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Today Alan Murray makes an admirable attempt to deal fairly with a topic we've been reporting on for a while now, the crazed money party in private equity. Funny thing is, when we talk to private equity guys, they tell us the madness is in the securitized debt and credit derivatives markets that have been fueling the now collapsing housing bubble. Talk to the securitized debt and credit derivatives guys and they tell us to keep an eye on private equity. It's gonna blow! Unfortunately, we think they're both right.
Alan gets a lot of this right, to his credit.
A Question for Chairman Bernanke: Is It Time to Yank the Punch Bowl?
February 14, 2007 (Allan Murray - WSJ)
Less than a week after completing the Equity Office deal, Blackstone is well on its way to selling off half the property it bought, locking in billions of dollars in profit. Insiders believe the massive buyout will yield 30%-plus returns for Blackstone and its investors.
Should any of Blackstone's moves concern policy makers? Join the forum and give us your thoughts.
In normal times, a decision to dump $20 billion of office buildings onto the market might depress prices. Anyone remember the law of supply and demand? But these aren't normal times. Some analysts have argued with a straight face that Blackstone's gambit may actually accelerate office-price increases. That suggests buyers are willing to pay Mr. Schwarzman more because they think he knows something they don't.
AntiSpin: No, these are finance economy times. The reason that monetary authorities don't take away the punch bowl that's causing asset inflation is because in the Fed's view, asset inflation is an objective, not a problem. Wage inflation. Now there's a problem. High rents–those are bad, too.
And in normal times, tapping the mortgage-debt markets for four or five times as much money as has ever been raised there before, to finance a $39 billion real-estate extravaganza, might cause a meltdown. But today, that money flows like cheap champagne.
So think of Mr. Schwarzman's 60th birthday as a sign of the times. There is a big, bubbly investment party going on out there, rolling from one asset class to the next, inflated by remarkably easy credit. Or as Mr. Zell puts it: "We have a massive excess of capital."
AntiSpin: Yes, the Finance Economy is alive and well, and doing exactly what it is supposed to do: generate large capital gains at low tax rates for owners of assets, profits from the sales of which are in turn channeled back into the capital markets to create yet new sources of money for leverage. The process is not unlike the venture capital, dot com, IPO money amplifier of the 1990s, except the speculative asset in question is office buildings and EBITDA positive companies versus parodies of technology companies. That makes this finance economy money machine all the more dangerous, as far as we're concerned. A lot of people are employed by these now debt laden companies.
A venture capital firm is a bank that funds losses. We expect they are going to get a lot of competition soon, at least with respect to opportunities to fund losses. Big ones, and lots of them.
Ben Bernanke wasn't going to go to Mr. Schwarzman's party either. Instead, the U.S. Fed chairman had to prepare for his semiannual testimony before Congress, where he is likely to address two serious questions that arise from all this.
The first: Should the Fed take away the punch bowl before the party gets out of hand?
AntiSpin: Too late. The PE (LBO) party was "out of hand" two years ago.
Mr. Bernanke is an economic historian and knows that when the Fed tries to stop investor speculation, it gets in trouble. Witness the Fed's tightening in the late 1920s, and the dismal decade that followed.
AntiSpin: Greenspan tried that in 1994. Didn't work.
Moreover, the Fed chief argues the liquidity flooding today's markets isn't really a monetary phenomenon. The world's central banks, he believes, are doing a good job keeping money creation in check. And ultimately, it is excess money creation that leads to inflation -- the Fed's No. 1 enemy.
Instead, Mr. Bernanke argues that the funds flowing into investments are coming from what economists call the "real" economy. Fast-growing countries in Asia, and the oil-rich nations of Russia and the Middle East, are growing and earning money faster than they can spend it. The result is what Mr. Bernanke has called a "savings glut." The world's newly affluent, who might have stuffed their money in a mattress in an earlier era, now are parking funds in U.S. Treasury securities and driving down interest rates. That leads other investors, unhappy with low rates, to chase after higher returns, wherever they can find them.
AntiSpin: Correct on the first point. It ain't Fed money–it's money created by the latest Finance Economy money machine. Rich Chinese are not buying U.S. treasuries. Global central banks are, to prevent their nations' currencies from appreciating. Why aren't rich Germans buying? Italians, French, Dutch? Don't they get as much joy from placing their "excess savings" into U.S. debt?
Even if it isn't a purely monetary phenomenon, however, Mr. Bernanke surely sees the danger for the economy in this scenario. A glut of savings pushes interest rates down, bids up risky assets and prods investors to do things they otherwise wouldn't -- and probably shouldn't do. Moreover, measuring the central bank's creation of "money" is an imprecise art. Such measures aside, at some point plentiful credit buoys the economy and greases the way to higher inflation.
AntiSpin: Creates desirable Finance Economy asset inflation without the undesirable traded goods type, but even the good inflation can spill over into the Industrial Economy, to the extent that those of us who live in it have to eat, and sleep in a dwelling that we have to heat and insure.
The second question is more political than economic, and more difficult to answer: Will disaffected workers crash the party? Mr. Schwarzman's birthday party, and the swelling private-equity fortunes it symbolizes, are manifestations of the rising inequality that Mr. Bernanke referred to in a speech in Omaha, Neb., this month, and that he will certainly be asked about today and tomorrow.
Americans have long been willing to tolerate unequal economic outcomes, because of a faith that they, too, might someday have a shot at the brass ring. Recently, however, there are signs that faith is fraying. Financiers who celebrate fast fortunes made while workers face stagnant pay and declining job security risk becoming targets for a growing dissent.
AntiSpin: Ten points for Mr. Murray. As concluded in Economic Cognitive Dissonance, the long term problem with the Finance Economy racket is that it produces wealth inequality that can turn into a political nightmare if and when the music stops and the 90% of the population comprised of debtors looks for political solutions to their plight.
That is why investors will likely conclude, after listening to the Fed chief's two-day talkathon, that he is far more likely to raise short-term interest rates in the coming months than cut them.
AntiSpin: Don't tell that to Goldman Sachs. Today GS issued a report to clients today that predicts GDP will grow 2.3% this year, slightly below the 2.5% consensus. GS expects the Fed Funds rate to end the year at 4.25%, implying not one or two but three quarter point rate cuts this year.
GS sees the Industrial Economy slowing, with the rate of growth in Business Fixed Investment to decline from 7.4% in 2006, to 4.3% in 2007 and 4.0% in 2008. This causes the rate of increase in consumer spending to decline from 3.2% in 2006, to 3.0% in 2007 and 2.4% in 2008.
This prediction contradicts the consensus among those we talk to in the collateralized debt market, who are expecting, if any change, a rate hike or two. There is also an apparent internal contradiction in GS's expectations. We observe the not too hot, not too cold Bernanke body language on inflation and hear the upbeat blah, blah, blah on the economy. GS expectations take us from this benign outlook land to a scary place where the rates are cut and then back again to an expanding economy, with the story ending happily with 2.3% growth, full circle all in the span of ten months.
Does GS see something to trip the U.S. economy that no one else sees? It wouldn't be the first time.
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