But Chanos was certainly right on the money on the U.S. subprime mortgage crisis. In April, 2007, he and hedge fund manager Paul Singer were asked by Bob Steel, an old Wall Street friend who was then undersecretary of the U.S. Treasury, to deliver an hour-long briefing to the G7 finance ministers’ meeting in Washington. Chanos and Singer explained that the major American banks and brokerage firms were highly vulnerable to a real estate bust because many were leveraged 30-to-1 or more, and were holding large amounts of dubious mortgage-backed securities and derivatives.
The banking and stock market meltdowns of 2008 resulted in a hugely profitable year for Chanos, but also a frustrating one. The first major domino to fall on Wall Street was the investment bank Bear Stearns, which collapsed in March. As the end neared, Bear Stearns CEO Alan Schwartz lashed out at short sellers. For Chanos, the experience crossed into the bizarre. He wasn’t short Bear Stearns, and the day before the collapse, Schwartz asked him to go on television to say so. Chanos refused. “I was stunned to get that phone call,” he says. “Here they were trying to co-opt a short seller to tell the market everything was fine. Talk about misdirection.”
Chanos says he spent much of the summer of 2008 doing what a long-term short seller should be doing: buying. That meant closing off roughly one-quarter of Kynikos’s short positions—ones in U.S. home builders and financial sector stocks. Yet he also railed against short-selling restrictions imposed by regulators. In July, the SEC banned so-called naked shorting of 19 major banks and brokerage firms, including Lehman Brothers and Merrill Lynch. Chanos doesn’t naked-short (the issuing of a sell order for shares you haven’t borrowed yet or have no likelihood of securing soon). But he says the regulator’s ban backfired—it screamed to the market that the firms were weak, effectively putting bull’s eyes on their backs.
In September, after Lehman collapsed, regulators banned shorting altogether on 799 American financial companies. Chanos argues this move made the ensuing global hemorrhaging much worse than it should have been. The crisis of confidence meant that banks and other institutions wouldn’t deal with one another to temporarily lay off risk. And investors wouldn’t buy their stock. “Beware of the law of unintended consequences when you start fiddling with the market just because you don’t like where prices are,” he says.
This past August, however, Chanos was buoyed when the United Kingdom’s Financial Standards Authority and the U.S. Securities and Exchange Commission declined to follow suit after European countries banned short selling. Shorts, at least the long-termers among them, argue that they actually help stabilize markets during massive sell-offs—they have to buy to cover their sale positions. “The FSA and SEC now do seem to consider evidence before they implement policy,” Chanos says drily.
So what’s the evidence on China? Sitting in front of a whiteboard that takes up a whole wall in Kynikos’s boardroom in midtown Manhattan, Chanos argues that not only are many Chinese companies, including banks, hugely overvalued, but so are Western companies that have been swept up into the bubble—building contractors and resource producers and the like. And there’s more. Chanos and other shorts say that many of the hottest Chinese investment plays may be out-and-out bogus, particularly so-called reverse takeover stocks—companies that do most or all of their business in China, but which have secured listings in North America.
In June, Sino-Forest Corp. , a company listed on the Toronto Stock Exchange that owns and manages timberlands in China, garnered worldwide publicity when its share price plunged by almost 90 per cent after a report by a mysterious young U.S. short-seller, Carson Block, alleged that it is a massive fraud—a charge that company executives strenuously deny. Chanos wasn’t short Sino-Forest, but he says it fits the pattern.
Chanos says he and his analysts first began digging deeply into China’s economic statistics in the summer of 2009, after seeing that commodity producers were relying heavily on Chinese demand. In one favourite anecdote, Chanos says that one of his analysts reported a Chinese government forecast that the country would build 2.8 billion square metres of Class A office space over the following couple of years. “I said, ‘You’re off by a factor of 10.’ And he said, ‘I thought the same thing, and I’m not.’” It helps to convert the number to square feet, says Chanos. “That’s basically a five-foot by five-foot office cubicle for every man, woman and child in China.”