September holds the dubious honor of being the month that marked two cataclysmic events with profound global impact: the Sept. 11, 2001, terrorist attacks that ignited the war on terror, and the Sept. 15, 2008, bankruptcy filing of Lehman Brothers that marked the beginning of the global financial crisis.
“This is an incredible week, I think in the U.S. and for the whole world,” said Wharton Dean Geoffrey Garrett, who moderated a panel of Wall Street veterans at the Tarnopol Dean’s Lecture Series on ‘The Future of Finance: 10 Years After the Financial Crisis.’ “If I look back on the first 18 years of this new millennium, the two most important dates are 9/11 and 9/15.
“Today, we’re looking back, and looking forward, on the 10th anniversary” of the financial crisis,” Garrett said. The crisis was followed by the Great Recession, and “amidst all of that, I think we had literally unprecedented, coordinated global economic policy action.” Post-crisis, he said, the recession was so deep that global trade declined 30% in one year after three decades of yearly gains. “We had a very long recovery, but most people think it’s been a much shallower recovery than others in American history. And we continue to have more financial innovation — it just looks different from the period before.”
Sharing their recollections of the crisis and prognostications for the future were Robert Wolf, former CEO of UBS Americas who now heads 32 Advisors; Marc Rowan, co-founder and senior managing director of Apollo Global Management, one of the world’s largest private equity firms; James Dinan, founder and chairman of York Capital Management; and Ruth Porat, former CFO of Morgan Stanley now CFO of Google and parent Alphabet. She joined the panel by video. (Watch a video of the complete panel discussion using the player below.)
Wolf remembers that fateful weekend before Lehman Brothers’ collapse. He got a call on Friday right around the close of the market to come to the Federal Reserve Bank of New York building in Manhattan from his office in Stamford, Conn. He would later find out that he was one of a dozen executives who had been summoned — 10 were U.S. CEOs and two came from foreign firms UBS and Deutsche Bank.
Wolf said he walked into a room and saw the who’s who of Wall Street, many of whom are no longer in their positions: Merrill Lynch CEO John Thain, Morgan Stanley CEO John Mack, Citigroup CEO Vikram Pandit, JPMorgan Chase CEO Jamie Dimon, and others. “We didn’t know what the situation was at that time,” Wolf recalled. “All of a sudden, [former Treasury Secretary Hank Paulson, former New York Fed President Timothy Geithner and former SEC Chairman Christopher Cox] walk in and say, ‘We have until Sunday night to determine the fate of Lehman, and there will not be a government bailout.… We all were jaws down.”
Garrett asked whether anyone in the room objected to the government’s decision. “There were definitely challenging questions of why” there would be no bail out, Wolf said. But “they had made up their mind because of the backlash they had with Bear [Stearns],” which JPMorgan agreed to acquire after the government backstopped the deal.
That weekend, the plan was to split Lehman, putting the bad assets into one bank and good assets in another, Wolf said. The good bank could perhaps be shopped to billionaire Warren Buffett, Barclays, Bank of America or other buyers. The bank with the troubled assets would be financed by the group in the room. This was the plan as of Saturday. But on Sunday, the plan fell apart after the U.K. regulator would not clear an acquisition by Barclays. In hindsight, it was probably a good call. “The truth is, what is the good bank of Lehman? You don’t really know what was under the hood,” Wolf said.
Wolf noted that the ‘Lehman weekend’ witnessed the most cooperation he has seen among Wall Street firms, which normally compete against each other ferociously. “We were collaborative because we all knew what would happen on Monday morning if Lehman failed,” he said. “We were not collaborative because we actually cared about Lehman.… We cared about the outcome and [what] we used to call ‘fixed bayonets.’ You protect your own castle.”
Google’s Porat said back in 2008 she was asked by Paulson, Geithner and former Fed Chair Ben Bernanke to help lead a team to analyze what to do with Fannie Mae and Freddie Mac as the subprime-fueled mortgage crisis threatened to engulf them. She was also asked to help them with AIG, where a non-insurance unit that loaded up on credit default swaps was sinking the firm.
“To me, the most frightening moment in the financial crisis was actually AIG,” Porat said. During that ‘Lehman weekend,’ she went home on Sunday only to be called back to the New York Fed. “I got a call from Treasury [saying], ‘We worked on the wrong thing. Can you come back down?” Porat recalled. “It didn’t seem real at the time. Their comment was — ‘It’s AIG. AIG will be out of money by Wednesday.’ This was late Sunday night.”
Garrett recalled that period as well. He was in Australia, which has a highly regulated financial system that is largely insulated from Wall Street. But the country felt the tremors. “With the fall of Lehman Brothers, there was a near instantaneous freezing of credit markets in Australia — so much so that crisis meetings happening in Washington and London were also happening in Australia literally at the same time in real time. That showed me that this was truly a global crisis, and it was moving at warp speed.”
The Post-crisis World
But with the post-crisis reforms in the 10 years since Lehman Brothers’ collapse, is the global financial system safer today? “Absolutely,” said Wolf, who supported the Dodd-Frank financial reforms and was an advisor to President Obama. “The banks are much stronger today. Leverage in the system is probably 70% less.” He said U.S. banks recovered faster than European banks because “they took their pain and went on the offense quickly.… They understand when you’re on defense, you’re losing and when you’re on offense, you’re winning.”
“To me, the most frightening moment in the financial crisis was actually AIG.” –Ruth Porat
Apollo’s Rowan saw opportunity in the chaos of the crisis. As banks pulled back from the credit markets, his firm went in. “You have banks that are going through the fence and not lending. You have regulations coming in and pushing banks out of a whole lot of business. You have a regulatory environment where the best people no longer want to work in a banking environment. You have investors who need yield.” Indeed, Apollo went from managing $10 billion in credit before the crisis to $200 billion.
York Capital, a hedge fund, also did well. But Dinan initially didn’t expect it. Around late 2008 to early 2009, “we were looking at more existential issues that had not very pleasant endings,” he said. But remembering his experience in prior market meltdowns, Dinan said he learned that “when the dead start walking, that’s when you start paying attention.” York Capital went from “total risk neutral” to “total risk engage” and began investing. Before the crisis, York had a couple of years of losses. But in a few months, the firm had recouped it all.
Dinan shared another thing he learned in investing: “Credit investors smell the fear before equity investors do.” That’s because unlike shareholders, they don’t have a lot of upside but they assume the risk of debt defaults. He also gave his own spin on the popular Wall Street adage that the best time to buy is when there’s blood on the streets. “That’s sort of true, but not completely true,” Dinan said. “The best time to buy is when there’s blood on the streets, but not if it’s your blood.”
Porat said four lessons she learned in the crisis could apply to the world today. Every company and every industry needs to identify its source of vulnerability and protect against it when times are good. Also, build data analytics, strengthen risk measures and improve transparency so one is not running a business “with mud on the windshield.” Third, it’s important to have the will and the means to enact change. “Too often, by the time you have the will, you no longer have the means,” she said.
Finally, build a strong team. “How fortunate we were to have had Secretary Paulson … take that leadership role and to have President Bush have the judgement to really defer to the team that was assembled,” Porat said. “In my view, the country really benefited from that type of leadership, and we would have been dramatically worse off if we didn’t have a team that moved with that speed [to navigate through] a very tricky situation.”
Garrett asked the panelists what kept them up at night. What risks do they see emerging? Dinan said, “Right now, the situation in Europe is not very healthy. The third largest economy in the Eurozone, Italy, is undergoing a populist movement that could really lead to potentially the unraveling of the whole Eurozone. The ramifications would be too big.… I’ve hedged it out.”
Rowan is concerned about the surge in passive investing and ETFs. “A massive amount of the equity markets and the credit markets are now in the hands of liquidity-driven investors rather than credit or fundamental-driven investors,” he said. “Liquidity-driven investors buy something when they have cash and sell when they don’t have cash” instead of basing their investment decisions on fundamentals of a business.
Moreover, “if you’re a fundamental investor and you pick a stock that’s not part of the index, it’s generally not going to move,” Rowan added. “It’s unclear to me that fundamentals in the short and medium term will be reflected in the value of securities prices.… I think that destroys a lot of value. A lot of buy-side money focused on fundamental investors has moved out of their hands and into the hands of ETFs. If the buy-side was where regular folks went to get access to investment alpha [return], … I think it’s getting harder because the industry is getting indexed.”
Dinan added that the surge in investor money into ETFs is “basically making passivity and beta [volatility] a self-fulfilling prophecy, and it’s a great party while it’s going on, but all parties do end.” He observed that “as long as everybody feels good, the risk gene goes into remission and nobody wants to miss out.”
“Credit investors smell the fear before equity investors do.” –James Dinan
Rowan also is concerned about a Dodd-Frank change that “removed dealer capital from the industry. It used to be securities firms and banks made markets. They were the break between the buyer and seller.” But now, he said, “you have no break between buyer and seller because there is no capital in the securities trading system — and you have an indexed market.” For regular folks investing in the public markets, “you are almost at the mercy of liquidity. Liquidity-driven events going up — it feels great. In the next downturn, it’s not going to feel so good. I think we’ve actually taken steps from a regulatory and structural point of view that are going to exacerbate movements down in price.”
Rowan also is concerned about the mark-to-market decline in assets as passive investing activity soars. “You [could] have a massive decline in assets that has nothing to do with the quality of assets but as a result of liquidity,” he said. “Companies [could be] rendered insolvent, which is fine if there are long-term structures in place. But if there are not long-term structures in place and people start removing capital from places that have these kinds of mark-to-market, that’s how you get a full blown financial crisis.”
As for Wolf, “what keeps me up at night is the chaos in this administration.” Longer term, what he is concerned about is the “lack of fiscal discipline. I think that someone is going to have to pay the piper. I think it’s going to be the generations that come [afterwards]. You cannot have trillions of dollars of deficit and think that no one’s going to be paying for it.… I think we’re going to have a real fiscal issue that is going to really hurt the system.”