Winter 2009: Online Exclusive
An insider’s take on the economy
By Rick Rieder 83B
Rick Rieder 83B, president and CEO of the nascent investment firm R3 Capital, has been at home in the wilds of Wall Street and the global financial industry since the early 1980s. Emory Magazine asked for his take on recent economic developments. Here’s his answer:
The economy today is suffering from an extraordinary set of circumstances that built up over the prior five to ten years. The economy/financial markets tend to go through a period of stress every four years or so, subsequent to a period of relative calm and stronger performance. This happened in 1994, 1998, and 2002. If you believe that there is some form of normalcy to good economic performance followed by corrections similar to what we saw over prior cycles, then this economy was due for a correction in 2006 after roughly four years of generally good performance.
There were two main factors however, which have exacerbated this trend beyond anything that anyone has seen before. The first factor that everyone is aware of is housing. I have never seen a crisis before where not only was the epicenter of the problem rooted so deeply in one issue, but arguably this was the only issue that needed to be addressed in the economy over the past five years or so.
Public policy did not address this issue quickly enough, and I don’t believe that anyone anticipated that the rate of decline without policy action would be as precipitous as it was. Housing has never declined anywhere near as quickly or as precipitously in modern history, especially after such a rapid climb in the years prior. This extraordinary reversal in what has become the store of wealth, and in fact the engine of borrowing capacity for consumers, was destabilizing to the system.
This phenomenon created an unprecedented level of market stress. The other factor, which nobody really talks about, is the dynamic that manifested itself in the global marketplace over the five years leading to 2007. Arguably, for the first time in history, every single sovereign economy was growing, and virtually all had moved into fiscal surplus.
In prior cycles, some major economies were struggling. However, from 2003 to 2007, not only was the entire world growing, but in fact the BRIC (Brazil, Russia, India, China) countries were starting to surge and build tremendous levels of reserves. The sheer size of these economies and their high rates of growth, plus growth in the major economies, like the U.S., Europe, and Japan, resulted in a worldwide scramble to find assets to buy.
There were too few assets in the world at a time when many economies were growing and maturing and needed a store of value, and return potential, for this newfound burst of liquidity. This was largely what drove the tremendous desire to find new assets around the world, and there weren’t enough “quality” assets around to buy. Hence, the world became comfortable with taking lower-quality assets like subprime mortgages or leveraged loans and packaging them together to create more “quality” assets, due to diversification and the benefit of people willing to take risk with the lowest-quality parts of these repackaged assets.
Leverage in the financial system grew precipitously as this scramble for assets grew, simultaneous to a relatively low rate policy in the U.S. and abroad. With the entire world growing, private equity firms growing and investing their funds domestically and abroad (with the help of easy credit conditions), and public and private liquidity reserves growing so dramatically around the world, all the preconditions for a bubble were put into place.
Housing became the embodiment of that bubble due to the sheer size of the lower-quality assets that could be created and subsequently repackaged. Then, instead of the housing market declining in a smooth and manageable fashion to allow for unwinds and expected levels of defaults, it started to crash—and took the leverage in the global financial system with it.
The unprecedented monetary and fiscal stimulus will have a profound impact on markets and the economy. The Fed and the Treasury are liquefying a financial system that is in the midst of a massive de-levering process. Much of that de-levering has taken place over the prior few months, yet my sense is that there is still a bit more left to occur.
Not only is the financial system levered, so is the consumer. Dissimilar to Japan in the 1990s, the U.S. consumer has had negative net savings over the prior few years and will have to continue to build savings over the coming months. Thus, fiscal stimulus aimed towards encouraging spending will be beneficial, yet won’t have the same historic near-term impact due to a greater propensity to save on the part of today’s potential consumers.
However, it is my sense that with the tremendous monetary and fiscal stimulus taking place globally, particularly with a new administration in the U.S., the repair process will happen over a period of months, not years. Today, however, the government is virtually the only lender to the U.S. economy in an attempt to re-ignite spending and private sector lending. Confidence will come back over time, and the velocity of money will once again improve, allowing for a broader economic recovery. Yet it will take a number of months for this to play out.