On the opening day of the PDI New York Forum, Randy Schwimmer – senior managing director at Churchill Asset Management – conducted a keynote interview with Steven Rattner. Rattner was the lead adviser to the 2009 Presidential Task Force on the Auto Industry and is now chairman and chief executive officer of Willett Advisors, managing the investment assets of Michael Bloomberg.
Rattner reflected on the Global Financial Crisis and its continuing effects today, and how the US’s long economic recovery is not under immediate threat, but may eventually face challenges on various fronts.
Here is the interview in full:
RS: The decade or so since you’ve been managing Michael Bloomberg’s money corresponds with the ten years of recovery since the credit crisis. Everyone seems to have their top five lists of what happened and why. Please give us your view.
SR: Over the last few weeks it’s been interesting to look back at the Crisis. It came about because of a combination of factors including poor regulatory oversight from the Federal Government and poor risk management from banks and other financial institutions. It was a perfect storm that cascaded into Fannie Mae and Freddie Mac, then into many of the big banks, and then into the real economy and led to Recession. It could have been a 1929 scenario and we were very fortunate that we were saved from that.
RS: You have a storied background with tremendous experience in a variety of markets and asset classes. Where do you think we are in the cycle? Is it the sixth inning, as I think Jamie Dimon and Warren Buffett recently characterized it? Or later?
SR: Today, we’re in some ways better prepared for a crisis and in some ways worse. But the Fed put us back on a growth trajectory and we have had the longest post-War economic expansion. It’s going well. The biggest concern is that overall growth and productivity growth have been slower than normal. I think we need to have humility on when the expansionary phase will end and how it will end. The Economist found that over a 15 year period, of 220 instances in which a member’s economy contracted in the year-ahead, not once did the International Monetary Fund forecast the downturn. I think we’ll still be in recovery for the next year or two, because of fairly low inflation.
RS: Do you think the ‘fixes’ put in place, both regulatory and legislative, will help in the next downturn? Or are we fighting the next war with last war weapons?
SR: With respect to capital ratios, they are historically high. The banks have got rid of their off-balance sheet stuff and the Volker Rule has forced banks to be more careful about risk. That should make everyone feel good. But following a negative reaction to the bailouts, which were very unpopular, Congress took away from the Fed and the Treasury the ability to provide emergency funding. In my view you can hate the bailouts but they saved us from disaster, and Dodd Frank takes away the ability to do something that served us well. FDIC now has responsibility for saving the big banks, but they are used to having oversight of the smaller banks. I think responsibility for the larger banks should rest with the Fed.
RS: What signs or signals do you look at, both in the market and in the economy, to guide your investing decisions?
SR: The good news is the economic leading indicators are showing continuing strength. Unemployment is at a historic low and, typically, when you’ve had an unemployment rate at that kind of level, you’ve started to get inflationary pressure. What’s odd is we’ve not seen wage pressure this time, and on the cost side we’ve not seen much inflation either. The inflationary expectation is anchored at around 2 percent.
One concern is that when interest rates are raised it could impact the real economy and also the stock market. The stock market has remained high due to low interest rates, meaning there have not been any good alternatives. If interest rates rise, people will switch out of the stock market and it will roll over. This year, the stock market has also been propelled by corporate tax cuts, which have pushed earnings results up massively. But tax cuts are a one-time thing, they’re helpful today but won’t last forever.
RS: There’s an odd disconnect between headlines about global trade wars and new market highs on the Dow and NASDAQ. Why is that? What will create more correlation? What event will truly cause some kind of market correction?
SR: If you look at the Chinese stock market, all in all China is in a bear market. The Chinese are feeling very destabilised and nervous about a trade war. Meantime, there has not been much of an impact in the US. It’s been a tumultuous couple of years but the stock market has not seemed overly bothered about anything other than corporate profits. But tariffs have not yet really taken effect. In November they may well start to come into effect and we’ll see what happens.
RS: On the economic front, where are rates headed? Will we see an inverted yield curve? If so, does that presage a downturn?
SR: We’ve never had a recession which has not been preceded by the yield curve inverting. Over the last couple of weeks, the long end of the curve has started to steepen. But I don’t think it will invert in the near term. We will stay above water on the yield curve. It’s interesting that the Fed and the market have had a consistent disagreement on rate rises over the last few years. Currently, the Fed is expecting steep rate rises, which could affect the economy. But the market is expecting less steep rises, which would keep things stable.
There is an argument that, if interest rates are low, the Fed won’t have the weapons to deal with a crisis next time. But you shouldn’t raise interest rates just so you can lower them later. One thing people wonder about is why the economy has grown so slowly. There is a school of thought that the neutral rate of interest has declined so that it will be lower in the future than in the past. If so, then maybe they don’t need to go up too much. But it’s a matter of debate.
RS: What do you worry about most regarding the state of the economy?
SR: I worry about a trade war because tariffs are taxes and they are bad for the economy. If trade drops off, that’s bad for economic growth. It was tariffs that helped push us into the Great Depression. There is also a build-up of inflationary pressures, which many esteemed economists are pointing to. That’s a potential worry. Also, on paper you can see too much money chasing too few deals. You can see this in the tight corporate bond spreads and in the growing share of deals with covenant-lite structures.