James Chanos on Washington Actions and Long-Short

From Jim Chanos' interview with Chrystia Freeland of FT.com on January 23 2009. Watch the full interview with Jim Chanos, of Kynikos Associates, at VIDEO ON FT.COM

James Chanos, president of Kynikos Associates, is the world's biggest short-seller. While short-sellers are rarely popular among politicians and CEOs, the current economic crisis is a salubrious business environment for professional bears like Mr Chanos. A second-generation Greek-American whose father owned a chain of dry cleaners in Milwaukee, Mr Chanos studied economics at Yale before beginning his career in finance, working first in Chicago then moving to New York.

Now 50, he is best known for his prescient shorting of Enron and the work he did to expose that company's fraudulent accounting. In a video interview earlier this week with FT.com, Mr Chanos said he is bearish on healthcare, defence and for-profit education companies. He warned that the hedge fund industry needs to get used to the idea that there will be "lean years" as well as fat ones: his own fund, he said, has shrunk from $7bn to $6bn because cash-strapped investors are treating it "like an ATM".

An ardent Democrat, Mr Chanos spoke to the Financial Times in Washington this week, where he had travelled for Barack Obama's inauguration. Edited highlights from his interview appear below.

How much worse are things going to get?

No one knows for sure.

The last few weeks has seen fear re-enter the banking system, both here and in the UK. The [Bernard] Madoff affair also did a lot of damage to confidence.

Are people right to talk about nationalising the banks?

I don't know. We almost have it de facto for our largest institutions. The real crux of the problem [is] people still don't believe the numbers.

What will it take for people to believe the numbers? There is still a bit of Pollyanna in the air. We don't really know where these banks have marked these assets, because the news is still surprising us on the downside . . . The magnitude of these writedowns is still somewhat staggering.

What do you think of [head of the Federal Deposit Insurance Corporation] Sheila Bair's idea of creating some sort of aggregator bank?

We continue to violate all of Walter Bagehot's principles on lenders of last resort . . . As long as we continue to do that we are empowering the worst decisions, we are rewarding the people that got us here.

Are we running out of people able to run these big banks?

I don't know that we could do a whole lot worse than the people who have been running them lately.

Should the banks be lending more?

Prior to this the banks would lend to anybody with a pulse, and now even JP Morgan himself probably couldn't get a loan. It is a chicken and egg problem; you have people who are completely creditworthy, who probably don't want to borrow money now, and the people who do are your lower creditworthy borrowers and the banks are terrified to expand their balance sheets.

Isn't it prudent for banks to hoard capital now?

They should be coming clean with investors and with the government on their methodology for marking these assets and their loan loss reserves, and giving the Street as much transparency as possible.

Why isn't it happening?

Because so far the surprises seem to have been on the downside. I think there is still a lot of damage on these balance sheets that has not come out. My guess is the number is going to be over the trillion [dollar] mark when all is said and done.

What effect has [the alleged Madoff fraud] had?

It was a blow to confidence exactly at the wrong moment, when things seemed to be getting better, and injected that nasty concept of fraud into the equation.

Will we see changes in taxation for hedge funds?

We already saw it very quietly. One of the most attractive aspects of hedge fund management was taken away in the Tarp legislation, which was the tax referral for offshore managers. That very quietly went away, and that was a big deal.

Are you worried about a climate of criticism over pay in financial services? [People] should be upset.

Bankers still took home, and my hypothesis is that in fact they never really made the billion dollars.

That's the problem: we are going to find out when we go through the accounting that in fact these things were never that profitable.

Is America's financial capital moving from New York to Washington?

Power is beginning to shift, clearly, because of the government investment in these firms.

And anyone who doesn't see that is kidding themselves.

Have you identified any surprising areas of weakness in the economy? The three areas we are focusing on would be healthcare, defence and the for-profit education business. All those areas are going to be under a lot of pressure under the new administration.

What is the big thing everyone is missing?

The next battleground is private equity. It is going to be very tough for the industry to look at Washington with a straight face and say "Gee, you've got to be hands-off with us", while they are laying people off who are voting. That is going to be a PR nightmare, and I wish my friends in private equity good luck with that.

This is the week Barack Obama became president. What significance does that have?

I think the world is looking to America for a new beginning; I think a lot of Americans are too, no matter what your politics. The president-elect is hosting a dinner for John McCain, his defeated opponent, which is a very class act.

Long or short?

Oil? Long
US dollar? Short
GE? I'm going to hedge
Citigroup? Long
Ford? Short
Google?Long
Blackstone stock? Short
John Thain? A tough one. Long
HSBC? Long
John McCain? Long.