The implosion of world financial markets was caused by the bursting of bubbles of excess liquidity in the U.S. These bubbles were created by the massive current account deficit in the U.S. and the world’s willingness to finance that deficit, according to Ezra M. Safra, managing director of M. Safra and Co., a money management firm in Sao Paulo, Brazil. What is the most appropriate investment strategy for these times? In an interview with Knowledge@Wharton, Safra advocates caution – because rushing to make a decision when the markets are highly volatile is like “trying to catch a falling knife.”
Safra belongs to one of Brazil’s best known business families. His father, Moise Safra, was a founder of Banco Safra, Brazil’s 10th largest bank. He sold his stake to his brother Joseph in 2006. Safra spoke with Knowledge@Wharton in his office in Sao Paulo. An edited transcript of the interview appears below:
Knowledge@Wharton: What do you think of the world financial crisis and its impact on Brazil’s economy?
Ezra Safra: My guess about what is going on with the world financial system is as good as anybody else’s. The situation is fluid; it is changing rapidly with policy responses around the globe changing on an hour-by-hour basis. But the fundamental question is the implosion of the real estate bubble in the U.S., and some other asset bubbles of excess liquidity that existed in the U.S. dollar market.
These bubbles were created by the deficit in current account that the U.S. has been running for many years now and the willingness of the world to finance that deficit. That, in turn, generated a huge amount of liquidity within the U.S. market that created the asset bubble. By the end of the summer last year, it was clear that there was a serious problem with subprime mortgages. This escalated, as everybody knows, to the rest of the mortgage sector and hit the financial sector very seriously first in the U.S., then in Europe, and finally across the world. That, in turn, created a huge confidence crisis among banks in general. There was complete distrust between players, between banks to lend to one another, and between people to make bank deposits. Banks saw a huge flight to safety.
Then the governments stepped in, and said, “Our banks will no longer go under.” They did this in the hope that it would create willingness among people to trust the banking system and start reinvesting in the safest assets first. You start with the safest assets – such as bank deposits – and then you go down the ladder. This takes time, because people usually take time to make their own decisions. I believe money will start flowing back into the banks slowly. Hopefully the confidence and trust issues that we had in the financial system will start decreasing slowly. That does not mean we will be able to avoid the recession. It is obvious to everyone that the world would go into a recession. The U.S. is in a recession, and the world will have to grow at a slower pace than has been growing in past years.
Knowledge@Wharton: How will Brazil be affected?
Safra: Brazil is a player in the world economy. The “crisis” took a little longer to affect Brazil, but it got here. It was perhaps naive of people to think that would not affect this country, because commodities for a while stayed at a high level. Now commodity prices are coming down, and Brazil, at the end of the day, is a big commodity exporter. As the prices of commodities come down, this will affect Brazil.
The credit crunch in Europe, the U.S. and Asia has affected Brazil. Banks in Brazil were very reluctant to lend to each other, as well to lend to people. In Brazil new credit was growing at an annual rate of 30%. Bank loans were increasing. It is my estimate based on anecdotal evidence that banks have pulled back credit considerably. They are not making new loans; they are just rolling over loans. In addition, the exchange rate has moved quite a bit, with a lot of volatility, at a very fast pace. So, we have an exchange rate issue and we have the contraction in bank credit.
Knowledge@Wharton: Brazil has a considerable stockpile of financial reserves of about $200 billion. Do you expect the government to deploy that in some way to protect the currency? What will be the impact?
Safra: It is being deployed. It is very interesting — besides the $200 billion reserves, there were about $20 billion to $30 billion of foreign currency swaps in the local market. The Central Bank was long the U.S. dollar rate – the U.S. dollar exchange rate versus the Real – and it has been getting out of those swaps. It is a different way of selling dollars in the market, making dollars available. They have been doing this, though they have sold very little compared to the size of the reserves. I expect them to continue to do it, but I do not think they will target a specific exchange rate. This is being done to reduce volatility because if the exchange rate stabilizes at a certain level I think it is good. When the exchange rate is volatile, it is very hard to make decisions.
Knowledge@Wharton: To what degree are Brazilian companies vulnerable to currency swaps that they may have entered into at a time when they expected the Real to keep rising against the dollar? Now that the currency has gone in the opposite direction, they are trying to cover their positions. How serious is this problem?
Safra: This problem has been in the news. Some companies came out apparently with some issues that were short the dollar, long the Real, more than what they should have. It is a serious issue for some companies. In the medium term, this tends to get washed away, but it creates volatility in the short term because these companies have to cover their dollar liabilities. When times are good, people tend to do more than what perhaps it is prudent to do. This is natural.
Knowledge@Wharton: Part of the challenge in the U.S. has been that one financial institution after another has been revealing serious problems. As a result, the market keeps waiting for the next shoe to drop – and this creates tremendous uncertainty. Will the problems in Brazil be similarly serious?
Safra: No, I do not think so. What is driving the market now is that Brazil in recent years has been a favorite country for investment. People were over-invested in Brazil, and now a lot of deleveraging is going on in the world. First the banks were deleveraging, now the hedge funds are doing it. Banks no longer lend to them as much as money to buy or to sell. Since there is less leverage around, there are redemptions from some of these hedge funds. This creates forced selling, and it exacerbates the downward pressure on the market.
Knowledge@Wharton: You spoke earlier about investing in the safest assets. At a time like this, when the market is heading towards the bottom, usually it creates buying opportunities. Do you see such opportunities today? If so, where?
Safra: It is clear that some companies’ valuations are extremely cheap. Some companies are very cheap. I would favor companies that have low leverage, low debt maturing and not cyclically exposed, less cyclically exposed such as retailers for instance, such as utilities. I think probably there are a lot of bargains out there. But nobody is going to buy today if they think they can buy tomorrow cheaper. So you need to wait for things to stabilize a bit.
Knowledge@Wharton: What will your investment strategy be for the next 12 to 24 months?
Safra: It is hard to say. The scenario is very uncertain. At this point we are very defensive in our positions; we are basically all cash. We are waiting and watching on the sidelines because there is no reason to jump now. It is like trying to catch a falling knife. Anyone who tries to catch a falling knife hurts himself.
Knowledge@Wharton: Where do you see the biggest risks?
Safra: The biggest risk is in economic activity. How severe will be the economic downturn? The financial markets have priced in the worst scenarios. The asset prices are priced at the worst. The question is how severe the recession will be and how long it will last.
Knowledge@Wharton: Is there anything you would have liked the governments to do that you have not seen them do so far?
Safra: It is very hard to ask the government to do something. The government has to be careful — it cannot guarantee everything to everyone. Then the guarantee is no longer credible.
Knowledge@Wharton: Turning now to your company, you belong to one of the most respected business families in Brazil. Could you tell us about the history of your family in this country and where your investment and money management firm fits into the family’s operations?
Safra: We are a money management company. We recently took the initiative to raise money from the public in general. M. Safra and Company was founded by Moise Safra, my father. He was one of the founders of Banco Safra, one of the 10 largest banks in Brazil. He founded this bank with his brother [Joseph] and he sold out in 2006. Now he basically dedicates his time to investments, to charity and things like that. That is the history in a nutshell. Ours is an immigrant family that came to Brazil from Lebanon in the mid 1950s. They established banks in Brazil, in the U.S., Switzerland and Luxembourg. That is the history.
Knowledge@Wharton: How do you differentiate your investment strategy from others who may be offering similar services?
Safra: I think though alignment of interests. Our strategy is to do for our clients what we are doing for ourselves. We are big investors in our fund as well, so that leads to alignment of interests between the managers and the shareholders of the fund. That is the biggest differentiation. Of course, we have an extremely good management team, with well seasoned managers with very good education, very good work experience. We look after our investments.
Knowledge@Wharton: Could you tell me about your own background and how you came to be the Managing Director?
Safra: I have been the Managing Director of this company for a little more than 10 years since late 1998, when we started the company. When my father founded the company, I was with him, and before that I was working at the Republic National Bank of New York in Switzerland doing asset management. I moved to Switzerland after I graduated from Wharton. Before my MBA degree, I was working for Republic National Bank of New York, which was one of my family’s banks. The major shareholder was my late uncle Edmond and I was working in the M&A department at the bank, proprietary M&A. So we were buying some banks at that time, retail banks. Before this I was at Wharton undergrad and before that I was in Brazil. I was born and raised in Brazil.
Knowledge@Wharton: In the course of your career in money management, what is the biggest challenge you have faced?
Safra: The biggest challenge is attracting the best talent – having the best people working with you who are also committed, who have a long-term horizon with the company. Finding the right people, the team, and getting true commitment from them is the toughest challenge.
Knowledge@Wharton: How do you define success?
Safra: I define success as being happy with yourself. If you are happy with what you do and with your personal life, you are successful.