James Chanos and Jim Grant Stand Up For Capitalism

Thank you for joining us. I want to come to you both. Jim, I want to start with you. This plan that has been floated by Chuck Schumer, Senator Schumer, an RFC-like plan to hold a lot of these toxic assets. First of all, what is your thought about this kind of plan? Is this at all effective, do you think?

JIM CHANOS, PRESIDENT, KYNIKOS ASSOCIATES LTD.: Well, I haven’t seen the details. I’ve been a little preoccupied with a few other things the government has been putting down
the pike in the last 24 hours. I assume, if done right and done under the right circumstances, as the RTC model showed us, it could work. But right now the magnitude of some of these problems, the jury’s got to be out, certainly, from my perspective.

FOX: Jim Grant, what do you think? Are we going to solve this problem?

JIM GRANT, EDITOR, GRANT’S INTEREST RATE OBSERVER: Senator Schumer talked of the RFC, which was a New Deal creation which speaks to the constant harking back to the Depression and the comparison of these circumstances with those. Let me say about that that in the Depression the GDP went down peak-to-trough by 45% in dollars. The economy was sawed in half. That’s why they had debt problems.

Today, we have debt problems with what may or may not be a recession. In any case, the nominal GDP in dollars is rising. This speaks to a unique and unprecedented calamity of incompetence among people who earn seven and eight and up figures a year. This is the scandal and these talking heads who talk so blithely about the taxpayers money and the RFC ought to consider just what a horror show Wall Street and its facilitators have brought us to. This is a scandal of the first water.

FOX: Tell us how you really think, Jim. Don’t hold back here. I want to know. So what do you think? Is this a plan that you think -

GRANT: No. How about this? How about capitalism? How about capitalism? What no-one has stood up for in the past couple of truly-frightening weeks is the institution of markets - I mean, some have. But what you hear is let the Fed do this, let the Treasury do that, let’s have a plan and maybe we need a plan. Maybe AIG could not have been ``let go,’’ but let us at least pause over the cadaver of free markets and take off our hats.

The heroes of this saga is Bloomberg’s columnist, Michael Lewis, to point out. The short sellers are, in fact, the truth-tellers. This is free speech.

FOX: This is, in fact, what we’ve heard from Josh Rosner at Graham Fisher talking a lot about your ability as a short seller or an investor to take either side of the trade. You’ve heard, obviously, what happened in the UK - the banning beginning at midnight UK time - the banning of short selling and financial stocks. How can you operate in a market that seems to just have the rules changed on a
regular basis?

CHANOS: Well, to amplify one of the things Jim just said far more eloquently than I ever could, is that we seem to have capitalism on the up-side and socialism on the down- side. And that’s a pretty heady brew for a country that holds itself out as free-market paragon.

I would also point out that right now the United States’ credit as measured in the infamous CDS market now has nine nations ahead of it in terms of lower risk of sovereign default, including some nations, I think, we’d rather probably not in the past have considered ourselves in the same league.

(CROSSTALK)

FOX: - has come a long way.

CHANOS: I think even France might be one of them. But in any case, so we do seem to have this sudden disconnect at a time when, as Jim points out, the economy is still nominally not declining rapidly and arguably possibly not declining at all.

FOX: Let me cut to (ph)- let’s begin the conversation. I know you want to talk about what’s going on at Merrill Lynch and B of A. There was an interesting point you want to make there. But let me just pose this to both of you. What if the government does nothing? What happens to the value of people’s portfolios, the value of people’s bank accounts, if indeed we do start to see people pull their money out of banks?

If as you say, Jim, that not only are the heads of Wall Street, but some of the political figures not really playing fair and square with capitalism, isn’t is possible that in their neglect or if there is no plan that we’re going to have an even bigger crisis?

GRANT: Our system has become like a hothouse flower. It has been nurtured and pampered with Federal intervention, Federal subsidy, the so-called Greenspan Put, the ever- present, first-responding Fed. It was financial accident, the Fed had been there. People got the idea that there would be no trouble, hence the promiscuous extension of credit at spreads over Treasury Bills that you could not have believed only a few years ago.

So the question is, if all that is suddenly withdrawn will people get hurt? Yes, because the entire country has organized its affairs along the lines of no-one getting hurt, really, of there being no serious down-side to an excess.

FOX: But don’t you make it sound as if anybody had any choice? Maybe the people at Morgan Stanley, maybe the people at Goldman Sachs, maybe the people at the Fed had a choice,
but most individuals, they just had to go along and take what was being offered.

GRANT: Most of us are price-takers in the world. But the people who are in business to choose and to lead and to make judgments based in part upon common historical knowledge failed miserably and almost to the man and woman.

FOX: Jim Chanos, let me ask you. Talk about the issue having to do with extending credit right now. Who’s extending credit to who? And if the whole system seizes up, doesn’t that eventually hurt even the short seller, because you can’t cover your shorts?

CHANOS: Well, ultimately getting paid would be the ultimate irony of a short seller. But short sellers have a few other worries right now that are ahead of that. I noted today that Bloomberg ran a very interesting story as the heat is on short sellers for supposed rumor mongering and driving down the price of the stocks of these august (ph) financial institutions.

I noted that Bloomberg reported that John Thain told his employees that part of the problem a week ago that caused the cascading decline in his stock price was that Bank America pulled their credit lines from Merrill, the firm that eventually bought them a week later.

So I think it’s going to be awfully interesting if we do start investigating really what’s going on in these markets and who really is driving prices down, if anyone is at all, with knowingly false rumors, which has always been a crime, by the way, to find out if it wasn’t other banks doing it to each other and trading ahead of that knowledge.

FOX: Let me ask you, then. If indeed - let’s just put the short selling criticism aside, in terms of policy -

(CROSSTALK)

GRANT: I’d like to do that.

FOX: Let me give you a couple of minutes to breath easy for a little bit. Tell me, is this is market that you think - we saw this late-day rally today. Step back just a minute, give us a little perspective. Where do we go from here? Is this still a market that is going to decline? I know, Jim, I want to ask you about housing and its connection to the market. What do you see right now?

CHANOS: I defer to Jim on these questions. He’s much better in markets than I am. We have a longstanding view of not having a view on the market. We have views on -

FOX: How about a view on the financial system right now? You shorting anymore financial stocks?

CHANOS: We are as least short the financial sector as we have been in three years right now. And we’ve been public on that for a while. We were not short any of the investment
banks, the so-called five or six or - and the reason is simply conflicts of interest.

We don’t short people we do business with. Having said that, I think that we are seeing all kinds of interesting areas, mostly abroad and mostly in the area of infrastructure build-out, construction of the third world. If I could short Dubai I would short it, as a concept of a country and things like that.

The other big looming story out there and interestingly enough I’ve been talking to Federal officials about it - they occasionally ask my advice prior to trying to put me out of business - is the looming crisis in municipal finance and that is coming.

With the implementation of new GASBY rules at the end of this year where state and local taxing authorities are going to have to put on their healthcare and retiree benefits - much like corporations do - onto their books, I think people are going to be stunned at the level of unfunded liabilities in our local governments.

I note that East Hampton and South Hampton, the two- toney neighborhoods on the east end of Long Island, basically just in effect went broke this summer.

FOX: So we’re going to see a lot more of municipal defaults?

CHANOS: Well, the irony is is just as everyone decided to get out of the municipal bond insurance part because of structured finance and get into it because the business of insuring municipalities was a good business -

FOX: Not anymore, it seems.

CHANOS: I think it might not be.

FOX: Jim Grant, let me come to you and talk about the housing market for a moment. In the most recent issue of Grant’s Interest Rate Observer I am shocked to find - to borrow your phrase, shocked - to find that you’re actually looking at maybe, maybe suggesting to people that they should be looking at mortgages - Alt-A, subprime - that not everything is as horrible - or it may be as horrible, but
indeed what we see is people being overly pessimistic?

GRANT: Good parts of these markets and these structured loan products, these kind of science projects that Wall Street produced so fast and so poorly in the boom, a lot of these things are priced as if the housing market is going to collapse from here, at least twice as far down as it has come already.

Two things about that that are odd. One is that the ventures (ph) bonds of companies like Target, like Walmart, like JPMorgan Chase, like some of the home builders, these bonds are priced for a relatively normal business cycle - not great, but not bad. If housing prices are going to collapse again, the same - through the floor, people are not going to be going to Target in such great numbers.

So what you find in some of the Alt-A - meaning better than subprime, not so good as prime, and subprime structures - what you find are loans that we think are probably money- good trading at unleveraged - meaning plain yields without doctoring, if you borrow money - of 16%, 17%, and up, contingent, of course, upon the sun coming up in the East, upon the economy functioning - even in a recession - upon housing not collapsing down 40% or 50% in peak-to-trough prices.

Now we compared this with Treasuries, which are yielding, what is it nothing or a little more?

(CROSSTALK)

GRANT: So the Wall Street Journal has one stock phrase, it is ‘super-safe Treasuries’ and another stock phrase is ‘toxic mortgages’. So we change and the front page headline said, ``Toxic Treasuries and Super-Safe Mortgages”. So no asset class is inherently good, bad, attractive or repellent; it all is about price. No bad bonds, just bad prices for the trader’s sake.

So we think that of all things these orphaned, abandoned and despised mortgage structures are beginning to present some compelling absolute value. No doubt, they’ll get more value-laden in the way of the world. These things never stop going down just because they are value-laden, but we think that it’s time to start looking for opportunities where people have been mainly looking for disaster.

FOX: All right now, I’ve got about 30 seconds. I wanted to just ask you about risk right now, Jim. How do we get to a new risk model? Didn’t people plan for the sun not coming up in the East?

CHANOS: I think the SEC’s coming out with a rule (inaudible) the sun coming up from the East, so stay tuned.