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By Stephen Long - PM - Wednesday, May 30, 2007
MARK COLVIN: Jim Chanos was the first big US investor to expose Enron as a fraud.
Tonight, he's told PM why he thinks that Macquarie Bank is a 'house of cards'.
Macquarie's staff have made billions by buying assets around the world and spinning them off into funds and trusts controlled by the bank. The bank collects fees all along the line.
But Mr Chanos says this economic model can't last. His key concern is that the Macquarie Bank funds pay their shareholders not out of income they earn, but from borrowed money.
They continually revalue their assets, then borrow against the asset values to fund payments to investors.
He also says the structure encourages serial overpaying for assets, and that Macquarie is relying more and more on unsustainable self-dealing between the bank and its funds to make money.
This report from our Economics Correspondent Stephen Long.
STEPHEN LONG: Jim Chanos has made a fortune picking stocks that are ripe for a tumble.
He was the first big investor to say Enron was a fraud.
He's not saying there are crooks at Macquarie Bank. Simply, that the model that's made the bank billions is unsustainable.
JIM CHANOS: I guess the heart of our criticism of the bank is the model itself, this so-called Macquarie model.
STEPHEN LONG: The Macquarie model is now world famous. The bank scours the world buying assets, everything from toll roads to bowling alleys, and selling them into separate trusts that the bank controls.
This generates triple fees for Macquarie Bank: one for the up-front purchase; a second for selling the assets into the trust; then ongoing management and performance fees from the funds.
There's been much discussion in Australia about whether this raises a conflict of interest.
Jim Chanos' critique is more fundamental.
JIM CHANOS: The underlying economics, in my opinion, are flawed. Being the top bidder for these assets and then flipping them into the trusts leads to an unsustainable economic engine at the trust level. And when that breaks down all of the fees and whatever's being paid begin to break down.
STEPHEN LONG: Macquarie's funds pay their investors out of borrowed money and that's one of Jim Chanos' key concerns.
They revalue the assets they own then borrows money against the re-valuations to fund the payments to investors, a strategy that could founder when, inevitably, the period of cheap credit and asset price inflation comes to an end.
JIM CHANOS: And this is the real crux of the problem on an ongoing basis. If you look at the financial accounts of the trusts you'll see that in almost all the cases the companies are using Australian re-valuation accounting which is legal under GAAP (Generally Agreed Accounting Principles) in your country to write up the value of the assets annually and put that through operating income and into equity.
STEPHEN LONG: And your worry then is that the payments to the stockholders are being funded essentially by debt and re-valuation not out of income.
JIM CHANOS: Re-valuating and borrowing against that stream. So you need willing lenders, you need a credit environment that looks the other way, or you need a credit environment where the people lending are just lending on reputation and not numbers.
STEPHEN LONG: The man who blew the lid on Enron has other concerns, too. He says the fee structure encourages serial overpaying for assets because Macquarie gets fees based on the size of the assets it spins into its trusts.
He says the Macquarie model relies increasingly on unsustainable self-dealing between Macquarie and its funds.
And then there's the huge levels of debt and leverage.
JIM CHANOS: Capital gains alone in the fiscal year 2007, the year ending March 2007, capital gains alone of Macquarie flipping these types of assets into the trusts and elsewhere accounted for half, roughly half, of the pre-tax income of the bank. And that alone should be enough to call into question the quality of earnings.
STEPHEN LONG: If we came to the end of this extraordinary period we've been in, of cheap credit and escalating asset prices, asset price inflation, where would that lead Macquarie in terms of those capital gains?
JIM CHANOS: Well, I think that they would be greatly diminished or non-existent.
STEPHEN LONG: Although they're perfectly legal and transparent, Jim Chanos says the techniques Macquarie Bank uses have some similarities to those used by Enron.
JIM CHANOS: Let's just say, Stephen, I'm apparently not the first one to make those observations. That's exactly what they appear to be doing.
STEPHEN LONG: Macquarie Bank's boss Allan Moss says short of complete disaster, people will keep driving on toll roads no matter what.
Jim Chanos says that misses the point.
JIM CHANOS: All I would tell your listeners, Stephen, is simply just go in to the trusts, financial statements, and simply extract out the asset re-valuation number which is basically management's guess as to how much, what the asset's worth and just see what the cash flows look like if you take that out.
In many cases the cash flows are diminished or actually go negative. That's the simple litmus test to the Macquarie model.
STEPHEN LONG: Well, Jim Chanos, how concerned should we be that pension funds in Australia are major investors in the Macquarie Bank trusts?
JIM CHANOS: Well, if I was a pensioneer, in your country and my pension fund accounts owned some of these trusts, I would urge the managers to look at the financial accounts closely and not just look at the yield they're getting but look at how that yield is being received.
Is it actually from the economic output of the assets or is it from asset re-valuation which is simply writing up the paper value of the assets and borrowing the money against it.
These pension funds, which are answerable to the pensioneers in your country, if they're comfortable with that, well, great. If I was a pensioneer I wouldn't be.
STEPHEN LONG: Plenty of people disagree. Brian Johnson of JPMorgan is Australia's top rating banking analyst. He says Jim Chanos will join a long line of people who've lost money betting against Macquarie.
BRIAN JOHNSON: A lot of money is being lost basically shorting Macquarie Bank over the years. And while the model is certainly not without risk, the fact is the size of this potential market is absolutely massive.
STEPHEN LONG: So take your pick. Macquarie is either poised to run the world or heading for trouble.
MARK COLVIN: Stephen Long.
We were told Macquarie Bank's Chief Financial Officer, Greg Ward, would respond to Stephen Long's story, but he is yet to call.
