.

Of course, as it relates to frauds, again, people’s willingness to believe things that are too good to be true and look closely when everything is working, and everything is making you money, gets eroded in a bull market, whereas people are far more skeptical and far more parsimonious with their capital when they’ve lost money.

Luigi: Speaking of GameStop, what is fascinating is—

Jim Chanos: Do we have to?

Luigi: Yeah, we have to. I think it’s an interesting example because, of course, it went to crazy prices, but if we look ex post, the price settled much higher than what it was before the short squeeze. How do you explain that?

Jim Chanos: Well, they’re the only meme stock where that’s the case, Luigi. I will tell you the reason why was they were one of the smartest. They did a monster equity offering at very high prices and raised a ton of cash, I think well over a billion dollars, by selling equity well into the increase.

Now, they have a war chest, which gives their equity value a backstop. All the other meme stocks—AMC, Bed Bath and Beyond, Blackberry—all have given all back and then some.

Bethany: How do you think about that as an investor, when you’re analyzing a stock, that dynamic between the company and the stock? Growing up, many years ago, there was this argument that a company and a stock were two different things, and there were the fundamentals of the company, and that should dictate the stock price.

But as you’re pointing out with GameStop, actually, what happens with the stock can end up dictating the fundamentals of the company. I think Tesla is another example of that because the stock has stayed so high. That’s enabled Tesla to keep raising money, which has then, perhaps, changed what the trajectory would have been. And so, how do you evaluate that stock-trading-specific risk?

Jim Chanos: Yeah, well, that’s part of George Soros’s reflexivity theory, right? The price of the asset can actually have an effect on the operations of the underlying business. Very clearly, if a company is a good capital allocator and sells equity when things are quite high and buys back equity when it’s below intrinsic value, they can add value to the business. There’s no doubt about that.

But can you get an SEC-registered offering off without disclosing too much? We’ve watched, sort of amazingly, as one of our shorts . . . We’re no longer shorted, but we were short the shares of Beyond Meat, and that was one of the great 2020, 2021, COVID stories. Everybody was going to be eating plant-based hamburgers, and the stock went crazy.

The problem with them was they borrowed a lot of money to finance their operations, so they had debt. With their negative cashflow, we realized at some point in 2023, 2024, they were going to hit a wall. That’s exactly what’s happened now, and the stock has collapsed, but the company had myriad instances where they could have sold stock at really inflated prices.

Every time the stock squeezed—which was sort of two times a year, it would go up 100 percent—they could have issued equity and didn’t. One of the questions is, why didn’t they? Did they believe their own hype? Did they worry that the disclosure would be too bad? Did their investment bankers say there’s no real demand, it’s just traders? I don’t know.

Bethany: Fascinating.

Luigi: Many people, myself included, have criticized governments that have created short-selling bans because you’re trying to hide the thermometer, and you don’t cure the temperature, and all that stuff. But once you introduce this reflexivity, maybe there is some argument to stop a short seller in some situations, because the short sellers might impact the real life of the company, not just precipitate when this will happen, but precipitate whether this will happen.

Jim Chanos: Well, that’s been the argument, particularly for financial institutions, that there’s a trust level and the signaling effect. What we told the Europeans, when they did it in 2011 in their financial institutions . . . When Europe was having its mini-crisis in 2011, they put in place short-selling bans. We wrote to the authorities over there to point out that there were a couple of lessons in the short-selling bans in the US in ’08.

If you remember, there were two waves. In July, the SEC put out a list of companies that said you had to had the stock in hand to do a short. You couldn’t go out and do a so-called locate with a third party. There are three answers I get if I ask to short a stock. Yes, we have it in our vault; you can short the stock. No, we don’t have it, but looking at the marketplace, we believe within three days we can get the stock to make delivery. That’s a so-called locate. I have the green light to go ahead and short the stock.

Or, three, don’t do it, no way, no how; we can’t borrow it, we can’t find it. It will be a so-called naked short. That’s how the naked shorts developed. Don’t do it. In that case, the onus is on me not to short the stock.

In July of 2008, the SEC put out a list, in consultation with Treasury, of 20-some banks that you had to have a “firm locate,” meaning in the vault, in order to short the stock. You would think that that would be maybe a positive, but of course, the signaling effect worked the opposite in a bear market because it suddenly said the government is worried about these 20 institutions. That was number one.

More subtle was the fact that when a company gets into trouble and distressed—and Bethany will smile at this one—it’s not just short sellers like me who suddenly are looking to short the stock to hedge their exposures. You have commercial partners who may have exposure. Enron has agreed to provide electricity for me for 10 years in Phoenix. If they go bankrupt, they’re going to abrogate that contract, and that contract, based on where electricity prices are today, is really favorable for me.

How do I hedge my IOU that’s nonmarketable from Enron? That was the whole point behind CDS’s. The two ways to do it are really the CDS market or the equity market as an ability to hedge your commercial exposure.

When you cut off the equity market, immediately, it put pressure on CDS rates, which exploded because people couldn’t hedge their risk in the equity markets and had to buy CDS protection, which again sent the signal, which made things worse, not better. You pushed on one end of the balloon, and the other end of the balloon went the other way, in a way you didn’t really foresee.

Bear Stearns was a great example. There were real-estate developers that had real-estate commitments from Bear Stearns, who was an aggressive commercial real-estate lender and developer. When Bear Stearns started going down, they began to worry about their commitments from Bear Stearns Realty to fund their projects. So, they went out and started buying CDS's in Bear Stearns debt instruments, which, of course, sent a signal.

Luigi: Let me actually shift gears a little bit because I would be amiss if I didn’t take the opportunity to discuss with the two of you the crucial interaction between short sellers and journalists.

I would like Jim, first, to tell your side of the story of your relationship with Bethany, back in the younger days, and more importantly, how did you see this evolve over time, and is it a reason why short sellers are disappearing? Is it because good journalists are disappearing?

Jim Chanos: Well, I think Bethany is much, much better qualified to answer that than I am. I’ll step back a little bit and go up 10,000 feet and approach the question from a different point of view. In the ’80s and ’90s and early 21st century, the problem for a fundamental investor was getting the information. Then, if you got the information, to make sure that other people got the information, if it supported your investment thesis.

Now, of course, the problem is exactly the opposite. Disclosure and information come at you in a firehose. I can access all the financial information I need on any company I want, instantaneously. The issue is not getting the information or disseminating the information. The issue is analyzing the information and analyzing what’s important and what’s not. That’s a big difference.

When we spoke to Bethany about Enron, we had a really varied view on Enron. There were a couple of people whispering about it on sales, whatever, but this was an $80 billion market-cap company. Those situations today are much more rare because of social media and because of widespread dissemination of information.

They still exist: see Wirecard and a few others. But the nature of information itself is impacting how investors, including short sellers, work with journalists or become sources for journalists and the impact that that has.

People were openly talking about Wirecard fraud for three years before the FT wrote its first piece and widely disseminated on Twitter. That might not have happened back in the ’90s. If I have a great story, I’m not calling Bethany like I would have 20 years ago.

Bethany: But isn’t it also the case—I’m thinking specifically of Wirecard—that if you believed in a rational-market theory, you’d say once that FT piece was out there, once the information is out there, well, that should be reflected in Wirecard’s stock price? And yet, even after that first FT piece was published, what was it? Six, seven years until . . .

Jim Chanos: Wirecard was . . . Again, look, I believe markets are generally pretty efficient. Forty years have taught me that. But there are exceptions, and Wirecard was an exception you could drive a German Panzer division through. It was insane. Not only did you have the short reports from 2017 and 2018, then you had the FT come out in February of ’19, which is when we got interested.

More amazingly, you had the follow-up FT article in October of ’19 that actually had smoking-gun emails, so that it was no longer, we think this is questionable with the Abu Dhabi and Singapore operations in Dubai. There are actually emails that basically said this is b—t. From that point on, the stock dropped to a hundred euros.

It rallied back when the company announced it was hiring KPMG as a special auditor. But from October of ’19 to the collapse in June of 2020, the stock traded between 80 and 120 euros, despite the fact that the supervisory-board chair resigned, the fact that KPMG came out and said that the company would not cooperate with the audit, and about five other things I’m forgetting that were just red light after red light after red light, and the stock still, the day before it collapsed, was close to a hundred euros, until the company itself said, “Oh, yeah, we don’t have the $3 billion in the bank.”

It was incredible. Everything that the shorts said and, later, journalists said turned out to be true and arguably not even as bad as it was, and yet, there it was. All that information was out there floating in the marketplace, and yet nobody cared until they cared, and then, they cared all at once.

Luigi: I agree, but I would like to dig a little bit deeper on the relationship with journalists because my understanding is part of the story is that when Bethany was publishing an article putting Enron in doubt in Fortune, this was really a bad signal for Enron. And so, indirectly, you could trust that once it was certified by a reputable journalist, you could start to cash in your short.

Today, there is so much bad information going around. The case of Wirecard is exemplary in that nobody knows what to believe. There is so much going on, and people can point to the fact that rumors about Wirecard were there in ’17, they were there in ’18, but Wirecard did not collapse. There is a lack of certification of the bad news until you lack cash. That’s a certification, but it is the ultimate one. Right?

Jim Chanos: So, you’re saying the market needs editors?

Bethany: Yeah. You’re getting at a couple of different things, and I guess one thing I would say, at least about the old world of journalism, and particularly magazine journalism, is that one of the ethical ways it was done was that Jim wouldn’t have known when the story was being published, and he didn’t know in the end what the story was going to say.

It could have been a total shock to him in that the story could have been published when it was, or it could have been published two weeks later, and I could have come out and said, “I think Enron is the greatest thing since sliced bread,” and he wouldn’t have known that. There wasn’t this ability . . . At least, there were safeguards around, and Jim wouldn’t have done that anyway, he made it clear he wasn’t going to trade around Enron once he started talking to me, but there was—

Jim Chanos: I thought it was a positive story.

Luigi, though, does bring up a good point that links up with my earlier comment that there is so much disinformation around. The problem is not getting the correct, truthful information anymore. That’s out there. It’s easier now to get that and get it disseminated, but if it’s lost in a sea of nonsense and disinformation, picking out the value and being patient to understand that that’s the signal, and the rest is noise, becomes really important and, arguably, much more frustrating.

Bethany: Another company where there was a disconnect between the information that was out there and what happened to the stock, until there wasn’t, is Valiant. What does that saga tell you about that idea that there can be this gap between the information that’s out there and the ultimate end, until it happens, and what does it tell you about one of the central players in that drama, namely, Bill Ackman?

Jim Chanos: Well, I’m not going to make anything personal, but it told me that a lot of people in my business don’t understand accounting, because the Valiant story at the end of the day was a simple accounting story. The fact that that story carried on as long as it did because the narrative had trumped the fundamentals was also surprising.

At the end of the day—and it gets to one of my current problems with the marketplace—we’ve begun to really institutionalize and accept self-reported metrics that may or may not be correct. This is one area where I do criticize the SEC. The SEC said years ago that they were going to crack down on the use of pro-forma metrics relative to GAAP accounting and make sure that companies realize that pro-forma metrics were a supplement, not the primary communication nexus.

Nowadays, almost every company leads with the pro-forma earnings. I think that’s a real problem because it does give a little bit of institutional cover for bad guys like the Valiant guy to basically build a business model based on bad accounting, which was, as you know better than most, he was buying drugs with very short shelf life and, in effect, capitalizing his R&D, whereas Merck and Pfizer would develop drugs in the lab and expense things as they spent the costs.

Mike Pearson would simply buy a company and call it purchased R&D. The SEC-mandated write-off period was 10 to 11 years for a drug that might have an economic life of three years. And so, the more he bought and the more he told you to add back that amortization to cash earnings, the faster he grew. It was all nonsense. In 2015, when the stock went to $260, the pro-forma cash earnings-per-share estimate for the following year was $20 a share, but the company on a GAAP basis was still losing money.

Bethany: Wow.

Jim Chanos: Yeah.

Luigi: I don’t want to push you too hard on that, but I think for our listeners, on the other side of the trade was Bill Ackman, who was professing complete trust in the company and was long in the company. Maybe you should sell your advice to Harvard University on how to deal with Bill Ackman.

Jim Chanos: I’ll let Bill Ackman handle that question, Luigi. All I’ll say is, he was aware of our work.

Bethany: I wanted to come back to where we started the conversation, Jim. You’ve said at various times that this is the golden age of fraud, and yet, we’ve talked about these market dynamics, like the rise of these pod-driven hedge funds with these very tight risk-management parameters.

If you had to guess, how does this play out over time? Do we find out that it was indeed the golden age of fraud, or does it all get hidden because market dynamics are broken and the Fed starts cutting interest rates again, and it turns out that capitalism really is broken, in a way?

Jim Chanos: I don’t want to bet that capitalism is broken. It’s been pretty resilient, despite flights of madness from time to time. I think market forces will ultimately correct things. It just seems to me the willingness of market participants to believe in this deus ex machina coming to the rescue every time they make a bad investment decision has got to be weaned out of things. That may take time.

Now, if we want to take a look at the flip side of where this is all happening, where there was a large actor that was going to come to the rescue of everybody, and we’re still waiting for that, is our friends in China. For years, as you know, I’ve been talking about the silliness of their economic model and the debt problems and their accounting, and it was always, well, the government will just bail everybody out. The government will do this, and the government will do that.

And we’re seeing the flip side of this entire argument, which is, the government’s doing everything, and it’s not helping. It was priced in. The public-policy aspect of this that always worries me at the end of these sort of things, is the people that probably should have the least ability to handle the risks they’re taking are taking the most risk.

Retail investors didn’t come back into this market until the fourth quarter of 2019. You can see it in the commission numbers; you can see it in the options trading. We had a 10-year bull market where people basically funded their 401(k) and bought index funds or whatever, but they didn’t start buying individual stocks in a major way or speculating in the options market in a major way until late 2019. And so, you have a whole new generation of investors who just sort of know that, from 2019 on . . . I don’t think it’s going to end well for them, but I think it will end at some point.

Bethany: Thank you.

Jim Chanos: I’m always happy to do it. It’s great to see you guys. Have a great 2024.

Luigi: To be honest, the thing that I found most interesting from the conversation was the interaction between the media business and short selling. As Chanos said, in order to profit from your trade, eventually, the news should be certified by somebody. Otherwise, it’s not embedded in the market and doesn’t become a profitable trade.

In the old days, media were providing that certification. Today, they’re not, at least not traditional media. The Financial Times can write that Wirecard is a fraud, and the stock price of Wirecard doesn’t move or doesn’t move much. There are so many other sources of information, particularly social media. You get so much noise that is hard to tell the noise from the signal.

Bethany: I think that’s true. I guess I’d always seen Wirecard as more of a one-off rather than indicative of a change that the press no longer matters, that the press can put out a story alleging something as a fraud because there were so many other aspects to the Wirecard story of people, not just the press, alleging Wirecard was a fraud, and it was totally ignored, until it wasn’t.

I see that more as a phenomenon of markets in the 2000s and the fact that even questionable stocks only went up, or mostly only went up, for a long period of time, rather than a comment on how information is disseminated and the believability of the press.

That said, I think your overall point and Jim’s point that it’s changed a great deal is so true. Back when I was working as a journalist at Fortune in the late ’90s and 2000s, before the advent of social media, the only way for a short seller to get their viewpoint out was through a reporter.

Often, they did so on background because they didn’t want to be quoted, which meant that you, as a reporter, had to validate everything yourself. You couldn’t rely on somebody else saying so because they weren’t saying so publicly.

But the information traveled in really small circles. For instance, there was a large group of people who were skeptical of Enron running up to its collapse, including some of the world’s smartest hedge funds. But no one knew that. That information simply didn’t get out there.

What any average investor would know is that everybody on Wall Street, all the Wall Street analysts, had a buy rating on the stock, predicting it to double in coming years. And so, information traveled in these very, very closed loops.

It doesn’t anymore because short sellers have an incredible number of avenues to get their viewpoint out there, from Substack to Seeking Alpha to Twitter. There are numerable outlets for short sellers.

I actually think that’s probably for the best. That trapping of information in these closed circles meant that your average investor just had no chance of figuring it out for themselves. Now, at least, people have a chance if they’re willing to listen.

Luigi: I’m not so sure because it doesn’t mean that the average small investor can really filter it and get it and believe it. There is that information out there. There is also a lot of crap out there, and telling the crap from the real stuff is much more difficult than in the past.

Bethany: I agree with that, but at least, the information is out there. So, I still see that as a positive, and I agree, it’s really, really difficult, but at least it’s possible, whereas in the past, it wasn’t even possible.

Luigi: You might be right, but I see a strong parallel with the world of fake news or alternative reality. It’s true that in the past, there was an oligopoly of newspapers that determined what the truth was, but also, there was some etiquette among this oligopoly that it was very difficult to support completely unfounded ideas.

There may have been a common bias, but it was not possible. Today, there is what fraction of the American people who thought the 2020 election was fraudulent, and why is that the case? Because we lack a common validator, to some extent, of the system. We need somebody to pay the cost of validation.

A little bit like in cryptocurrency, who pays the cost of validation? In a purely competitive market, nobody pays it. And so, you don’t have validators. You need some form of oligopoly to pay some rents. In a civil-law country, you have public notaries who earn a fortune to validate transactions. Why do they need to be paid a fortune? In this way, they don’t cheat because the rents they make by behaving are so large they will never deviate. That’s what validators are. I’m not saying they are the most efficient thing on the face of the Earth, but without them, we have a problem.

Bethany: I agree with that. The difference I see between what was and what is today is that there was accountability. When I wrote about Enron, I had to call Enron and I had to say: “Here are the things I’m alleging. Here are the facts I’m using. What are your responses?” The Enron guys flew up to Fortune, and we had this very stressful meeting in Fortune’s offices. But the point is, I had to call them. I couldn’t just publish it. And if you, as a writer, made too many factual mistakes, you were likely to lose your job. There was a cost to all of that.

I don’t think that exists in many channels today. I think that’s a journalistic issue or an informational issue, and it’s also a broader societal issue. What I mean by that is that that old-school notion that if you’re going to say something about somebody, you should be willing to say it to their face, is really true.

In the old world of journalism, if you were going to print something about somebody, you had to be willing to say it to their face first and give them a chance to respond. That level of accountability is what makes free speech work. Without it, we’re all at risk of misinformation or, at least, more at risk of misinformation, than we were in the old world. So, I agree, that’s been lost, and I think that’s a problem.

Luigi: Yeah. Have you read the book The Constitution of Knowledge by Jonathan Rauch?

Bethany: No, I haven’t.

Luigi: I think it’s worth reading because he talks about science, but it can be applied to journalism as well. At the end of the day, what makes a truth is that there is a consensus among people with a certain reputation of being experts in that field. That’s what science is about. It doesn’t mean that the experts are always right. In fact, historically, we have seen a lot of examples of experts all being wrong.

However, it is a useful way to accumulate knowledge. Once you break those conventions, you cannot separate what is true from what is false. As you said, there are some advantages because new ideas can circulate faster, and especially if you search hard, you might find the bad news that before was suppressed, and we are less subject to groupthink.

However, I think that for a society to function, we need to know what is scientifically true and what is scientifically false with a high degree of precision, which doesn’t mean certainty, but a high degree of precision. And also, we need to know whether a fact is a fact or not a fact.

Bethany: But weirdly enough, in the world of business and the world of short selling, there’s always been an argument that you don’t need a public consensus about what truth is because the truth will out. What I mean by that is, even in the old world, there were some short sellers who would never, ever speak to the press because they didn’t believe they had to. The truth about the business was going to come out eventually because there was an underlying reality to it.

I still think that’s true today. Weirdly enough, the market may be the exception to what you’re laying out, where you don’t need to have a consensus around the truth because there is a truth, and it does actually out over time. If the truth hasn’t outed as much over the past decade or the past 15 years as it used to, I would argue that’s not a function of the decline of the role of the press in creating a truth so much as it is of the Federal Reserve’s interest-rate policy.

In a zero-interest-rate world, very few . . . It’s just as Jim Chanos says, the golden age of fraud. Very few things are going to get stopped because people are just willing to believe. So, is an argument out there that, as much as the past 15 years have been the golden age of fraud, we’re about to embark on another golden age of short selling, for a couple of interesting reasons? One is that with higher interest rates, it will be harder for shaky businesses to keep raising capital.

Businesses that are stable and produce actual cashflow will be valued more than those that might have the chance of producing cashflow at some distant point in the future. There are also some technical reasons around short selling in that short sellers now can earn a higher rebate than they ever have in the past. That makes short selling more profitable than it’s been in a really long time.

I’d go back to Jim’s comment that maybe the closure of his funds doesn’t mark the end of an era of short selling and that we might be on the cusp of a new era of truth in the markets, which does not negate at all what you’re saying about the rest of the world.

Luigi: I disagree on the fact that in markets, the truth eventually prevails because think about the case that we discussed of GameStop. It was a business that was dying. The short squeeze popped the price so high that GameStop ended up issuing stock at an overvalued price, and, as a result, the equilibrium price of GameStop now is much higher than it was before the beginning of the short squeeze. This is a situation in which you were right to begin with, but you could have lost your shirt, not only in the short term, of course, but also in the long term.

Bethany: I agree with that, but I’d also echo Jim’s point on that, which it I think that has more to do with market dynamics. You’re right, there are scenarios, and they’ve happened throughout the years, in which the truth doesn’t out. Perhaps I was speaking too broadly about that.

You can go back to AOL’s merger with Time Warner at the start of the 2000s. AOL would have crashed and burned, but it was smart enough to use its overvalued stock price to buy Time Warner. Not that that turned out to be great, either, given the decay in the magazine business, but for a while, it worked.

There have always been these market dynamics that are separate from the truth. GameStop, to me, proves the point of what I was saying because GameStop’s ability to issue equity, yes, was a result of a short squeeze, but also, it probably wouldn’t have been possible if interest rates hadn’t been where they were, if we’d been in a more restrictive environment with the Federal Reserve, and people had been more skeptical. We were at the height of pandemic-induced mania with super-low interest rates.

I don’t think we can separate this conversation about the truth outing from Federal Reserve policy, although, yes, I agree with you. There has always been this dynamic throughout history where a market dynamic can enable a company that should have failed to save itself.

Luigi: I understand, you hate power. You want to blame power for everything.

Bethany: No, no, no. But, look, the last decade and a half of almost free money has left a lot of distortions out there.

Luigi: I agree. But the biggest distortion is probably this belief that prices will always go up. In that sense, it is the legacy of this period, and that’s hard to defeat. I don’t think that can be overturned quickly by a change in interest rates because now, interest rates are well above zero, so it will take a while for this to have an impact.

Bethany: Among investors, people do try to think about market dynamics separate from a company’s fundamentals. In the old world of investing, the view I tried to lay out that the truth will out, that’s one way of thinking about it. But then, there are these market dynamics that change over time, whether it’s the role of index funds and ETFs in passive investing, in creating these self-fulfilling prophecies for a while . . . In momentum investing, when stocks go up, they keep going up. Investors have to think about market dynamics as separate from a company’s fundamentals because each one can be really meaningful.

Luigi: Yeah. Plus, I think that the business of short selling is a very risky business, and there is the famous saying that the market may be wrong longer than I can be solvent. I think that short sellers do need the news to get to the market relatively quickly if they want to profit from the trade. This friction in the certification of news is a major impediment to effective short selling.

Bethany: I would argue not. Don’t forget, there is another mechanism for dissemination of news, which is a publicly traded company’s quarterly financial reports. And so, yes, one way a short seller might look for a catalyst is by having a journalist write a piece or putting their own piece out there on Seeking Alpha or on Twitter today alleging improprieties.

But another catalyst is a company’s quarterly financial filings, in which they, at some point, have to admit what’s actually going on. And so, there is that other channel for dissemination of news or for the truth to out.

I would argue that might be the one that matters, at the end of the day. In other words, even in the old world, if I had written that piece about Enron, and Enron’s business had actually been great, then nothing would have happened. Enron would still be in existence. My piece would not have created a self-fulfilling prophecy.

The problem was that Enron and its quarterly financial statements eventually had to admit the bad news and that there were all these things going on, and that’s what cratered the stock. That channel of dissemination of information has always existed. I’d argue it’s the more important one for ultimately certifying the truth.

Luigi: I think you have more trust in auditors than I do, because Wirecard and other financial frauds prove that financial accounts can lie for a long time. As long as you find a complacent auditor—and, unfortunately, there are plenty of those—you can go on for a long time.

Bethany: Well, that’s another subject and one we should talk about, which is complacent auditors. I agree with you, by the way. What I’m saying is not an absolute. As we’ve talked about, I don’t think the truth always does out. I think there are lots of exceptions to that argument, but there still is a channel for the truth outing, and there is an argument that it could eventually happen, if a business is fraudulent enough.