Chapter 1: What is the main topic discussed in this episode?
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You certainly ask interesting questions.
Bloomberg Audio Studios. Podcasts. Radio. News. The legendary Wall Street short seller Jim Chanos also spoke out about private credit not so long ago. He said, quote, now with the advent of private credit, institutions are putting money into this magical machine that gives you equity rates of return for senior debt exposure, which, again, should be the first red flag.
We rarely get to see how the sausage is made. Jim Chanos joins us now. He is president and managing partner of Chanos & Company. He is here with us exclusively. Good to see you again, Jim.
Good to be here. Thanks for having me.
So you heard what the CEO of Barclays said about this idea of whether it's one bad actor or some aspect of circumstances that leads people in companies to behave a certain way. What does your spidey sense tell you?
Well, I teach a course on the history of financial fraud, as you know, and one of the themes of the course is that the fraud cycle follows the financial cycle with a lag. And the more extreme the financial cycle, i.e., the bigger the bull market is, Usually more fraud follows thereafter with a lag. So you don't really see the large amounts of fraud until after the cycle turns. This is early.
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Chapter 2: What concerns does Jim Chanos have about private credit markets?
This one's pretty extreme. I mean, we're now really 16 years into a bull market in credit, in equities. It's getting more speculative. We saw a mini speculative blow off in 2021. We're seeing it again in 2025. Standards get reduced, as I like to say, people's sense of disbelief.
erodes over time, they begin to believe things that are too good to be true because there's pressure to put investors' money to work. And I think some of that's happening now in private credit.
So the stock market has barely blinked with all these blow-ups. The credit market kind of dismissed them as idiosyncratic until Jamie Dimon warned about the prospect of more cockroaches. And then that kind of got people's attention just a little bit here. At what point does this become something that the credit market starts to panic over?
Well, we haven't seen it yet, as you say. Credit spreads are still almost record, record lows. So people are still partying. You know, if the punch bowl is being taken away, only a couple of people may have noticed it yet. But so far, it's still partying like it's 1999 in the credit markets for the most part.
What I found really fascinating was that Jamie Dimon didn't really target private credit in his comments. He kind of just made the comments generally. Yet the industry got kind of defensive when he spoke up. Are these firms justified in doing so? I mean, you point out that they have promised these equity-like returns that raises questions about the economics of their business.
Yeah, there's two things that bother me. The way private credit is being sold to investors, and I sit on investment committees, so I see this. And really, it's one of these too-good-to-be-true type promises.
We're going to give you senior debt exposure, often secured somehow, but with equity rates of return, double-digit type returns, which makes you wonder about the underlying credits themselves. That's number one. And then... Related to that is how much leverage is being used within the vehicles to juice the equity-like rate of return.
And then the other thing that's concerning to me is the explosion now in captive regulated subsidiaries by the largest largest players in this area, owning insurance companies. And where there really isn't a true arm's length difference between the people buying the credit and the people selling the credit to them. And that is worrisome. That's something we saw in the Drexel days, by the way.
One of the things that got us so concerned in 1988 and 89 in the Drexel junk bond kingdom was the fact that more and more of Mike Bilken's clients had regulated subsidiaries like savings and loans, insurance companies, thrifts, trust companies, where they were buying the same credit that, in effect, others in the kingdom were selling without a lot of arm's length disclosure.
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Chapter 3: How does the financial cycle influence fraud according to Jim Chanos?
Everyone talks about it. Every asset management firm wants to be able to offer. Every bank seems to want to get in after missing out.
Sort of like private equity five to ten years ago.
Exactly. Everyone's a stakeholder, so it feels like everyone's kind of incentivized to make sure that whatever happens stays an idiosyncratic story and nothing more.
Right. Or hedge funds 15 years ago. Yeah. Look, these things are being sold aggressively. It's a wonderful product for people that have targeted rates of return needs, endowments, pension funds. But again, it's just something that worries me when equity rates of return are promised on credit instruments. Usually there's something you're not seeing.
Let's talk about something that may or may not be worrying to you, which is what's happening in big tech. They are investing tens of billions of dollars to build out data centers to boost their AI capabilities. They announced partnerships where they take equity sticks in each other and buy stuff from each other. Is this so-called circular funding a problem in and of itself?
Does it raise your antenna?
Well, what we've told clients, because we went through the first time we saw this in 99, 2000, 2001, where there was a lot of circular financing and vendor financing. Back then it was the telecoms. But the customers that were taking that vendor financing from the Lucents and Nortels of the world... were predominantly profitable.
The Celex raised about $45 billion over five years, competitive local exchange carriers. They had a flawed business model. Most of them went broke. And then the fiber optic guys did build-outs, and most of them had to be restructured or went bankrupt.
But we were talking about $100 billion of vendor financing over the five years or so that it was happening, which was a lot at the time, but it pales into comparison of some of the numbers we're starting to hear about, both this year, next year, 27, 28, for the capital needs of the AI companies. And that's a red flag.
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Chapter 4: What red flags should investors look for in the current credit market?
So the problem in 2000, 2001 was basically, wasn't really vendor financing. As I said, that was all in about $100 billion over five years. The real problem was double and triple ordering of equipment, where people put in orders for routers and network equipment and capacity, and then... Basically, all at once, in late 2000, early 2001, they pulled back. We don't need all these routers.
We don't need all these switches. We don't need all this fiber optic gear. And order books just collapsed. And S&P earnings dropped 40% from peak to trough. The S&P dropped about 40%. There was a mild recession. GDP dropped about 1% for two quarters. It really was not like the global financial crisis or even 89-90 when we had a banking crisis.
But it was terrible for corporate profits because there was so much basically steroidal profit participation, profit margins from all this. So that's what we're kind of keeping an eye on is order books and looking for any signs that suddenly maybe we don't need all of these router GPUs or all of these data centers or what have you.
And it's not just things tied to AI. I look at the $55 billion takeout of Electronic Arts marking the biggest LBO ever. It's deal-making like it's 2007. Going beyond the order books of the big tech companies, as an inherent skeptic, what are you watching for to get a sense of how and when the music stops?
Well, again, we want to see the underlying profitability of the engine, right? Will AI come up with a profitable business model? Because right now, if you think about it, open AI is, I think, roughly two-thirds of all queries in AI are open AI. And they're going to do $13 billion of revenues this year, $30 billion next year. with capital spending needs in the hundreds of billions of dollars.
So at some point, someone's got to come up to say, we actually have a model that will directly lead to cash flow and profits so we can service the debt that we're taking on to build the data centers and build the infrastructure. And we'll have to see. I mean, what I've said is I'd rather be long-term
the companies that are producing the magic from the chips than the landlords of where the chips reside, right? So if this is going to truly be revolutionary, and it probably will be, I think you're going to have to see stuff coming out of the hyperscalers and open AI and really interesting applications that can be monetized.
I think a lot of investors, however, are basically investing in the picks and shovels, the data centers, the equipment guys. And I think that's, at the end of the day, going to be a commodity business.
Okay. Well, eventually it will be. As of now, it hasn't gotten there yet. Jim, stay with us because we're going to discuss a lot more, including some of your trades. This is Bloomberg.
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Chapter 5: Why is Jim Chanos skeptical about the current state of private credit?
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This is Bloomberg Markets. I'm Scarlett Fu. We are back with Jim Chanos, founder of Chanos & Company. Jim, I want to get an update on your bet against MSTR, Strategy. And to be clear, this is not a bet in which you, Jim Chanos, are anti-Bitcoin. You're kind of agnostic on where the price goes.
You just don't believe that the stock should be trading at this hefty premium to the value of its Bitcoin simply because Strategy owns Bitcoin and is raising money to buy more Bitcoin. Where are we at here?
So you're exactly right. I mean, we're agnostic on Bitcoin. I have no idea where Bitcoin is going or what it's worth. But we own Bitcoin against the micro strategy short. This was an arbitrage. And we just, as you know, we just weren't and aren't believers in this whole concept of Bitcoin treasury companies trading at premium to the underlying asset.
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