Overnight, we presented the views of 4 people who saw the last financial crisis coming, and shared their outlook for the future. There was one name we forgot, however, perhaps the most famous of all: Steve Eisman, who was popularized by the movie The Big Short, and who not only “saw it coming”, but made a lot of money in the process.
Now a fund manager at Neuberger Berman in New York, Eisman spoke to the Financial Post’s Barbara Shecter about the crisis, its aftermath, and how he’s investing now. Below we present the key highlights, including not only his takes on former Fed Chair Alan Greenspan, but also the Fed’s response to the financial crisis, how markets responded to the crisis, his views on US, Canadian and European banks, the risks to the US economy, where the next crisis will come from, and what his favorite long idea is currently.
As published originally in the Financial Post
Q: This Saturday (Sept. 15) marks 10 years since the collapse of Lehman Bros. What has been the most significant change you’ve seen in global markets since then?
A: I think the biggest change, at least in the United States, is how much more extensively and harshly banks are regulated. Let’s use Citigroup as an example. So just before the financial crisis started, Citigroup was levered about 33 to 1. Today, it is levered about 10 to 1. That is, in my world, like comparing the distance from Mercury to Pluto. It’s such an enormous change it’s hard to even describe it. I can honestly say for the first time in all the many, many years that I have covered the financial services sector, I actually think the banking system in the United States is safe.
Q: What about Canada?
A: One of the potential issues with the Canadian banks is that the risk weights that are given to mortgages are exceptionally low and that’s because there have been no losses in Canada for 25, 30 years. So for example, if you look at the larger Canadian banks, you’ll see that they assume the risk rates are in the single digits — and to get to that number they assume 85 per cent of the mortgages that they have that are not government-guaranteed will produce losses of 20 basis points or less per year.
Q: That’s low?
A: Yeah I would say so but, hey, it’s Canada.
Q: And Europe?
A: Look, I’m very critical of U.S. regulators before the crisis — I think they were horrendous, just horrendous. But post-crisis I think they’ve done a good job. And they basically did two things: they made the banks write down their losses as quickly as possible, and they made them raise a lot of capital. And the combination basically allowed the financial system to heal relatively quickly. In Europe, they took a bit of a different attitude. I think they felt that if the banks wrote down assets too quickly it would sink the economies, and so they were much more permissive. In Italy, we’re still dealing with the same non-performing loans they had 10 years ago. And the second thing is that while they certainly made banks raise capital so that their leverage ratios are better than they were, they’re still 1.5 to two times more than the United States, the absolute leverage.
Q: How do you think history will judge the Fed’s response to the crisis?
A: If I had to give it a grade, I’d say pre-crisis I’d give the Fed an F. And I would say that Alan Greenspan will go down in history as the worst Chairman of the Federal Reserve in the history of the United States. I’d say, during the crisis (Ben) Bernanke did a very good job, I’d give him a B or B+, and that’s what I think about how they did.
Q: And post-crisis?
A: I think they did a very good job regulating the banks under the leadership of Daniel Tarullo.
Q: What’s surprised you as an investor over the past decade?
A: I think what surprised me most about the markets was how quickly they recovered and how quickly people forgot what happened.
Q: Why do you think that happened?
A: I think that’s a function of the fact that the Fed embarked on this great quantitative easing experiment. There were three Q/Es: QE1 took place in the spring of 2009 when markets were just dead. This was very successful and so the fixed income markets went back to normal. And then two years later, the Fed decided that, hey, interest rates are zero, the economy is really not growing, we’re worried we going to go back into a recession. So they went out and bought U.S. government bonds and mortgage bonds backed by Fannie Mae and Freddie Mac, and the idea was they were therefore removing trillions of dollars worth of risk-free assets from the marketplace with the idea that that would force both investors and companies to go out on the risk curve. The idea was that that would somehow get companies, for example, to build factories and hire people and that would get the economy growing faster.
Q: And that wasn’t as successful?
A: In my view it failed, 100 per cent. It caused the stock market to go up because people took all that liquidity and invested it in the stock market, but it did not cause the economy to grow even 10 basis points faster. I like to nickname quantitative easing “monetary policy for rich people.” You could quote me on that. You know, they took a shot; it didn’t work. And then they doubled down and did it again. Same result.
Q: From a global perspective, what is the biggest risk today that people aren’t talking about?
A: I’m pretty sanguine these days about the U.S. economy. I don’t see any real risks out there. A lot of the things I usually look at that would tell you there might be a problem — like changes in credit quality — are not showing any signs of stress. And I think the only real threat is some sort of global trade war.
Q: Is the current growth of the U.S. economy sustainable?
A: I don’t know. All I can say is that given the data I look at I don’t see any slowdown until 2020. It’s just not in the data. Again, barring a trade war it could stay more or less like it is — three per cent, high twos growth rate, which is pretty powerful for us.
Q: Where will the next crisis come from?
A: I think it’ll come in the corporate sector because I think that’s where a lot of the debt’s been issued. It’s not going to come from the consumer sector. But you need a real slowdown in the economy for that to happen.
Q: When you look back at the crisis of 2008, do you think of it as “lesson learned”?
A: Well, lesson learned in the sense that the banking system is much less levered than it was. But other people are more levered, so we’ll see how they do next time around. But whatever happens, it’s not going to be a systemic issue. Let’s make a hypothetical: say there’s a recession and let’s say there’s a lot of these high-yield companies go bankrupt. That’s not a systemic problem, that’s a problem for the people who own those bonds. If you ask yourself what made that crisis different, there were four elements to it. There was too much leverage, a big asset class (residential real estate) blew up in everybody’s face, important firms owned that asset class, and number four was derivatives, like credit default swaps, that tied balance sheets of all the institutions together. So this one bank went down, another bank would go down. Today, they’re less levered — maybe some of them will own some of an asset class that blows up but since they’re less levered it’s not going to destroy them.
Q: Has your approach to investing changed? I think you were quoted a few years ago saying that judging stocks on the fundamentals was not a good business anymore.
A: Back then, I was running a hedge fund that just invested long/short in financials. And what I was really trying to say was that in a world where rates are zero, and credit quality is pristine, investing in financial stocks to try and generate alpha out of them had become unbelievable difficult. So it’s, like, you took my game away from me! It was impossible to differentiate for a long time. I still do long/short but I do all sectors.
Q: We’ve been talking about big shorts for 10 years now. What is your favourite long idea?
A: I think there are certain companies in the U.S. that are kind of oligopolistic, that are big data stories, where they control the data that they sell, and there’s very little competition. There are three companies like that in my portfolio. Equifax is an example, but there are a few others that have massive databases and because it’s so expensive to recreate what they have, there can only be a few companies that do it. Google controls a lot of data but it’s a different kind of data. It’s not the same thing. The best predictor of consumer action is the databases that the consumer credit bureaus have of their credit behaviour. It’s every loan you have, and whether you’ve paid monthly on everything that you’ve ever had. It’s the best database I know of.