Resiliency & Risks for Global Financial Systems
COVID-recession consequences, monetary & fiscal response, and global markets are discussed with Professor Peter Fisher
Ken Herold: Peter Fisher is a senior fellow at the Center for Business, Government and Society at the Tuck School of Business at Dartmouth where he also serves as a clinical professor. He’s the director of the John F. Kennedy Library Foundation, and of the Peterson Institute for International Economics. He is a member of the Systemic Resolution Advisory Committee, of the Federal Deposit Insurance Corporation, and of the Advisory Board of the MIT Golub Center for Finance and Policy. Peter has extensive experience in both the private and public sector. On the private side, he has served in several capacities at BlackRock; in the public sector he’s served as Under Secretary of the US Treasury for Domestic Finance. He worked at the Federal Reserve Bank of New York, including his service as an Executive Vice President and Manager of the Federal Reserve Open Market Account. Peter, thank you for joining us today.
Let’s start with your big picture thoughts on how the economy proceeds from here. Do we get the V-shaped, U-shaped, or W-shaped recovery?
Peter Fisher: I’m a fan of the reverse J, fishhook recovery. We’re going to get a bounce, and how high we go, I don’t know, because that’s where the picture gets blurry. But what I do know is the reason why I’m very skeptical about the V-shaped recovery, is because [of] what we know about where we were at the start of the year. At the start of the year, we were not at an equilibrium point for our economy. This was not a mean we’re likely to revert to easily. Recency bias is one of our strongest cognitive biases; we all think the recent past is what’s most important. At the start of the year, we were at a 50-year low in the unemployment rate, historic highs in equity prices, and historic highs in corporate debt, the GDP, non-financial corporate debt to GDP. Those are all outliers. The idea we’re going to revert to that point in some tidy fashion seems to me completely implausible.
What are some of the underlying issues with corporate credit that you see?
It’s what makes me the most anxious. A year ago, Chairman Powell and the Fed told us the US corporate sector was “highly levered,” his words, not mine. In September of last year, the IMF issued a report, their financial stability report, in which they said US corporate indebtedness was reaching the point where more and more companies were borrowing that they couldn’t repay, neither principal nor interest, out of their current income. That’s Minsky’s third stage of a credit bubble, which Minsky called “Ponzi finance,” when people borrow money, and their current income is inadequate to pay either principal or interest. So that’s the backdrop we go into this recession with, a highly levered corporate sector.
Now the other thing to understand is in most recessions, corporate debt to GDP contracts a lot. Businesses don’t want to lever up into the face of weak demand. They want to contract that part of their balance sheet; they don’t want to take on more fixed costs; they want to have less. There’s only one recession in the last 50 years where corporate debt rose modestly, 1982. That was when Paul Volcker was declaring his victory over inflation. I think the US business community was prepared to invest in that recession, because they saw he really was going to win the battle with inflation; he brought it down from the super high levels at the end of the ‘70s. That’s a very rare event. Usually corporate debt contracts, and that gives us this puzzle here: How’s the Fed going to stimulate the economy through corporate credit if the natural inclination of businesses is going to be to contract and not want to borrow more money?
What are the possible implications as we come out of this pandemic?
The good news is Congress acted quickly, and spending is terrific in stabilizing the economy. And I think part of the reason the Fed announced all the programs is to put the burden back to Congress, because as soon as Powell announced all the programs, he’s now been saying, it’s up to Congress to do more. So we shifted the burden of proof, and I think implicitly the Fed is worried they’re not going to get a lot of take-up; they’re not going to create $4 trillion in credit. But the good news is Congress acted quickly, and I think that’s important to see.
The bad news is our capital markets are much less efficient. We’re not going to be getting capital, and so I worry about productivity and investment to come out of this cycle. If we’re locking in everyone’s imagined credit spreads and credit ratings on February 1, then it’s going to be harder for the new startups to get capital because the old zombie companies are going to have an easier time getting it. So a little less creative destruction; I think the COVID crisis will create a lot of creative destruction, but a little less, and that I think is worrisome. And pumping up debt at this point is also worrisome.
If there’s more volatility in the marketplace, active managers tend to do better. What’s your thought around active managers?
They have the opportunity to do better, I have no doubt, because relying on the indexes and the averages should make us all nervous, and the information content. So first step is, the investor who thinks hard about intrinsic value, has their own value, takes a stance and an opinion about what this asset is worth, is going to do better than the closet indexers over the next five years. Closet indexers did pretty well over the last five weeks; I’ll have to concede that.
Most of the returns we make as active managers are from asset allocation; you bet on a sector and you choose. Now, there’s good news and bad news. The good news is, diversification is the only free lunch in finance. The bad news, it’s always a moving target, because it reflects the behavior of other investors. So I have no doubt that five, ten years from now, we’re going to be able to identify some active managers who brilliantly targeted the companies they wanted to own during this period. It’s really hard to figure out who those guys are right now.
What is your view on Europe and what the recovery looks like for Europe?
Let me digress to what little I know about the healthcare system. Another way to think of our high level of deaths in America [is] as an index of the inefficiency of our healthcare delivery system, sadly. I don’t know a lot about epidemiology, but I do know we’ve got a very inefficient healthcare system. We spend more as a share of GDP than any country in the world, and have worse outcomes, so not a good metric. And Europe has pretty good healthcare delivery systems. Now I want to draw a connection to the path forward. Continental Europe – the UK is a little different – has done pretty well with the pandemic. They’ve also held their big guns of stimulus until now. I’m one of a group of people who is worried that we shot off most of our stimulus early; that’s what we were told to do from the last Great Recession because of the financial crisis; you don’t let a financial crisis fester. But this wasn’t quite the same; we’re not fighting the same war, and it looks like Europe and China and Japan have sort of held their stimulus until you get past the nadir of the healthcare crisis, maybe the nadir. And the benefit of stimulus is to provoke animal spirits. And we might have shot our wad too early, and Europe might have better timing.
What’s your view on Asia coming out of this pandemic?
I think that China has kind of a corporate debt problem too. They’ve also doubled down on the state sector, so unfortunately, they’re going to have a hard time getting the productivity surge they got over the prior 10, 15 years, because of high levels of debt concentrated in the state sector.
Japan has gone down the path of price-fixing that I refer to the Fed as now beginning. Once you start as a central bank price-fixing, it’s very hard to stop. And I know of no evidence that yield curve control, the Bank of Japan’s effort to freeze the yield curve, has stimulated domestic demand in Japan.
Any final thoughts from you as we wrap up?
Well, I think that there’s lots of opportunity ahead. The future is always uncertain. It feels much more uncertain now. We’re all becoming sort of little epidemiologists, so we read the paper to try to figure out what happens.
I think that should be a wakeup call for investors that, yeah, we’re always making decisions in conditions of uncertainty; let’s just get on with it. We may have to have slightly bigger haircuts on our conviction right now, whatever our conviction might be. But that’s really what investing is about – both having conviction in an idea, and being prepared to scrub it. I think that’s the most important takeaway, and particularly when we look out at what all the prices are telling us, they’re telling us less than we think.
Investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments.
Unlike passive investments, there are no indexes that an active investment attempts to track or replicate. Thus, the ability of an active investment to achieve its objectives will depend on the effectiveness of the investment manager.