Charles Ward of Lazard (left) and Kenneth Griffin of Citadel Investment Group (right) discuss navigating market volatility.
Ever since the onset of the mortgage meltdown last summer, dramatic developments have dominated the headlines. Everyone is watching closely to see how Wall Street fares, and how its performance will affect the global economy. The recent market dislocation has resonated through every corner of the Street, from full-service institutional bastions to niche players focused on specific services or sectors.
But it isn't all bad news: Innovation often emerges from market turbulence. This panel featured speakers from the leading edge of the finance industry, who shared their viewpoints on how such large losses blindsided Wall Street and how to convert chaos into investment opportunity and competitive advantage.
Moderator Paul Calello of Credit Suisse opened the session by noting that uncertainty in the market has affected everyone in the financial services industry. "Hardly a week goes by that you don't read of more staggering losses by the universal banks," he observed. "But in these markets, the brightest of the bright have found new opportunities."
He threw the discussion to Kenneth Griffin of Citadel Investment Group, asking whether the financial community should have been able to foresee the current turbulence. "It's very obvious that a number of firms were not dotting the i's and crossing the t's when it comes to risk management," Griffin replied. "We have had a very mild economic downturn in this country but near-catastrophic losses within a number of our largest banks and investment banks. Could we have foreseen? Not necessarily. Should we have been better prepared? Absolutely."
Kenneth Moelis of Moelis & Company recalled that for much of his career, personal relationships were key. "I do think that what Wall Street forgot in a very deep sense is that behind a lot of these transactions were people. There were relationships, and there were decisions made around furthering a relationship, depending on people to do the right thing. I think when you look back at a lot of the mistakes here, you see the reliance on piles of paper and statistical arbitrages in the market that ultimately didn't pan out . . . In the old world of these investment banks, the life cycle of a relationship was years, decades, lifetimes. And we're on one-year bonus cycles now."
Calello turned to Charles Ward of Lazard for his views on new financial regulation that might be crafted to deal with the aftermath. "I do think you're going to see changes in the regulatory regime," he predicted. "When something like this happens, the American people are not going to stand still for business as usual. I think it's up to the investment community to be actively involved in trying to shape the regulation to be sensible, but it's going to change . . . it's going to be a political fact of life and we'd better get used to it."
Addressing "the elephant in the room" fell to Peter Weinberg of Perella Weinberg Partners. "Regulation will evolve . . . but the financial markets need to figure out a way to keep the fluidity of capital around the world very liquid. We desperately need sovereign capital to come in to bolster the financial system. We cannot tolerate the protectionist kind of instincts that are, in my view, wrong."
Charles Ward agreed that sovereign wealth funds have been instrumental, but he did not feel they will be the answer moving forward. "They have a part to play, but it's largely been played. From here on, the capital's basically going to have to come from the market. We need to see attractive prices to tempt the market. It's going to come from private equity. It's going to come from a lot of sources that are going to be looking for very good bargains — and I suspect that they'll get them."
Bennett Goodman of GSO Capital Partners agreed that "the banks were very fortunate they had access to these sovereign wealth funds who were willing to write big checks in a very quick period of time. But I think these investors are upset that they're out of the money on a lot of these investments."
Looking ahead to the next year, Goodman predicted, "I think other private equity firms are going to go public. I think other hedge funds will go public. It might take another 12 months before we see that happen. But there are a lot of advantages for firms that are able to access permanent capital. There's a lot to be said for having the currency to grow a firm and retain talent."
"The asset management businesses have really been the shining star of the last 12 months," observed Griffin. "They've been rock-solid. Investors are going to be very attracted to that quality looking forward." One of the factors underlying that quality, Griffin insisted, is a fundamentally new approach. "A handful of firms are truly interested in being partners, and they know how to leverage partnerships wisely and create a lot of value for everyone at the table."
Bigger isn't always better, Moelis agreed. "Go back 10 years, and you had real investment banks out there. But everybody followed into a financial conglomerate model, and I think you're seeing the outcome. The result is, the larger the institution, the worse the disaster on the balance sheet. There is no place for a conglomerate in a world of expertise. I'm sure Tiffany's runs a great business and Wal-Mart runs a great business, but they probably shouldn't merge."
When asked about international prospects for M&A deals, Ward noted the huge contrast between the prevailing mood on Wall Street and the outlook around the world. Even though volume will be down, he predicted more M&A activity by U.S. corporations now that prices are reasonable, including restructuring deals in financial services.
Griffin felt it was important to understand the root of the current crisis in order to move forward. "With little exception, our largest banks and investment banks — they blew it. We've lost a substantial amount of respect because of our failure to engage in basic risk management." Why did the system break down? "Walk across any of the trading floors. They're full of 29-year-old kids. The capital markets of America are controlled by a bunch of right-out-of-business school young guys who really haven't seen very much. They don't understand what tough times can look like."
That inexperience was a toxic cocktail when combined with the tremendous pressure to accumulate assets during the recent global run-up, according to Griffin, leading to uncontrolled growth. "You had institutions under leadership that only understood a small part of the business, financial conglomerates that really only have true capability in one or two fields, yet deploying tens of billions in esoteric products that the people at the top truly did not understand. It was a recipe for disaster, and we had a disaster. I think what we'll see over the next two to four years are the large universal and investment banks rethinking their business models."
When will we start to see a recovery? Weinberg predicted that we're in for a few sucker rallies in the equity markets, but he envisioned the crisis working itself out toward the end of the year. According to Moelis, "I don't think we'll have a deep Main Street recession. But it'll be years before Wall Street puts on the party hats and starts dancing again."
Ward also saw a mild recession looming. "But on Wall Street, it's going to go on for a while. In the meantime, there's going to be a lot of opportunity for firms and investors to make money in this environment. It sounds like doom and gloom, but a lot of people will find a way to make money."
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