“…in virtually all cases of major financial market fraud over the past 20 years, the only people who really brought forth the fraud into the light were either internal whistleblowers, the press, and/or short-sellers. It was not the normal guardians of the marketplace – regulators, law enforcement, external auditors or people like that — that did it. It was people who had an incentive to come forward either for personal reasons or for profit to point out what was going on at the Enrons and the Sunbeams and Worldcoms. Short-sellers played an important role in the marketplace not only in terms of capping, sometimes, irrational exuberance in terms of prices, but also in ferreting out wrongdoing.” – Jim Chanos, Interview with Lynn Paramore, Aug 2013
In late 2008, when Federal Regulators were in a mad scramble to contain the fallout from the housing bubble that had inflated and then exploded right under their noses, one of the prime targets of the drastic regulatory catch-up measures that were being implemented was short selling. Indeed, for a period, the Securities and Exchange Commission took the unprecedented move, among others, of temporarily banning the short selling of almost 800 different financial companies on the market.
Short-sellers make easy scapegoats in times of mass uncertainty and crisis, and this has been the case since at least the fabled tulip craze that took place in the Netherlands in the early half of the 17th century, one of the regulatory responses to which was an English ban on short selling in the aftermath of the popping of the tulip bubble.
To a certain extent, it is understandable that the practitioners of short-selling would find themselves well within the range of motion of reflexive institutional responses to financial crises. After all, what kind of individual has no moral qualms about betting against companies, and doing so for a living? Do we not want all companies to do well?
While the actions taken by the SEC against short selling in the immediate wake of the financial crisis may have had motivations other than simply giving the general public the impression that “something” was indeed “being done” to deal with the situation, they certainly played into a facile stereotype about the function of shorting.
Jim Chanos is perhaps the most legendary short seller of our time and throughout his career has embodied the positive role that short selling can play in the marketplace, especially if this marketplace is to be characterized as a “free” one. He was among the very few who were able to identify ahead of time the rotten underpinnings of companies such as Enron, as well as the housing bubble that unleashed so much chaos upon its collapse in the latter part of the previous decade.
Chanos was born to Greek parents in Milwaukee, Wisconsin. After graduating from Yale in 1980, he proceeded to make a name for himself as an exacting analyst whose strategy was predicated on “intensive research into stocks.” By 1985, Chanos had developed quite a reputation for himself and started up his own firm Kynikos, the Greek word for “cynic”.
The word “cynic” is broadly defined as an attitude full of distrust for the motivations of others, based on the assumption that most people operate on unrealistic or selfish motivations. But the original Greek meaning of the word is far more nuanced, and by no means nearly as pejorative. Indeed, cynicism was one of the many philosophical schools of thought in Hellenic Greece. Its precepts, virtuous living, being in harmony with nature, and the shunning of conventional desires, meant that cynical philosophers often lived as mendicants and beggars.
It is easy to forget that the practice of philosophy in ancient Greece was not limited exclusively to academics as it is in the present. Diogenes of Sinope (not to be confused with Diogenes Laertius), one of the school’s most well-known thinkers, was referred to by his detractors as “the Dog,” an accusation he is believed to have rejoiced in. His retort: "other dogs bite their enemies; I bite my friends to save them."
This historical anecdote should provide some insight into how Chanos sees what he is doing, aside from making money that is, and the example from praxis that never gets old despite how often it is repeated is the case of Enron.
Chanos and his firm took a keen interest in Enron in 1999, and began doing research on the company. At the time, the company was winning the title of “America’s Most Innovative Company” by Fortune Magazine every year (for six years straight). But Kynikos had their own ideas about Enron, and after about two years of research had come to the conclusion that the company was more or less lying almost every time it spoke to its shareholders about its finances and earnings.
In November of 2000, when the stock had just broken $90 per share and was working towards price targets of $130 and greater, Kynikos initiated a short position that would grow with time. Within a year, the company’s scandalous behavior left many previously breathless analysts with egg on their faces, to say nothing of the regulatory bodies tasked with watching out for such malfeasance.
And though Kynikos walked away from the whole affair richer, the whole debacle presented an object-lesson in the upsides of short selling, as a sort of corrective mechanism for overvalued (or deliberately inflated) companies. Indeed, Chanos and his firm were pretty much the first to have spotted what turned out to be the massive boondoggle going on at Enron, and were also the first to say so by taking their short position on the company’s stock at a time when investors were getting carried away in what was essentially a manufactured bullishness.