耶鲁大学金融市场英文文本Financial-MarketsLecture-20-Transcript.doc

Financial Markets: Lecture 20 Transcript Professor Robert Shiller: Well, I have the pleasure of introducing to you today Stephen Schwarzman, who has kindly agreed to lecture our class. Mr. Schwarzman graduated from Yale in 1969. He was at Davenport College. Do we have any Davenport people here? A few, not a lot. He graduated then from Harvard Business School in 1972. He worked for Lehman Brothers as-I dont know if it was his first job, but one of his first jobs, and became Managing Director at Lehman Brothers at age thirty-one and he became head of their Global Mergers and Acquisitions team. In 1985, Mr. Schwarzman, with Peter Peterson, founded the Blackstone Group, which has become the lead manager of alternative assets. In some sense, what he does and what David Swensen does, whom we had heard from earlier this semester, are similar. Theyre both looking at unusual and different investment assets and they are both very successful in doing this. Mr.Schwarzmans firm has had a return on private equity investments of 23% a year for the last-on average-for the last twenty years. This is a little bit in excess of David Swensen, but I think we have to put them both as remarkable investors. In the real estate group at Blackstone, theyve had 30% a year for the last fifteen years and this is after fees. Blackstone Group has been very much in the news recently. It just came out that they are apparently going to be buying $12.5billion dollars of leveraged loans from Citigroup at a steep discount. So, apparently theyve seen a profit opportunity there or theyre supporting our economy from the ravages of the subprime crisis. Also in the news, China has announced that it plans to buy $3billion dollars stake in Blackstone Group as its first effort to diversify its $1.2 trillion dollars of foreign exchange reserves. So, the Blackstone Group was picked by the Chinese government as the most fitting place for it to put some of its reserves. With that, I will leave it to Mr. Schwarzman, who will speak for a while and then we will open it up for questions. Im going to have to ask-can you repeat their questions because it will be difficult hearing otherwise? I have to move the two microphones. Mr. Stephen Schwarzman: Well, thank you very much for coming out on whats a bit of dreary, slightly rainy morning. When I was an undergraduate, you wouldnt have gotten much of an attendance; people would have been sleeping in. So, its awful nice of you to be here. There are some dramatic differences from when I was an undergraduate and you are. One of the first differences is that this course wouldnt have existed because no one had an interest in finance at that time. It wasnt a particularly interesting time. In the 1960s, the securities markets actually were regulated, commissions were fixed on the New York Stock Exchange; so, it was very difficult to find some way to compete. It was sort of rigged system, if you will, and it wasnt open. So, there was very little to no interest, really, in finance. There really wasnt an SOM-School of Management-at Yale at that point. Business generally was utterly unfashionable. We were in the midst of the Vietnam War and business was sort of linked to the perception of that war because they supplied certain types of war materials and that was the most unfashionable thing that you could be involved with. So, there was a very anti-business, non-existent finance orientation at the school and, obviously, thats changed in the society generally, with enormous differences. As a result of when I grew up, I didnt even take an economics course at Yale. I frankly wasnt much good with math; I stopped in the eleventh grade and I think calculus was, for me, that was way too much of a reach. So, Im more in the add, subtract, multiply, and divide kind of category, which worked and still does quite well for me. When I graduated, I was lucky enough to get a job at a firm that had just gone public. It was the first New York Stock Exchange firm that had just gone public; it was called Donaldson, Lufkin & Jenrette. Bill Donaldson actually founded the School of Management after he left DLJ. That was, because this is a financial markets course, that was quite interesting for me because I didnt even know what common stock was when I graduated. Hopefully, you will have learned more in this course. I went to DLJ-I couldnt read a financial statement, which is like going to a foreign country and not being able to speak the language; it was sort of hopeless. One of the interesting experiences I had about-which really, now that Im a little bit older and can look backwards on financial markets, it was my first visit to a company. DLJ basically was one of the first large institutional stock managers of pension fund assets and so forth and I was allowed to go and interview a company. I had never interviewed a company executive; I read their annual report and I went up to see this gentleman and I sat there. I figured out all the things Id want to know so that I could figure out whether I should buy his stock or invest in his company. I went through my list of questions and he wouldnt answer most of them. I found it a very frustrating experience. I went back to the office and by the time I got back to the office, Dick Jenrette, who was president of the firm, had gotten an enraged phone call from this executive and called me into his office. He said, geez you made this man very angry. I said, well how could I do that? I was just asking questions and he wasnt answering them, so I just asked the question again. I couldnt quite understand why he wasnt answering me. He said, well you were asking him things that hes not allowed to answer. I said, what do you mean? He said, well you were asking him for inside information. I said, well I dont know what inside information is; Im just asking the question that I need to know to know to answer whether to buy the stock or not. He said, well Steve, there are all these rules of what you can ask somebody. Then if he tells you, then he has to tell everybody in the world and thats just too cumbersome, so thats why he didnt answer. I said, well if he didnt answer, how in the world can you figure out what to do? I said, Im not that smart; I need to have all relevant data and hes the person who has it, so why wont he give it to me? It became pretty clear that I was doing the wrong thing for a living. In effect, thats the dilemma for people who want to buy liquid securities. I decided very quickly this was a bad business, certainly a bad one for me-that I couldnt figure out how I could win that game when somebody wouldnt fully share openly everything they knew. I guess if you were like a sumo with a good fashion sense, thats how you manage liquid securities and beat other people. Its not just what you know, its a question of whether the rest of the world will buy into what you know and drive that security up. So, I basically retreated and went to Harvard Business School, where I figured maybe somebody will tell me how this game really works in a way that I can prosper in it. That was a good experience for me. They basically taught you-youre undergraduates, so you dont know what theyre teaching you at the school like that-so, I can explain it actually pretty clearly. Its basically-theyre teaching you that everything you do with a company has something else to do with that company, so that its an integrated system. If you are trying to develop a product for sale, it would be good to know whether somebody wants it. What happens, actually, in the real world, is that sometimes people just get an interesting idea and theyll produce a product and nobody will want it. If you integrate all the different kinds of knowledge in the company so that youre doing intelligent things-and I know this appears very elementary-youll have a better company. Thats sort of what they were teaching and after they taught that for two or three months, I sort of got it and thought about dropping out of school because it got a little repetitive, frankly. I was convinced by my friend, Dick Jenrette, who also thought about dropping out of Harvard Business School. In December, it gets very cold in Boston and really miserable-he was going to drop out and go and get a PhD in Economics. I was going to drop out and go back to the real world and he said that his staying on was a good thing and I should stay on, so I did. What Ive sort of done for a career is try and solve that problem of my initial meeting, where people will-I want people to tell me whats really going on, so I can figure out whether what theyre saying makes sense or doesnt make sense. You can do that in the private equity business, which was sort of our largest business, and you can do that in the real estate business because youre allowed to get all that inside information, if youre trying to buy a company with our rules and also the rules of other countries. If you sign a confidentiality agreement that you wont use that information for any purpose other than buying the company and putting a price on it, then the shareholders get a chance to vote on whether they want the price that you give them. So, to me that was like an answer to my conundrum of how could we get all the information and then figure out what to do with it, including improving the company. Im sure you know something about private equity. If you read the general newspapers, Ill tell you basically what it is. Well, all we do is we buy companies and thats the simplest thing we do. We do a lot of other things, but lets start with, we buy companies; we borrow money to buy those companies. Historically, its been about three dollars of debt for every one dollar of equity. We then improve those companies through a whole variety of sort of managerial actions and then those companies grow with the general economy. Lets say-if they just grow at the regular rate of all companies, then if youre leveraged three-to-one, youre going to earn a much better return. If you take a company and can accelerate its growth so its growing faster because youve improved it and you have three-to-one leverage, youll get a way better return then any normal stock market kind of return. Thats sort of the model of what we do in that business. As Professor Shiller was saying, weve compounded, after fees, at 23%; but before fees, because we charge a 20% part of the profits of the deal goes back to the general partners, which is us. We actually earned around 31%, which from you being in a course like this, youd see thats really pretty high compared to a stock market average over a period, which would be around 11%, in real estate, where we do the same kind of thing. But, real estate is an easier business because buildings dont talk. Management of companies talk and you have to figure out what theyre saying. Companies are very complex-you have interesting competition, you have global competition-and its a complicated asset class. Real estate is very simple. I mean theres a-buildings dont talk, so you cant get misled by a building; they cant tell you something; they dont have a belief system. Its just there; its on the corner; its in the middle of the block; and there are other buildings that are either getting built or planned. You can figure out what the supply/demand is for real estate in a much easier way. Because of that, our returns in real estate have been better because its an easier asset class and weve earned, after fees, 30% a year since we started and, before fees, close to 40%. This alternative asset class, if handled right, is really a much better way of earning money for investors as well as the general partner-lets not forget us-than regular financial markets investing. That world has been started very small. When we started it, the institutions had less than 1% of their assets. It was like infinitesimal in the private equity side of the business. Its now up to about 4.5% and the returns are so much higher; you wonder why people dont give us all their money on an asset allocation basis. I actually still wonder why they dont since we put most of our money in that and we keep making more and more and outperforming. It just takes the rest of the world apparently the equivalent of your lifetime to sort of figure out exactly what they should be doing. I think the projections are that this should be growing at a lot faster rate going into the future and some institutions, like Yale, have private equity with around-I guess its around-16%, 17%. It was up to 18% of their portfolio and thats one of the reasons why Dave Swensen has done much better than regular money managers. Turning to a different subject-its a financial markets course and I thought it would be useful to talk to you a little bit about whats really going on in the real world. Even though this course is being recorded and whatever you say about the current moment turns out to be right or wrong, but its just a current moment; its such a fascinating one. You all are, I guess, somewhere between eighteen and twenty-one years old, probably nineteen and twenty-one, so you dont have the perspective to understand how really interesting and dangerous this current environment is. Whats happened is that through an abnormal issuance of something called subprime securities-nobody in this audience, certainly people watching, have probably owned a house. What happened was that in the late 90s, the government in Washington passed a law to encourage more low-income people being able to buy houses and resulted, along with other factors, in an explosion of these types of loans. In terms of loans-and Professor Shiller can correct me if Im slightly off on this-but in the year 2002, of the total mortgage loans that were originated for houses, probably around 2-3% of them were subprime. These are for people who dont have enough money to really pay normal principle or interest and expect their mortgage to be current-to not go into default. By 2006, this had exploded to 30% of all the mortgages that were issued that year. When you go from 2-3% to 30%, this is an almost out of body experience and to entice these people to take these loans they actually would tell somebody-in the olden days, when I was your age, to buy a house you had to put up 25% of the cost of the house. Sometimes, youd have to put up 20% of the cost of the house and you can borrow 80%. The subprime loans-sometimes you only had to put up 3% of the cost of the house; sometimes you didnt even have to put up anything. That makes it really affordable and then you didnt have to pay any interest for two or three years. So, you put up nothing and you paid nothing, so this led to a stampede of people who wanted this. Whats happening now is that the mortgage-the interest which no one-a lot of these mortgages didnt have to pay now, two to three years later you have to pay it and a lot of the people who didnt have the resources cant pay the mortgages; those mortgages are defaulting. The issue that created all the problems in the financial system that youre reading about in the front page is that these mortgages were pooled in a new security. Imagine just, sort of, a jar where somebody threw in a few thousand of these mortgages and then put the lid on it. They had these new securities and what they did is they said, well the first 83% of them must be really safe because mortgages basically hardly ever default. They rated those-the rating agencies, which tell people how secure something is, rated this as a triple-A security. In the world of finance, when you tell somebody that a security is triple-A-they get rated all the way from AAAs down to CCCs and CCC means somethings about to blow up; AAA means theres no possible chance youre ever going to lose your money. Because 83% of this jar was rated AAA, people bought this all over the world as if it was a security that could never, ever, ever default. As you can see, these were basically mortgages made to low-income people who werent even paying, in some cases, interest on it and the chance that these were going to default was really sky high. Historians will go back and figure out why anybody would believe that these things could be AAA. They did and they were bought everywhere; so, these securities became like American SARS. They were exported throughout the world, creating enormous problems for individual institutions around the world. In the United States, theyve created what will be hundreds of billions of dollars of losses for the financial institutions. As part of Sarbanes-Oxley, which was a law passed after Enron and some other things, weve developed accounting procedures with something called-very technical-called FAS-157, which is called Fair Value Accounting. It means, before these defaults even happen, the fact that other people think theyre going to happen results in the securities being worth less and you have to take a loss based on that expected value. The financial institutions were losing all this money without the defaults even happening or people knowing how bad it would be. As a result of that those large losses, the financial market started losing confidence in some of the financial institutions and different asset classes in those financial institutions. Principally banks started trading in a really bad way. People thought they were going to be forced to sell some of those and we had a variety of different asset classes, ranging from municipal bonds, basically changing their value. People said, I dont want these anymore, there were hedge funds that owned those on leverage, so there were margin calls, which forced those securities to be sold, which made them worth even less. That got the banks even more nervous. That resulted in hig