Bloomberg Wall Street Week: Summers & Ferguson

David Weston on Bloomberg Radio. Welcome to Wall Street Week on Bloomberg Radio. I'm David Weston. Coming up this hour, we'll bring you a conversation on geopolitics with Harvard's Michelle Flournoy, plus what has in store for the world of philanthropy. But first, it was the bull market that defied a euro crisis, political earthquakes and shaky corporate earnings, and central

banks danced to a dobish beat. Now we under the next decade, with interest rates at record lows and an asset bubble that many fear is ready to pop. Let's bring in our roundtable now We're joined by Larry Summers Warmer, US Treasury Secretary and Roger Ferguson, President and CEO of the Teacher's Insurance and Annuity Association. Larry, it gives a sense of this decade that just happened, a big run

up in the markets, particularly equity. What drove that. Part of what drove it was how weak the markets were at the beginning of the decade as a consequence of the financial crisis. Part of what drove it was we

had the longest recovery we have ever had. But crucially what drove it was that interest rates fell so low that uh people applied a much lower discount factor to future earnings, and that inflated the price of all assets, whether it was stocks, whether it was real estate, anything that promised future cash flows became more valuable as interest rates came down. So Roger, that raised the question, obviously,

are we inflating asset values through lower interest rates? So look, I agree with Larry that without a doubt, the big driver was the moving interest rate both here and around the world. Question are we inflating values? I think it's too strong to say that that implies some massive bubble, that's about to burst. However, what we have seeing, David is that the p multiples have started to increase as well, which is suggesting that every dollar of earnings is getting

a bigger and bigger return. So I've been a little cautious when we're inflating, but I agree completely with Larry that low interest rates were the major drivers for markets. Is the market overbought when it comes to equities, I

don't think it's clear that it is. I think that given what's happened to interest rates, which in my view is heavily driven by wheel events in the economy, more saving because more of the money is going to affluent people, less investment because the price of capital goods has come down so far. I think those are the reasons why you have lower interest rates. And when you have lower interest rates, you have higher higher multiples. I'm not sure

that it represents some fundamental imbalance. This certainly isn't a moment like the moment at the beginning of the decade when markets look cheap, and I think we've got to recognize that because interest rates are much lower, and maybe risk premiums are the same as they always are, that returns going forward are going to be substantially lower than they have been over the last decade. And that is

the question. If lower interest rates and starting from a low base drove the last decade, what's going to drive the next decade. I think it's gonna depend on the news, and we don't know whether the surprises are going to be positive or negative. But I think if things work out as everybody expects them to, then you're gonna be looking at equity returns that are much lower than people

have become accustomed to over most much of the last generation. Uh. My guests would be that if you invest your money in part in stocks and in part in bonds, you're gonna be looking at returns perhaps in the five six percent range um, which is much lower than people experienced over the last decade. And that's probably going to be an unpleasant surprise for some people. So, Roger, you're responsible for a lot of money for a lot of pensions.

People are gonna count on that money over the long term. What is that thesis that Larry set out? What does that tell you about investing? Well, first, a point I would have made that I didn't hear that. I make the thing that's going to drive markets over the next several years. It's what's driven them the last several First question is our interest face is going to main low, right, and so the expectation that the Fed and other central banks will be on hold for a period of time.

I think it's going to continue to support equity valuations and other valuations. I think Larry is absolutely right. The return that the average investor can expect an equity market, so the next two or three, five, maybe ten years, is going to be somewhat lower than we had in the past. Um, that does not mean that it's gonna sort of burst. It does mean that one should expect

slightly lower returns. The answer to all that, though, when I think about pensions is you want to have broad diversification, so equity fixed income, but certainly alternatives will be another to look and they're going to want to play the big global themes as well. What do you think. I mean, one of the things that strikes me in the last ten years, there's a delta they've been cutting interest rates is just static low interest rates enough. That's the key point.

Roger's right about diversification. Rogers says they're going to be slightly lower over the next decade. I think it's gonna be a good deal more than UH slightly lower. I think that people will do fine if they earn five or six percent on their money. I think that people are going to realize that it's not going to be

the kind of happy decade that we saw. I think the happy decade came in part from the positive surprise of falling interest rates that drove up on prices definition ly, and it drove up stock prices because falling interest rates meant higher multiples. We might see continued low interest rates, but they're written that much room for interest rates to fall starting from a ten year of one point eight.

So I don't think it's going to be nearly as bullish a period over the next decade as it has been uh in the last, and since the level of interest rates is a kind of fundamental determinant of everything, um, I don't think that. I think the versification is absolutely the right strategy, but I don't think people are going to be able to avoid the reality that returns are going to be lower in the future than they have been in the past. We'll be back with Larry Summers

and Roger Ferguson after a decade of growth. It's clear global central bankers fear are reckoning to come, but our monetary policy makers out of ammunition. We'll discuss with our roundtable. Next. I'm David Weston and this is Bloomberg Wall Street Week. This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. We continue our round table with Larry Summers, former U S. Treasury Secretary, and Roger Ferguson, President and CEO of t I a A. Central banks may no

longer be the only game in town. That was the sobering message from the American Economic Association's annual conference in San Diego, a decade after the financial crisis rocked the global economy. Policymakers confront a risky world of what could be perpetually low growth, something Larry Summers warned about in his speech to the I m F back in two thousand thirteen. So, Larry, I guess congratulations that you were right, but I'm not sure you wanted to be right. Secular

stagnation isn't good news. It suggests much more profound trade offs between rapid economic growth and financial stability and fiscal prudence than we thought we had and raises all kinds of questions for macroeconomic policy going forward. But look what's happened relative to the time when I put forth that secular stagnation hypothesis in is, we've had bigger deficits than

people thought. We've had lower interest rates than people expected, We've had more credit growth and higher asset prices than people expected. So the accelerator has been on the floor, but the car hasn't gone very fast. We've had lower growth and lower inflation than people expected. And what that suggests is that the underlying energy that the private sector

generates is much less than it used to be. That we've been able to give some energy, but only by having rising debt to GDP ratios, only by having quite extraordinary monetary policies and low interest rate. And there's a question how long that lasts. And there's also a question of what the long run side effects of that are. You know, people say that the so called to WE neutral interest rate has declined by two or three percentage points.

What I've been able to show in some recent research is that if we hadn't been running up the national debt globally, that probably that real not neutral interest rate would have declined by four or five or six or seven even uh percentage points. So there's a fundamental structural challenge around the fact that people are living longer more the money is going to people who have high savings rates.

And at the same time, as you see with my cell phone that costs five dollars and has a hundred times as much computing power as the whole Apollo project, capital goods are getting cheaper cheaper, and so the money slashes into existing assets, leading to asset price inflation. But with limited economic energy. It's a little bit like the plight of Japan or some you might even call it a monetary black hole. So Roger, as an investor, how

do you process all that? Basically, I think that Larry saying we've kept it growing but basically running up the credit card. No, look, I think Larry's points are certainly well taken in terms of what happened in the last decade. The way you process it is to say two things. One is is there going to be a fundamental change

anytime soon? In particular, you know what we haven't talked very much about is one of the things that's kept rates so low as inflation and so inflation for variety of reasons has been a no show, which has allowed central banks to continue to be very very accommodative and to drive down interest rates. So the way you play it is, first, is that picture gonna change? Our interestate is going to start picking up anytime? Is gonna have

to worry about. Secondly, as I said before, you know what are the asset classes are going to benefit or not benefit? And so you're gonna have to be thinking, you know, much more cleverly about you know, how you differentiate. You also are looking for is this has been a global phenomenon? Is the US still the best place to be? Or should we be looking at different emerging markets? How

should we think about it? So again, I think this is the time where you move from the broad general down to a much one now much more focused, much more particular theory. It just strikes me that you are an investor, but you also were vice share the FED. Have the central banks basically done what they could do? Essentially? I mean they've really kept a lot of simulus monetary students and have they basically done everything they can do?

So Look, I think the general consensus and I share it, is that the last recovery depended much too heavily on central banks. Um. Uh heaven here in the US where we had some fiscal stimulus. In hindsight, a lot of folks think maybe we should have done more and kept it going. Certainly, for one looks in Europe. Um clearly that we'd say central banks are asked to do too much. So yeah, I think too much weight has been put on the shoulders of central banks. They responded by doing

a couple of things. One is using their regular tools I called interest rates, and then to using some unusual tools and new tools qualtitative easing for sure, building up the size of their balance sheets, going in and buying a variety of fixed income securities. And then they polished up the use of forward guidance. You know what was it? They said? So when you look at the debate that's going on, the question is that enough? And will that

be sufficient the next time around? And I think that's really a question that we former and current central bankers are worried about. This is something that was the topic of discussion out the a A that conference that you attended in San Diego. One of the things that you raised, I believe others have raised as well as something called semi automatic stabilizers. Basically, as I understand, automatic fiscal injection when certain things turned south. Is that a realistic alternative?

It better be um ben Burn Ankie gave a speech out there which I think was a kind of last hurrah for the central bankers. He argued that monetary policialed be able to do it the next time. I think that's pretty unlikely, given that in recessions we usually cut interest rates by five percentage points, and interest rates today or below U two, and I just don't believe that quantitative easing and that stuff is worth anything like another

three percentage points. So I think we're gonna have to rely on putting money in people's pockets, on direct government spending. I think that's okay in a country where public investment and infrastructure are decaying so badly. But I think that's where we're going to have to look for our countercyclical energy. And what Olivier Blanchard and I were talking about when we discussed UH semi automatic stabilizers was the idea that rather than relying on Congress to organize itself to act

each time there's an economic downturn. We should do more with rules that would lock in changes in spending. Perhaps greater assistance to states, perhaps more assistance for people who are unemployed, perhaps working off a backlog of infrastructure investments, perhaps giving temporary tax credits for those uh who spend, And that that kind of fiscal stimulus is going to

have to be a larger part of the story. And I think it's very I think central brankers have a very difficult road to walk because on the one hand, they don't want to say they're out of gas and they can't solve the problem. On the other hand, they'd better be giving some warning if they want fiscal policy to be ready next time. And I think that's reality that it's going to need to be. Larry Summers and

Roger Ferguson will stay with us. Coming up, we turn to the world of philanthropy for a fresh perspective on what holds in store. We're joined by the chief investment officer for Carnegie, Kim Lube. That's next. I'm David Weston, and this is Bloomberg Wall Street Week. This is Bloomberg

Wall Street Week with David Weston from Bloomberg Radio. We continue our roundtable with Larry Summer's former US Treasury Secretary, and Roger Ferguson, President and CEO of t I a A. It's been a roller coaster start to global markets as investors grapple with America's killing of a Runnyan military leader, Solomony,

and it's aftermath. So over and above things like prospects for economic growth, changes in monetary policy, and government spending, investors have to be considering geopolitics that can change in an instant. Michelle Flournoy has made a career of analyzing and understanding forces just such as these. She served as Under Secretary of Policy that was under Defense Secretaries Robert

Gates and Leon Panetta. Michelle's currently senior fellow at Harvard's Bell for Center and a senior adviser to the Boston Consulting Group. She joins us, now give us your take today. Is it a constantly changing story? But it really was a lot of upheople last week it seems to have calmed down. Is that a false dawn? Well, I do think the circuit breaker has been thrown on the most recent cycle of escalation between Iran and the United States. But I think we would be foolish to think that

this is over. The fundamental issues that the United States and Iran are in conflict over have not gone away. So I think what we're likely to see is a

reversion to sort of previous approaches. You we've heard that the Trump administration is going to go ahead and increased sanctions, sort of doubling down on their maximum pressure campaign, And for Ron's part, I think you can expect them to revert to their traditional playbook, which is really using more covert and clandestine means that give them some measure of deniabile. Whether it's cyber attacks or whether it's use of proxies

to launch attacks on their behalf. Those are the kinds of things we're going to see in the future unless we see some kind of breakthrough that gets the parties back into negotiations, and I don't see any sign of that as yet. So Michelle, thanks for that set up. A curious question or question on my part is um

markets are very focused on headline risk right now. I think there's a general side relief if in fact, the Iranians go back to more covert activities, and may be that that nothing will be visible and markets will therefore be pretty calm. So what's the possibility that Uranians will do something over the next few weeks months that were really royal markets, because it will be surprising, will be large, will be visible, and it will be clearly a direct

challenge to the United States position. I think that's possible because you know, where the redline has now been drawn is the killing of Americans. UM So I think iron understands that. But you know, I don't think it's out of the question that we could see another attack on either oil tankers in the Gulf or oil infrastructure in the region that would rattle the markets, because I think

Iran understands that our partners in the region are vulnerable. Uh, you know, they could they could certainly take advantage of that and launch attacks against that infrastructure again if they felt they weren't getting the right attention from the Europeans, from the US, they weren't getting support to try to lessen the sanctions on them which have been crippling. Taking out Sulamine was a choice Michelle that President Bush rejected and that President Obama rejected in a choice that President

Trump made. Are we more or less secure as Americans? Uh? Today? With him dead. Um, But the consequences of of our having engaged for the first time in forty years, fifty seventy years in assassination of the senior official of another government, would you say Americans are more or less secure today as a consequence of what's happened. He was a terrible man with the blood of hundreds, if not thousands of Americans and many others on his hands. So in that sense,

he was a legitimate target. But he I think other presidents had the opportunity decided not to take him out because of the second and third order strategic consequences of doing so. He was not only the head of designated terrorist organization, he was also this arguably the second most powerful Iranian government official. And so what this has done has basically now set the precedent of assassin senating a government official of a country with whom we are not

formally at war. So what is to stop Iran from assassinating a forced r U S General or a National Security Council member when they next visit the region. It

sets a terrible president, It opens an Pandora's box on assassination. Furthermore, the way in which it was done on a rocky soil without any coordination with the Iraqis has now set off a set of issues there where we may very well get pushed out of a rock and at a time when we still have work to be done with our allies in terms of fighting ISIS and making sure that they do not regenerate and start attacking US interests

and facilities around the region. Thanks to Harvard Senior Fellow Michelle Flournoy, Larry Summers, and Roger Ferguson, We'll stay with us. Coming up, we turned to the world of philanthropy for a fresh perspective on what hold in store, which ooined by the Chief Investment Officer for Carnegie, Kim lu. That's next. I'm David Weston and this is Bloomberg Wall Street Week. This is Bloomberg Wall Street Week with David Weston from

Bloomberg Radio. We continue our round table with Larry Summers, former US Treasury Secretary, and Roger Ferguson, President CEO of t I a A. Each week we welcome a guest with a somewhat different perspective on the big stories that we're covering. This week, it's the perspective of one of the most prominent foundations in the country, the Carnegie Corporation of New York. Kim Lu is Carnegie's Chief Investment Officer, responsible for investment management and oversight of some three point

five billion dollars in assets. Earlier in her career, ms Lu managed private equity for the Ford Foundation, and last year Institutional Investor named her c i O of the Year. She joins us. Now, from the point of view of a foundation, how is what you do different from what

we're talking about? How is it the same? So one of the things that I heard that was particularly concerning, because I think it's true, is when Roger was talking about the fact that expectations for returns over the comington years is probably going to be significantly less, and Larry made the same point, And so there is consensus around the fact that because interest rates are so low, the

expectation is that returns maybe more modest. And for a foundation, that's death by a thousand cuts, because we are mandated to give away five percent a year. So unless we can feel pretty confident that we can receive a five percent return, then that is a slow declining of our portfolio.

And really it really puts our grantees at risk because we'd have less and less to provide for them over time, and so that is a much worse scenario, quite frankly for us than if we had a big decline, because if we had a decline, we reset our payout and then we'd slowly see it rise back up again. But right now there's a general expectation that we're going to bleed assets slowly over time, and so um pretty concerning it for the foundation community. Okay, what are your options?

Do you take on more risk, do you change your liquidity or duration? I mean, what can you do to address that issue? We're looking for more active management, and we're looking for picking be its sectors or opportunities that we think offer us the opportunity to outperform. Traditionally, foundations and endowments have put a lot of their assets in alternatives, and that has been possible because we are long term investors and so we don't have to worry about the

short term nature of the market. We spend much less time thinking about what's going on in the stock market and in the bond market in any one time, and the fact we can make investments in things that we think are underpriced and just hold them until they realize feel value without having to report one quarters and maybe not even annually sometimes. And so what we mean by the fact that we long term is that we don't have to worry about what happens in the short term.

We can we can invest in things that maybe don't actually produce substantial returns in the short term because we believe that they're going to produce returns in the long run. The problem because we have a lot less degrees of freedom, because we have so much wrapped up in alternatives, is that there's less ability to rebalance and to take advantage of things that happen in the short run. We just sort of have to set an asset allocation and stick

with it. For you, because I think is big and alternative. We're very big and alternatives. I think we're bigg alternatives for maybe some of the reasons that Kim talked about, which is we're thinking about payouts over the next ten years because we're retirement oriented company. And so I think both of us share in common this notion that you want an investment that is gonna somewhere with short term, but it's always going to be long term, which leads

to a question. I think that the thing we have in common is this notion of not needing immediate liquidity, and you should talk about maybe there's how do you think about liquidity, your liquidity needs, how you project out, and how you drive, how that drives your investment thesis and activity. So liquidity is in amazing really important for us because we have no influence of capital, and so because of that we have to plan for it. Now.

We are equity bias. The portfolio is invested in some form of equities or equity like securities, with very little

in fixed income securities. The issue being that we we make sure that we have sufficient liquidity to pay our payout five percent a year, plus the cost of running the office, plus the cost of rebalancing and meeting our other liabilities, which is a significant number of unfunded commitments as a result of having so much in alternatives, and what we think of that as ballast for the portfolio becomes an under normal circumstances, when the market doesn't behave

particularly well and the Fed wants to stimulate, they lower interest rates, makes people go out and spend more money and and makes bond prices go up. We sell the bonds,

We reinvest in equities. That's how we've rebalanced. Now we are concerned about the fact that people will not actually go out and spend because they feel like they have to save more because interest rates are so low, and rates are so low that it will not have as big an impact, and so our fixed portfolio doesn't have as much balance as it used to have, and so

that's a big concern. And there are a number of things like that with which we have traditionally relied on in order for us to portfolio construct for the long term, which are not as dependable as they used to be, and so we're concerned about what that means and how we should think about things differently. I'd love to be wrong, but I think you guys are way optimistic for the

next decade. On alternatives, it used to be that there were only a limited number of alternatives trying to pick stocks, and there were all kinds of households making bad trades, and the alternative managers could make money there. For now there's much less so called noise trading and many many more alternative managers, and they're still all charging high fees. Used to be you could give up liquidity and make private equity investment and expect to get paid for the

fact that you've given up liquidity. Now there's trillions of dollars in private equity investments, there aren't that many more deals, so they're being bit up in UH price. Are you really confident that by turning through alternatives you're going to generate substantial out performance relative to stocks and bonds going forward in the way that's admittedly been true in the past. I wonder if the game isn't losing some of its edge. I hope you're wrong too, but I do agree with you.

I do think the game has changed, and I do think that what we've traditionally done is invest in alternatives because we believe that we can create value out of the noise. And you're absolutely right that there's far less inefficiency than it used to be. There's so much capital flowing into the market, there's so many different types of people sort of leveraging all the different opportunities. We saw. One of the advantages that that Carnegie has, which unfortunately

Roger doesn't have, is the fact that we're small. We're only three and a half billion dollars. We can play in spaces that are niche spaces that capital can flow, and it's not worth it for some of the larger managers to go into a market that's only can support a hundred million dollar fund or seventy million dollar fund, but we can play in that market. And so what we're doing is we're tending to go smaller, we're tending

to go even more inefficient. It's a different risk profile, so we need to think about it differently, and we know that we are taking on more illiquidity risks because we're going into these markets which do not have the same level We've got to remember. We do have to remember here that when you go to alternatives, you're usually paying one two percent in fees and then you're paying returns.

And until you get those fees down, they've got to they don't just have to outperform, they've got to outperform a lot to outperform on an after tax fee basis, because nowadays, as you know, you can get into index funds and pay zero, nothing at all. And so I'm just not sure that that for the general investor, alternatives are going to be as good going forward as they have been in the past. If we're looking for markets where there may not be the efficiency that are just described.

What about emerging markets. There are emerging markets where there isn't as much transparence that there isn't as much efficiency. There's risk, But is that an opportunity. It is an opportunity, but it is a challenging markets to play in because what you need in those environments are good management teams.

You need people who are good investors. You need aligned investments who who people who think in a similar way about the relationship between their investors and the markets and how they do things, and that's hard thing to find.

People have very different insentives and quite honestly, when you're talking about emerging markets at this point, you're talking about China, China of the emerging markets benchmark, and that is one of the areas that we have to really start to think about how markets are changing, because we've relied on the fact that emerging markets could be differentiators, and we've just said that we're going to invest in emerging markets

and that's gonna be a form of diversification. Increasingly, seeing that the world is not dividing evenly between developed markets and emerging markets, and there may be other ways we should look at it, and possibly China is a form of diversification. There's very likely to be a decoupling between the United States and China because they are going to

make very different decisions about technology. And there are countries who are going to line up behind China, and then there are companies and countries that are going to line up behind the United States. And I don't really know who the winner is going to be. And we're gonna have to decide how we're going to participate in those markets and provide us with some opportunities. But there's clearly

a lot of risks. There is especially risks when um, you know, we're concerned about what's going on there, and we're concerned about the laws and the regulations and how they will change in response to things that we do here. And it isn't an inorder amount of risk, but it is a big market. It's hard to ignore it. One of the things looking back in the last decade is the tide has risen pretty well with China. Looking forward to the next decade, how far is that? How you're

going to keep going? Well? They are slowing, but even though they're still slowing, they're still growing a lot faster. Than we are, and if so, if you're looking for growth, you need to go there. I also think that it's it's not insignificant that it is a government that can control a lot of things, and it can turn on a dime in many respects, and so it can make adjustments in ways that that are arguably more challenging for us to make adjustments. Roder hoping an opportunities to China

in the next decade. I think, broadly speaking, you're right, it is growing, it is still emerging. I think the challenges have to do with transparency, the ability to you know, get your money out depending on how you invest um and you're very good point around, you know, having teams to really understand what's going on. So I think it is absolutely still a class who want us to look at.

But I'm a little more cautious maybe for those Thanks to our roundtable Larry Summers, former US Treasury Secretary, Roger Ferguson, President and CEO of t I A A. And Carnegie's ce IO Kim Lou that's it for Wall Street Week from Bloomberg Radio. Coming up next week of Sonny Beschloss and Sam Paul Masana will join us around the table. I'm David Weston, this is Bloomberg