Wall Street's Vulnerable to Downturn, Summers Says

under President Clinton, and top economic advisor to President Obama. Larry, you, in your comments that you just made you said that banks, despite all the capital that they have raised, or not necessarily better capitalized or better protected from a downturn. Does that mean that we are as vulnerable now to a financial crisis as we were in two thousand and eight. I wouldn't go quite that far, at least, so we

we've done a whole set of things. Banks are much more liquid, uh than they were in two thousand and eight. They've surely learned some lessons about the management of their activities from what has taken place in two thousand and eight.

But the idea that we're on a new plateau of capital, which has been embraced by the regulatory community to an extent that surprised me very greatly when I looked at it doesn't really show up in market data, so you don't see it if you look at the value of their common stock relative to the value of their assets. If a business becomes much less levered, what you expect

is that it's going to become much less volatible. And there isn't really much evidence for that UH in the pattern of UH bank stock prices, And so I am relative to stock prices of other of other firms, and so I am concerned that we may not be in as strong a position as UH we think we are. I don't think that's an imminent threat right now, but we've not seen the last recession in the United States, We've not seen the last period of excess, and I'm not certain that our system is quite as robust as

many people suppose. You also said that you are skeptical of the idea that the Vulcal rule has been a net benefit to financial stability, So should it be repealed? I think it's certainly. We certainly need to take a very hard. Uh hard, look at what the consequence, what the consequences have been, you know, in some ways, Uh, it may already have happened. I'm not sure institutions that

abandoned businesses are going to go back to those businesses. Uh, no matter, no matter what by it does seem to me that an idea that had I had a certain argument in favor of it um doesn't look to have been the contributor to financial stability. Uh that uh that many hoped. There isn't really any evidence even in all the retrospective since that proprietary trading was an important contributor

to the crisis. And I think that anything that removes a viable business line, anything that involves very large compliance costs, and anything that adds to illiquidity and markets is at least not is at least having some adverse effects on financial stability, and one would have to ask what the offsetting benefits were. So do you think that if more regulations were rolled back that it could actually increased financial

stability by increasing profitability of banks? I think. I think the great mistake is to have a debate that's all about more regulation versus less regulation, instead of better regulation, versus worse regulation. And I think that UH more regulation on the shadow banking system, more regulation to make sure that UH banks are responsive to dynamic changes in their

capital position UH is very much appropriate. But I think it is appropriate to review the huge compliance burdens that have been placed on many institutions to see whether those compliance burdens are really necessary. And yes, I think you caught a key pointly so, which is that a bank's expectation of future profitability offers secures to security to those who lend it uns and if you undermine that future profitability, you are undermining banks borrowing, and that in turn is

raising questions about financial stability. Another point that you raised was the importance of regulators in the next downturn to be very open and to respond incredibly proactively to the first science of a problem. UM. You also recently wrote a column in The Washington Post talking about Secretary Treasury Secretary Stephen manution how he has compromised his credibility with

some of his recent comments. Do you believe that his if he continues down this path, that this could compromise, for example, the Treasury's ability to fight it downturn or or or other policies being think the Treasury secretary's credibility is a crucial asset in any time of economic crisis, and I think that plutent Treasury secretaries are very conscious of preserving that credibility. Deserving that credibility means being seen as a person who says what he is analytically true,

rather than says what is politically convenient or expedient. And I think some of the statements that have been made outside of the financial regulatory area, particularly in the tax area, are hard to understand except through the prism of political expediency. The claims that UH tax cuts will raise revenue are I think ludicrous. The claims that the currently proposed tax cuts will benefit substantially the middle class relative to the

wealthy are I think indefensible. And I don't think it serves us well UM for policies to be advocated in UH those kinds of terms. As former Treasury secretary, do you think that the idea of a fifty year one hundred year bond is is potentially I think it's something that deserves study if it is linked to UM commitments to long term investments, and if we can commit to issuing long term debt to finance high return long term investments, then I think it's something that can be very that

can be very attractive. UH. If it's a standalone independent of UH making long term investments, then I think the case is less clear, and it depends upon what the appetite for those financial instruments is and at what yield the Treasury will be able to sell them. In a recent column that you wrote for The Financial Times, you were talking about how the FED, if the FED overdes it now, they will have little room to respond in

another financial downturn. How likely do you think it is for them to overdo it, and sort of what would you determine to be overdoing it at this point. Yeah, that's a judgment that you have to make on an

ongoing UH basis. I would just say that I think the risks of a the risks of a recession UH seemed to me or a downturn seemed to me to be far more serious than the risks of developing substantially excessive inflation as we did in the nineties seventies, and so I think the FED needs to be very cautious about rate hikes, and I think the FED is has tried to be very cautious about at a rate about

rate hikes. The tendency has been for the D to um expect that over time it will be able to engage in more red hiking rate hiking than in fact it has been able to. And so I think the FED has acted UH prudently in general, but it has sometimes been a bit over optimistic about how much rate increasing it will be able to do. UH in a

prudent way. What do you think the terminal level is for how high they can go in this particular cyclone, I think the neutral real rate is substantially reduced from where it was, and so the old idea of four seems pretty unlikely to make. But just where it will end, uh, I'll wait. I'll wait for some more cards to be

turned over before making that prediction. One thing that I've heard at this conference is people are talking about how they are more concerned that benchmark borrowing costs decline rather than rise, that the idea of yields falling could be more of a threat to financial stability than rising. Would

you agree, I'm not sure. I think it depends on you know, clearly, if you're a pension fund and returns rise and there aren't increases and asset prices that can be returns decline, and there aren't increases and asset prices that can be adverse. UH for you. On the other hand, UH, obviously lower rates are in many respects good for borrowers. I think on balance, I would tend to think that more liquidity and lower rates tends, at least in a

short run sense, to be favorable for financial stability. I obviously would recognize the concerns that over the longer term, if they lead to unsustainable asset price inflation or lead to the creation of bubbles, that could be problematic. And and lastly, I just would love to get your thoughts on how big of a risk we are right now of another recession than your term, Lisa, I don't. I think that I don't see the roots of a near

term recession in any of the current data flow. On the other hand, I'm very much aware that you look at the current you look at history, and people never predict recessions a year in advance, and so something things have a way of coming up. I think the right reading of the data is that the odds are about twenty percent a year that if the economy has not yet gone into recession, that it will go into recession in the next year, and that would seem to me

to be a reasonable estimate right now. Thank you so much, Professor Summers, Thank you so much for joining us. Thank you. Larry Summer is a distinguished professor at Harvard, former president of Harvard, former Treasury secretary under President Clinton, and top economic advisor to President Obama. We want to take a moment to let you know about something new from Bloomberg.

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Chrome Store to try it out. Learn more at Bloomberg dot com slash lens Well. This morning, a Pacific investment management co PIMCO came out and said that it expected ten year treasury yields to climb to three over the medium term. I am curious to find out whether our next guest agrees. Matthew Freund. He is co chief investment Officer and head of fixed income Strategies at Calamus Investments, overseeing eighteen point three billion dollars UH. The company is

based in Naperville, Illinois, and Matt joins us now by phone. Matt, thank you so much for joining us. I wanted to start really with treasuries and the idea that Pimco is seeing, the idea of ten years going to three UH in the medium term. Would you agree? Yeah? I think I would. So when you think about treasuries and where they're going UM in the short run, treasuries are really influenced I I think by UH the Federal Central Bank policy, meaning

what what's the Fed going to do? The feed has told us that they're raising rates, but very very slowly. The wild card is what they're doing with the balance sheet and whether they decide to aggressively reduce the size of their balance sheet. That's great, but it's put on a position of an economy which is actually looking a lot like last year. So we had a week Q one. It was whether it was seasonal factors, but there's always

weather or seasonal factors. Earnings look good, jobs look pretty strong, but really they're acting very late cycle. So when you put it all together, I think that the economy is gradually getting better, that rates are gradually increasing, and that's actually priced into the forward curves now. But I don't think we've seen the low and rates, and I don't think we're going to see the low and rates until we get through the next recession. Fortunately that's not coming

up right away. Hold on a second, because this, this to me, is a really compelling point. In other words, you think that ten year yields could potentially go much lower, Yeah, I do so. Again in the short run, uh, this year is shaping up to look a lot like last year. It's not a recession, but there's no escape velocity either, And in that environment, the idea that rates grind higher makes a lot of sense very short term. Longer term, we have an outlawed recessions just because rates were lower.

We have a new administration, and when the next recession hits, I think we're going to quickly grab the tools that worked in the past, and I think we're going to see rates come a lot lower. The good news though, Uh, you know, the recession doesn't appear to be on the horizon. Uh, certainly over the next nine to twelve months. Well, just to give a number to that, where do you think rates could go? I think no, I think I think.

I think the idea that forward curves now have rate tenure rates staying under three percent for the next year or two, and that feels about right. The risk to the long end of the curve is not the FED moving too fast. It's that the FED moves too slowly. So if the FED were to aggressively raise rates in the short end, I think you'd see the long end of the curve be very well behaved. You would see

a flattening in the yield curve. So I I think that the base case has to be that rates are gradually getting higher, not in a big rush, and very very slowly. But again, we're keeping an eye out. We're watching some things in the economy that worry us, things like increased delinquencies, uh, poor real earnings weekly real earnings have actually been poor, and and some some troubling numbers with tax receipts. So we think the economy is fine for a while. We think that the direct natural direction

of rates would be to trend a little higher. But again we're not out of the woods, and when that next recession comes, expect rates to retest their loves. So, uh, I want to pick up on something that you said about increasing consumer delinquencies. We've seen rising credit card charge offs,

rising auto loan delinquencies. At what point do you care from a systemic point of view, what point do you say, you know, this means that the consumer is weakening from a credit perspective more than is being currently priced into

the market. Yeah, that is a fantastic question. So when you look get delinquencies, they are trending up a little bit, but they're trending up from very low level, certainly levels that uh bottomed dramatically post what we saw in oh eight oh nine, But it feels like we're at an inflection point. So again, delinquencies are still very low, but the rate of change in those delinquencies is going in

the wrong direction. And that's what interest rates. As as we started talking being very very low, we're interest rates to go up unexpectedly, certainly higher. That's in my forecaster pimco's forecasts. Consumers are going to be um stressed. But the most important thing that I'm looking at is and again I don't have to answer, it's a it's a question, it's a dilemma for the market. Real weekly earnings have

been negative, they're they're right around zero now. And typically when you're after when you're real wages, meaning after inflation, wages are really being crimped, you start to um miss your payments. We're seeing that, and then that generally is an early sign of weakness in the consumer sector, which is the majority of GDP so or or production activity here in the United States. So it is an early

warning sign and it's one we're watching very carefully. So as an investor, how do you take this information and how do you apply it to what you decide to buy or not? You know, that's a great question too. So I think diversification is really important in this market. And what I've come to find out is that most

investors don't want to be diversified. I mean, they say they do, but when you talk to them, they want half their portfolio to go up ten percent and the other half to go up twenty And that's not the way diversification works. Diversification is where you have assets that will do well in different environment. So with that right now here at Calamos, we do think um that the risk markets have more to run. But again we we

we like international markets, we like emerging markets. We think fixed income, even with our expectation that rates will gradually go higher, has a place it will do well. Should the economy we can unexpectedly it will provide more income and within the fixed income market, and I like to remind people it's it's it's not one bond market, it's a market of bonds. We do think that high yield

still has some attractive risk returns. I know people are pulling back on risk and we are certainly being more cautious. But when you think about high yield, it's always got something wrong with it. That's by definition. That's why it's it's high yield. And we do think there are select areas there that we find attractive. Where so again it's it's not something i'd recommend your listeners going to. We're

spending an awful lot of time in retail. So retail is a horrible place um to be From the headlines, I mean, there's all sorts of stresses, but when there are these sorts of stresses in that space when there are more sellers, we often find that people are throwing um good companies out with bad and even in companies that are a little bit um stressed, they're throwing good securities out with the bad. And so we're doing a lot of work there. Uh, just nibbling at the moment.

It's it's not a dramatic change in what we do, but that's got is very interested. And then the other one is specialty pharma. So we had some interesting news from Valiant and Endo today. Um, you know, this is the sector that we've been interested in for a long time. Again, it's been out, it's been out of favor, negative headlines, but we often find the best valuations in areas that people don't like. Matt, thank you so much for joining us.

Really fascinating. Matt Freund co, Chief investment Officer and head of fixed income Strategies at Collamos Investments in Naperville, Illinois. The company overseas about eighteen point three billion dollars and Lisa Abram boys here at the twenty second Annual Financial Conference at Amelia Island, Florida. This is Blueberk. I am honored to bring in Alicia Garcia Ro Did I pronounce

that correctly? She is a cheap economist for the Asia Pacific Region at NA, Texas and a longtime economist who has advised UH with everything from the I m F to other authorities to really gauge financial stability across the world. Alicia, you know you have a viewpoint on the one area that most people have the most questions about, which is China. Do you think that the concerns about a hard landing

are overblown? Yeah, in tramps of economic activity they are, at least for this year, but in trimps of financial stability they aren't. I think Chinese indeed undergoing major shot waves in terms of financial instability. And that's not so much about the stock market of what we saw in two thousand fifteen is actually about banks. And that's a massive endeavor because today Chinese banks are actually larger than European banks. So we're talking about thirty five trillion US

dollar in bank assets in China. It's a major in dava for any financial regulator to deal with. Well. Um one paper that is going to be presented here today is going to talk about how sort of the unconsidered consequence of China's actions to prevent a crash is that there will just be much slower growth in China over the longer term. Do you currently feel like that slower growth in China, which has been an engine of growth for the world, is currently being priced into markets, particularly

emerging markets. Certainly not. It isn't priced him because China once again as engineered physical simulus package. We're still talking about it. It It doesn't it physical Stimus package as if they weren't any new package. But if you look at fiscal data in China, it is quite obvious that we call the augmented fiscal deficits. Unfortunately don't have a consolidate deficits, so we need to come up with the numbers that are not very accurate. But it's hovering around tempers and

of GDP. So if and that has been the case since two doesn't tend. So you know, once they finished that fis Custimus package, they've actually only go on going on on the same path. And that means that that growth that we see today is pretty fictissues. So yes, we're not contemplating lower growth down the road, and I think that's due to come. So what do you think is the appropriate growth rate in China to price in

say two years, three years, four years down the road. Well, it's not enormously low, so so you know, I don't want to go all the way to the you know, to the catastrophically, but it's currently about sicks for about four percent to answer your question, and this is all based on you know, potential growth. What is happening with aging labor productivity coming down? Return on assets below two percent?

That's basically where you get it from. And and we are pricing it quite a lot of total factor productivity out of innovation, which is indeed there. So that's not the problem. The problem is that that massive capital dis location in terms of banks, you know, basically allocating capital in the wrong sectors through massive government intervention to do so,

is just lowering down massively the return on assets. So what would that do to the real to the countries in that region that the countries that depend most on China's growth, what would that do to their economies if say China does go down to a four percent rate

from an ultimated six percent rate. Actually, that in a way has already happened in two husand and fifteen early thousand sixteen, because the actual real growth rate in China, especially what was you know, the old economy, was probably even lower, and that all the economy, what was the one that was driving commodity imports into China, let alone also parts and components from the rest of China. So I think they've already gone through that. And if you

look at the resilience, it was quite impressive. The reason being that if you look at as An as a grouping point, they're actually much less leverage than China. They're actually more resilient in a way to China's chock that we actually China China shock that we actually think they are. So I'm not too worried actually about the rest of origin. I'm worried about China though with the worst case scenario in thirty seconds um, I don't expect the crisis anytime soon.

I think they have enough instru ment still today to deal with that. But this will only worsen their potential growth they it will only lower that potential growth and just mentioned in the future because of that massive misallocation of of capital that is still going on. Thank you so much for joining us. Truly a fascinating discussion. Alicia Garciarero.

She is chief Economist for the Asia Pacific Region at n Texas and also a long time advisor to the I m f H, and she starts as an advisor to the research arm of the Hong Kong Monetary Authority as well as others. Someone who has a very clear view on what the challenges are currently facing China and what the solutions are and just to sort of repeats,

I find this a really fascinating point. The more that China has to do now, the more it's going to slow their longer term growth and potentially be a threat on that level. There are reports that health insurers are asking for sharp increases in the cost of their Obamacare plans this year. Why well, they blame instability in the laws coverage markets that's been compounded compounded by the Trump administration.

To make sense of this, I want to bring in Max Nson, a Bloomberg Gadfly columnist, and Max joins us from the Bloomberg eleven three oh studio in New York. Max, what's your take on this, because so far three companies have reported their insurance premiums for the Obamacare plans that they have and the costs are up more than twenty Yeah, I have to say it's not especially surprising that this

is happening. UH companies are having to price their insurance plans for next year really having no idea what the market is going to look like next year. There are a couple kind of primary areas of uncertainty. The first is whether the mandate that people buy insurance is going to be enforced next year heavily or you know, with any kind of urgency by the Trump administration, or even if it will actually be in place if the a

c A becomes law. So that means that people on these markets might face a less healthy marketplace enough to pay more more healthcare costs because people healthy people aren't compelled by that financial penalty to buy insurance. Well, so the just let's put the increase in Obamacare premiums in the three states that have posted rate so far, how does that compared to previous UH premium rate increases in

previous years, because they've been subtly increasing, haven't they. Yeah, you know, things vary so much state by state and year by year that it's hard to kind of have a consistent comparison. But they're they're pretty similar to it, and actually somewhat less than what we've seen in some

of the states with shake care markets. But um, I think the fact that we're seeing this again after kind of you know, consecutive years of price increases just kind of goes to show how how concerned insures are about what the market might look like next year. You know, on top of the mandate, you also have the fact

that the administration might choose not to fund, uh. You know, these payments or subsidies that help low income people pay for out of pocket the art of pocket portion of their costs, which helps them kind of maintain insurance and actually get healthcare. So are actually these insurance companies when they put out their their estimates for what the plans will cost, uh, do they give some kind of statement

about what they hope to see in Washington? Um? I mean, I think they're sending a signal that, you know, they can't really price it at the level they might otherwise they have to kind of plan for the worst case scenario. If you price your plan too low and have high medical costs or kind of an unexpectedly um risky set of of people that you ensure, then you end up losing money and then that that's something they're out to avoid.

So they're kind of planning for the worst, and I think with the way that they're setting premiums there, they're suggesting that the worst could be pretty bad. Indeed, Um, well, we thought that the worst could be pretty bad, indeed from for Valiant. I know that you and I have spoken extensively about your views on Valiant, and yet Valiance shares are up more than as I know, I just completely changed the topic, but I feel like we would be amiss if we didn't talk about this, and I

know you cover the issue closely. So do you think that this pop the Valiant and seeing is is sort of more wishful thinking than reality, or has Valiance prospects actually materially changed. I absolutely think it's once again wishful thinking by any kind of conventional measure. Valiant actually had a pretty dreadful quarter, missed both earnings and revenue estimates.

The company's sales continue to deteriorate pretty aggressively, and within that sales decline, there are a bunch of troubling trends for some really important du things for the company. But investors kind of seized on what they wanted to see and in that case, uh, it was a fifty million dollar increase in the companies adjusted and I mean adjusted Ebitdakians. So um. You know, with the with the company that it's bettered as this, people will kind of take what

they want. And in this case, because the company for once didn't cut its estimates, uh, they saw it as a big positive. Well then they also sort of suggest that they were going to have some kind of capital raise and they talked about selling a number of their businesses as they've been doing. Um, and they projected higher a full year forecast. So this also could be potentially positive. Now yeah, I mean it's it's more of the same

rhetoric from valiant Um. You know, we're going to have more asset sales, we're gonna turn the business around, etcetera, etcetera. But it really, for the most part, has failed to materialize. I wanted just to switch and quickly get Allergan in because they also reported earnings just now for the first quarter, and they reported earnings that were better than estimates, and it also is seeing a boost. What do you make

of that? Um? So all again, you know it's it's kind of the anti Valiant in the sense that you know, they're able to because of you know, their relatively healthier balance sheet, continue to make deals that are kind of a creative in the near term, and you're seeing that with these earnings. So they boosted their their guidance for the year in part because they acquired Celtic, which is a UM kind of a company that provides a technique

that produces fat on the body UM. And then Botox continues to do really well, so um, you know, on one hand, it's it's a nice quarter. They're seeing the benefit acquisitions, but they're also not quite seeing kind of a plan for trans transition of the company from being really narrowly focused on aesthetics, um, you know, things to approve the appearance, towards a more conventional pharmacutical company. It's still the aesthetic stuff that's really driving results. So we'll

see if that transition continues. And perhaps that's the reason why the shares really are not really doing much of anything. So even though Valiant might have a worse outlook according to you Max Uh, it shares her up more just on a mirror hope, whereas Allargan is seeing nothing after reporting it another round of pretty solid earnings. Maxis and

thank you so much for joining us. Max Neison is a Bloomberg goad Fly columnist covering healthcare as well as the pharmaceutical industry, and he comes to us from our Bloomberg eleven three oh studio in New York. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa abramoids one.

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