Carson Block (3:36)

I will try to nutshell this but I grew up in investing. My father was an equity analyst and was working with him from 99 to 02 alongside covering micro caps. And we were just getting lied to incessantly by these managements and back then they had 45 days to file their forms for so we take them on non deal roadshow to meet institutions. Stock would go up and then we'd find out later that they hit the bid. So this is the same time that you had the largest companies in the world like Enron, WorldCom, HealthSouth, Adelphia blowing up an accounting scandal. So my realization around 2002 I was really demoralized. It's like look, I want to be an investor but this market is riddled with financial predators from top to bottom. How do I protect myself against that? So I went to law school with just this amorphous idea that that would give me some tools and fast forward decided to practice law. Ended up in China. Jones Day left to start the first self storage business in mainland China. I don't recommend it and anyway I was just sort of, you know, keep trying to keep that business from failing. In 2009 when my father got really excited about a bunch of these Chinese companies that had gone public in the US via reverse merger and like I had my own problems, I wasn't really that interested. But he asked me to look and he asked me to look at this first one called Orient Paper. And first thing he told me he'd been at a conference that these guys had gone to and you know what he's hearing is oh, you know Chairman Liu, he's different from other Chinese company chairmen. He doesn't smoke and he doesn't chase women. And you know, my father's telling me this while I'm in, you know, late night in Shanghai and I'm like, I'm sure neither of those things is actually true but the fact that this is making its rounds at the conference, somebody is trying to game western investor psychology. So that got my attention early 2010 went up to see the company and it was a Potemkin factory. Like I never Believed that such a thing could exist where at the time its market cap was 150 million, had just reported $103 million in revenue and the real revenue 2 to 5 million dollars. That it was these empty boxes. So I exposed that with a 30 some odd page report. And the only reason I did that was I felt like I was stuck in my business in Shanghai, like a few hundred people who are leaving their stuff in my facility. The industry did not exist because it's a bad industry to be in in China. And I don't know, there's like a power and feeling like you have nothing to lose. So I just threw the ball as far down the field as I could, wrote that report, it went viral, quickly found out this was systemic. And one year later Bloomberg's like, oh, he's one of the 50 most influential in global finance with Ben Bernanke and Warren Buffett. And it's like, well yes, of course that's the natural path from self storage.

Barry Ritholtz (6:50)

That's every 30 page analyst report tends to lead to that. So it's funny because you and I kind of came of age in the markets similar period. The dot com implosion was certainly fundamental to my view of both markets and short sellers. And then the financial crisis. How do you look at how the markets have changed over the ensuing decade as between QE and zero interest rate policy and more recently the CARES act and the masked fiscal stimulus. I grew up thinking short sellers were the ones who kept the market honest and responsible. That seems to be a minority view these days.

Carson Block (7:33)

Yeah, well I've come to the view that there's an inverse relationship between interest rates and the amount of dishonesty in society. So the lower your rates, the more easy money is, the more dishonesty you get in society. And so the emergency monetary policy outlived the emergency. And what I felt is that just each year I've been doing this that investors are more and more anesthetized to risk. Now the flip side of that is that behaviors that were once really only present in micro cap land, well those bubble up to mid cap land because of the inflation of market cap. So on one hand my business has gotten harder because unless it's something really, really egregious, people don't care. But then, yes, you'll find that type of behavior now even in mid cap companies and in an environment where, and just to be clear, it's a small minority of companies that are frauds. The world's bigger problem is the gray zone, the things where yeah, Nobody's gonna get convicted. Lawyers have signed off. The auditor is okay with it. And that gray zone behavior whereby you can significantly misrepresent economic reality, that is almost maybe the norm in many respects.

Barry Ritholtz (9:05)

So the secret is to corrupt the attorneys and the auditors and then it's home free.

Carson Block (9:09)

Wait, corrupt the attorneys.

Barry Ritholtz (9:12)

Right. So. So you mentioned micro cap, small cap, mid caps. I read a note of yours not too long ago talking about the big caps and the mega caps where so many people have been calling this a bubble and so many people have saying, gee, I'd like to shorten video. You kind of went out of your way to say, hey, maybe one day there's a downside play here, but this freight train is really difficult to step in front of. What are your thoughts on. On the hyperscalers, the mega cap tech companies?

Carson Block (9:44)

Three things. Number one, there are easier better shorts out there than Nvidia. Number two, the reason why I was making those comments is that flows have driven so much of this. Like you have, obviously the passive bid. And it squeezes floats. And by squeezing floats, it's not a linear impact on stock prices and it's a parabolic impact on stock prices, at least of the winners. So the idea that something is overvalued, that's a reference to its fundamental value. But I think you have to consider its technical value. And that's what everybody fails to say when they're criticizing these things on a fundamental basis. It's like, well, what are the technicals of this? Now that's my second point. My third point is, up till one month ago, I was completely sanguine on the on S and P and markets in general and the economy. And My view has 180. And I think the wrong question is, well, what do you think of the valuations or stock prices of X, Y, Z of these AI companies? And the right question is what is about to happen to society and to the market as a result of AI and I. And like I said, I'm 180 on this. Like a month ago, I wouldn't even refer to these models as AI. I had this rule. These are large language models. They are not going to create new information. They merely process information that's already out there. Don't call it AI, they're lms, but I call it AI now, right?

Barry Ritholtz (11:19)

They're neither artificial nor intelligence. They're something else. But given that and given this 180. But we're going to dive right into AI in a minute. But since you built your reputation before the firm has pivoted into a full service research shop, both long and short. You've criticized SPACs, crypto, thematic ETFs, NFTs. Where has there been the biggest destruction of investor wealth in that group?

Carson Block (11:50)

Well, in that group, okay, so it's a little bit in vogue, I think, to pull point toward private credit right now. And the reality is like, who knows, right? There's no data. It's really opaque. My concerns there, and I recognize that data is not the plural of anecdote. But in the past few months, some of the research we've done, I've looked at some ABS issuers and this is not private credit. But I was really surprised to see as I went down the rabbit hole of ABS issuances, that a lot of the paperwork that should be done to basically show release of liens of loans that are being securitized and filed publicly, that paperwork is not being filed publicly. And I at first I thought, oh my God, we've got these guys on fraud. They're selling off loans that are still encumbered. And I spoke with a couple of securitization attorneys and they said, no, no, no, that's market practice. The, the warehouse lender just provides a letter saying that the liens are released. It doesn't get filed publicly. And so I asked each of them, well, what's to stop the sponsor of the securitization from forging the letter? Because he thinks like, look, the loans are. The ABS's are already over collateralized. I can double pledge these because if the warehouse lender, if it's not public, the warehouse lender wouldn't know if somebody forged it. Huh? Yeah, that's a good point. And so when I see that the largest financial institutions are not dotting I's and crossing T's, that conversation with somebody recently who gave me a data point from a private equity firm that's doing a lot of clos. The conversation from somebody who's on the PE side going to the CLO guys is like, hey, so what do we know about the performance of the underlying loans? How are they performing? Why would we track that? We don't service them. Like, this is reminiscent of right out

Barry Ritholtz (13:45)

of the, right out of the big short.

Carson Block (13:47)

Yeah, this is reminiscent of some of the behaviors and credit. So then, okay, I combine, again, it's not data, these are anecdotes. But I combine that with also what I noticed starting a few years ago. You know, every time I talk to an allocator, you know, we're actually, we Run a fund. We're a hedge fund. So you know, we're talking to allocators all the time. And you know, what do you, what are you guys investing in? Everybody all of a sudden starts saying private credit, private credit, private credit. You know, that also reminds me of the Internet bubble because the way I used to think about that as it was happening is there's too much money chasing too few investable companies. So I don't think if there are problems in private credit, like my first bet is not that it's at Apollo, but I also know we have looked at the insurance industry and so I know a lot of these insurers have been bought by smaller PE firms. I mean, they're basically using these things to finance their deals. The FT did a great article Alphaville a few months ago on the credit ratings agencies. I mean it's not even S and P and Moody's. The number one is Egan Jones. So corporate headquarters is like an eight bedroom house in suburban Boston, literally. And I think they did like 2000 deals last year that they rated. I mean, if you lived through the GFC and we're paying attention, starting to see some dots connect. So that does have me worried also. And if that does intersect with what I think could happen in the labor markets from AI job displacement. I know you want to pivot back to it, but I'm just going to put it out there. I think it's not unrealistic to say 15% of knowledge work jobs in the US in three years are gone. And if it's not three, it's going to be five. But it might not be 15, it could be 20, 25%. I mean that's. And I can work through how I got there.

Barry Ritholtz (15:38)

Let's dive deeper into AI. It's both an investable asset, a shortable asset and a tool that you're using to run a business. So I want to hit each of those things, starting with how are you using AI as a tool to manage a business, to identify long and short opportunities? What is true? I not just LLMs mean for your daily work?

Carson Block (16:08)

Well, I mean in the past gan since finding Religion just a few weeks ago, I mean this is something I've been hammering. Most of my employees have worked for me for over 10 years. We're, we're an old firm for a hedge fund. I mean, I used to joke that this is probably true, that if you look at trips and falls per dollar of aum, we maybe are the highest in the world. And that was kind of funny. To say, until I started saying, guys, why are you literally taking months to put together 150 page slide decks to discuss something internally? Stick it in the machine. And so one of my analysts, my longest serving employee, ex auditor, super bright, but always struggled with communication. I mean, one of my skills was over months, weeks or months, many, many hours, trying to draw out of her the patterns that she sees, but she's just unable to elucidate. Now she's just pumping out the memoranda from Claude. And I'm like, wow, this is, I mean, Cindy, this has saved us like, you know, probably five weeks of, you know, like frustrated conversations in the conference room like this. So from that perspective, it's helping, I think, hurting a little bit. You know, I've, I've always felt that we have an edge as activist short sellers over our competition. In terms of how I write and communicate, like that edge is gone. I mean, you can go to Claude and say, hey, you know, write this up as a short report in the voice of Carson Block. And you know, it's not bad. I mean I, it gets you a lot of the way there.

Barry Ritholtz (17:52)

So, so let me flip the question on you and ask how has AI changed the fraudsters toolkit? What can Claude do for a fabricated document? Deep fakes, fake video, fake voice fake docs, fake everything? Has it just become an arms race between the good guys and the bad guys?

Carson Block (18:16)

Well, look, I mean the tools for forgery never really needed to be that sophisticated. I mean, one of my favorite examples of that was the Peregrine Financial. That guy had a post office box and an inkjet and that's how he forged his auditor letters. And you know, that was a few hundred million.

Barry Ritholtz (18:34)

But Bernie Madoff did not exactly use the most sophisticated technology.

Carson Block (18:39)

Yeah, I think the, I think the thing that will get to be more interesting is if you're a company CEO and you know, you're kind of, you know, like you're pumping your stock price, you're monetizing it and hitting the bid. I think the more interesting thing is querying it. You know, if I were the CEO of X, Y, Z company, what would a short seller focus on? You know, like, what should I do about that? So I think that we're going to get in this cat and mouse game of preemption and reaction. But I mean, at the end of the day, I mean, if you're, you know, if you're just ramping your stock price and mortgaging your future and I think as activist short sellers, we'll still get there. But you could at least dig a wider moat around your, you know, around what you're doing if you use these AI tools.

Barry Ritholtz (19:29)

So I always think of short sellers like Jim Chanos and the original guys who really pioneered forensic accounting as being so deep into the documents. How useful are tools like Claude Cowork as a forensic accountant to help either identify patterns in every SEC filing or honing in on a specific company's filings and seeing what doesn't smell right.

Carson Block (20:00)

For me, that's a little tbd. I don't know yet. I mean, I'm not sure that you can just upload a 10K and say, oh, you know what, what's dodgy about this? I mean, first of all, one of the, one of the secrets, it's not a secret, but of what we do is we obtain documents from places people never look. So again, like we're, you know, we're pulling UCC files to look at asset securitizations. We love companies that have overseas subsidiaries because most overseas jurisdictions there are publicly filed financial statements. So we'll pull those and upload them. And then also, I'm sure it really helped connect the dots with people. I mean, right now or up till now, we've had to rely on memory. Like, oh, wait, yeah, this dude. You know, we've looked at 58 entities. This dude was in that entity. Oh, interesting. So the AI is going to get rid of. It's going to make that part easy. But you still have to go out and do the legwork. And you know, a lot of times you have to send people in person to do document retrieval. So I don't think it's as simple as, you know, hey, I woke up today and I want to be an activist short seller. Like, you know, which, you know, Claude, which company should I write about and you know, what's my thesis like? You have to still do a lot of legwork. But the, the accounting stuff, Claude has demonstrated internally, again, turning my, you know, my accounting analyst, the former auditor, turning her poorly expressed thoughts into actual words, you know, and of course she's iterating with it. No, no, no, that's not what I mean. But it's got real accounting knowledge. Oh, well, according to asc, blah, blah, blah, this does not meet the definition of the data. And wow. I mean, that's, it's really interesting. I mean, look, I think at the end of the day, part of the edge of being an activist short seller is the willingness to be sued or the tolerance for being sued. So I'm not worried that a bunch of people are going to run out and like, commoditize this. And. And I think at the end of the day, also having a brand where if everybody can produce skeptical, you know, pieces, it's also knowing when the model is kind of bull. You. Right. Like, because that happens too. I mean, these things are sycophantic. Like, wow, that's brilliant. But of course it's a fraud, Carson. Like, you know, no, to say nothing

Barry Ritholtz (22:17)

of double checking for hallucinations. And a bunch of lawyers who have been using AI keep getting into trouble because it's citing cases that don't really exist. And the judge's clerk also using AI, discovers these cases don't exist. But you mentioned a word that's really fascinating. You mentioned edge. If all the participants in the markets, long and short, are using the same tools, is there any edge to be had there or is it really about how you're applying these tools, where the edge comes from?

Carson Block (22:53)

That's an interesting question. I mean, look, on the short side, you only make money if people care, right? And so I think that's been the problem that most. So since the gfc, almost everybody who was running money principally focused on short strategies has gone out of business. I mean, some. They rode off into the sunset, made a bunch of money, most carried out. I think the problem that a lot of the short sellers have had, and I had this too, and I have to actively correct for it, is you tend to view the world the way it should be, not the way it is. And so that's the problem. Like when people short, you know, Tesla because, you know, Elon Musk this and that, like, nobody cares, right? And that, that's, that's the thing. So I, I think you, to be good on the short side, you have to understand why people are buying the stock. And you have to have a view that goes directly against that or that undermines that thesis. And I think so much of the time that doesn't happen. So I don't know. I don't know that this erodes the edge of just of judgment when it comes to the long side or short side. And then on the long side, I mean, kind of buy what the smart money is buying. Seems to have worked. Like, I hate to say it, but, you know, again, technicals versus fundamental value. The technical value of something, you know, like, I don't know that AI helps a ton with that right now, but it certainly can.

Barry Ritholtz (24:24)

Let's talk about AI pretenders, and I'm pulling something Else you had written a while ago. And there's a little bit of a rhyme with late 90s, every company added a dot com and their stock would see a pop. What are you noticing amongst the fake AI stories, the fake pivots, the companies that really have nothing whatsoever to use to do with AI, other than two or three people who work for the company, have a perplexity app on their phone. Tell us about the narrative of AI pretenders.

Carson Block (24:56)

Well, I, look, I think if all of a sudden a company has started talking. So I first did this shortly after I started on the, on the short side, cloud became the thing, right? And so then saw some companies that had just done a global find and replace, like, you know, find this, replace it with cloud. And so if you see that with AI in a company's filings and in their statements, then yeah, I mean, they're probably a pretender. I think it's pretty clear, you know, AI, real AI requires scale. I mean, whether you're on the process, on the hardware side or you're, you know, or you're actually producing the AI models. So I don't know everybody who's like AI enabled and look, I'm out over my skis here because I don't really understand the technology, but everybody who's AI enabled, it's like, well, what's the foundation? You know, if you are an AI enabled, this, what are you running? Are you running Perplexity Claw chatgpt? And if you're like, well, I made it myself, like, no man, like I'm not going to buy that, you know, like these things have cost way too many billions of dollars to develop for you to be able to vibe code.

Barry Ritholtz (26:05)

Your AI short sellers are always looking for a downside catalyst. When you start thinking about the mega caps, the hyperscalers or anybody else that's really blown up in value and in price that's created a little bit of an air pocket. Has that catalyst come in yet? Or is there something off in the future that's going to lead people to say, hey, this has gone too far, we need to take something off the table.

Carson Block (26:33)

Well, if you take my view that a lot of these names have traded based on their technical values as opposed to fundamental, then you need to get into, okay, like what, what are the underlying technicals here? So I'm a fan of a guy named Mike Green. So I think Mike is going to prove to be really prophetic. And so what he's been saying since maybe 18 or 19, is that so passive has broken the Market, you know, don't disagree, but that when the flows, especially the buying from the target date funds tapers off and then you get net outflows, that's when you get, as he calls it, or was calling it, 1929 magnitude crash at fill in the blank with the year speed. And that's what scares me about AI because like I said, if this thesis is correct, that then three years or a few years, 15% of knowledge workers have lost their jobs, okay? It's not like they're going to find new jobs. It's not like, you know, fiscal or monetary stimulus creates new knowledge work jobs. They are going to, and they all have college debt, mortgages, car leases, eventually they're going to start hitting up their 401ks. And so first they stop contributing as they're laid off, then they need that money and they start taking early redemptions. And so if Mike Green is correct that when that happens there's nobody there to catch the falling knife and the technicals have basically for, you know, better since the GFC just created this tremendous amount of air, that's when it's really time to panic. Because that, that's what I think. That's what's going to make his thesis, that's what's going to test his thesis. And if you asked me five weeks ago did I think that we're in any danger, anything on the horizon in terms of seeing reversal of 401k flows and significant rise in unemployment, I would have said no. I was completely sanguine five weeks ago. And like I said, I've 180, so

Barry Ritholtz (28:50)

I can't leave on that much of a downbeat note. So for the last question, you run a long short funds. If that's the downside of AI, if that's the negative we're seeing in the world of white collar work, what's the long side of the portfolio? What looks attractive through and on the other side of whatever happens with either the AI thesis or Green's thesis.

Carson Block (29:19)

Well, okay, the tough thing is there obviously are going to be companies that benefit from AI, right? And so they're the hyperscalers. But if you have, but if they're in the index, which they all are, and they're major parts of the index and you have index fund flows. Well, the bull case is that over the long term they're going to be, you know, there's going to be a great buying opportunity. So I'm not sure that's where you hide out. I mean what, what we've been doing for the past month is creating a set of what I think are highly convex trades in the book, especially basically shorting credit. So it's not like the lead up to the gfc. There's not, you know, deep CDS market. But I think, I mean, credit spreads are stupidly tight and credit volume is stupidly low. So to me, you want convexity. And there are lots of ways to pay it where you're capping your potential loss. That's how, that's how we're approaching it. So like, and look, I hope this doesn't play out. I mean, I because I don't have like a plan B or C after AI takes, you know, like my job. But, you know, at least as it does play out, we're, we're positioning for it.

Barry Ritholtz (30:28)

That was my conversation live at Future Proof Citywide Miami with Muddy Waters, Carson Block. If you enjoy this conversation, well, check out any of the 600 we've done over the past almost 14 years. You can find those at ITW, YouTube, Spotify, Bloomberg, wherever you get your favorite podcast from. I would be remiss if I didn't thank the crack team that helps put these conversations together each week. Alexis Noriega is my video producer.

Vanguard Representative (31:02)

Anna Luke is my regular producer.

Barry Ritholtz (31:04)

Sean Russo is my head of research. I'm Barry Ritholtz.

Vanguard Representative (31:07)

You've been listening to Masters in Business on Bloomberg Radio.

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