“I actually thought the story was pretty innocuous, but it gave credibility to a 24-year-old analyst,” says Chanos. It also made him think he might have a future in shorting. “That’s when the light went on with me. We started getting calls from clients asking, ‘What else does Chanos not like?’” In 1985, he and a partner, James Levitas, launched Kynikos with $16 million—$1 million of it their own money, the remainder from a single client. (The name of the company comes from the Greek word for “cynic.”)
Reporters kept calling, too. James Grant first met Chanos at a dinner in 1984, a year after Grant had left Barron’s to found Grant’s Interest Rate Observer. The two hit it off and have been friends ever since. They shared a nose for financial excess and chicanery, which they chased through both its 1980s incarnation (Drexel Burnham Lambert, Michael Milken) and the commercial real estate bubble that followed.
But Chanos also learned early on that the media can turn on you. A September, 1985, Wall Street Journal article accused him and several other prominent short sellers of underhanded tactics such as spreading rumours about companies. And he’s been getting hit with the same rap ever since: Chanos is an opportunist who quietly spoon-feeds reporters to cast a cloud over target companies. “I think every good investor is an opportunist,” says Grant. Over all, he says, Chanos is “a crusader for truth, justice and The American Way.”
Chanos makes no apologies. “We do not call journalists. They call here all the time.” When they do, he’ll explain his research. “We live by the rules,” he adds. It’s a crime to “knowingly pass on information that you know to be false.” In any case, he sees some hypocrisy in the name-calling. It’s fine for money managers and brokers who are long on a stock to explain why, but if a short dumps on a stock, “Oh my God, it’s pitchforks and torches.” In the final analysis, “The market is the ultimate arbiter.”
You’d think it would have been easy for short sellers to hit the jackpot during the tech bubble of the late 1990s. The stock market valuations of many dot-com start-ups were absurd—hundreds of times earnings per share in some cases. If there were earnings.
The trouble was that the sustained bull market that began in the early 1990s was very punishing for shorts, and particularly so for Chanos’s long-term approach to shorting. He’s no rapid-fire electronic trader who holds positions for milliseconds during market plunges. His usual strategy is to have his analysts comb through the financial statements of a potential target company. If they can develop a detailed thesis of why the stock is overvalued, Chanos will then take a hefty short position and wait for the market to catch up with him—sometimes for years.
But if stock markets as a whole keep climbing, the rising tide tends to lift all shares. “The general direction of the market shouldn’t matter, but it does,” says hedge fund manager Bill Fleckenstein, president of Seattle-based Fleckenstein Capital. Kynikos’s assets under management plunged from about $600 million in 1990 to about $150 million in 1995, and the company needed an investment from publishing heir Dirk Ziff to keep going.
Even as many fabulously overvalued dot-com companies began to blow up toward the end of the decade, Chanos struggled to hang on to his clients. Then as now, those clients were mostly pension funds, endowment funds and other institutions. Many of them were afraid of getting out of a bubble too early and falling behind rivals. “In the world of, say, pension investing in 1999, if you’re not in technology, you’re running significant career risk,” Chanos says.
The mechanics of shorting were problematic in the tech bubble, too. Shorts need to borrow stock, and the hot young companies that gave the bubble its particular effervescence often hadn’t issued a lot of it.
Fortunately for short sellers, the bubble burst in 2000 and dragged the rest of the market down with it. The Standard and Poor’s 500 index declined by almost half from 2000 to 2002. The hangover from a decade of greed also exposed several blockbuster accounting scandals. Chanos was a prominent and outspoken short in two of the biggest: Enron and Tyco.
Both calls played to his strengths—ferreting out elaborate accounting irregularities and guiding inquiring reporters through his findings.
Houston-based Enron enjoyed a gold-plated reputation—the energy giant was a stock market darling throughout the 1990s, and was named “America’s Most Innovative Company” by Fortune for six years in a row, 1996 to 2001.