Amid chaos in the markets, leaders from some of finance's biggest players came to Duke to debate the causes of the global financial crisis.
A panel discussion, titled "Private Equity, Sovereign Funds and the Global Credit Crunch," drew an audience that filled the School of Law's Star Commons Thursday to discuss the current credit crisis and the future of private equity firms and sovereign wealth funds. The panel was led by James Cox, Brainerd Currie Professor of Law, and featured three influential names in the world of private equity and sovereign wealth funds.
John Canning, Law '69 and co-founder and chairman of Madison Dearborn Partners, and Stephen Schwarzman, co-founder and chairman of The Blackstone Group, represented private equity firms and spoke of the progression of events that led to the current crisis.
"It all looks so obvious in hindsight that the business model for investment banks was not sustainable," Canning said, reiterating a sentiment that seemed to reflect the views of all panelists.
Also present was Gao Xiqing, Law '86 and general manager and chief investment officer of the China Investment Corporation-China's sovereign wealth fund responsible for investing and managing $200 billion in assets. Gao is also a member of the Board of Trustees.
Although several factors played into the current credit crisis, Schwarzman said sub-prime mortgages were a primary reason for the tight credit markets.
"The idea of lending money to poor people is the story of how this crisis started," he said.
He noted that a misalignment of incentives caused banks to only worry about reselling mortgage-backed assets, rather than assessing the value of the securities when they mature.
"Securities were bought by investment firms that were sold to banks around the world... it was like an epidemic started in America," Schwarzman said.
But when people started to default on mortgages and investors realized the true value of the loans, banks were forced to hold on to the assets despite huge losses. Because investors were unsure of the value of assets held by banks and investment firms, banks stopped lending to each other, Schwartzman said.
"Since financial institutions could not borrow, they stopped lending to everyone," he said.
All of the panelists stressed the need for banks to reduce their leverage ratios-the ratio of borrowed funds to equity. Some of the investment banks were leveraged 32-to-1, meaning that they borrowed $32 for every dollar they put up for an investment in hopes of maximizing their returns.
Members of the panel all agreed that banks needed to "deleverage" by selling off borrowings. But the panel cautioned that it would be a long, and perhaps painful, process.
If all the banks were to try and deleverage immediately, the market would be flooded with assets, driving down their prices. Schwarzman said the process can and should take up to five years.
"Slow is OK, deliberate is OK, but mismanagement is not OK and it is why we are seeing losses in the stock market," he said.
The three major financial players, however, did not agree on all causes of the crisis. A point of contention among the panel was the role of mark-to-market, or fair accounting, practices in the credit crisis. Mark-to-market accounting is the process of assigning values to assets held by a financial company based on the current market price for the asset, rather than historical prices.
Practices such as these played a role in the collapse of investment banks like Lehman Brothers, Schwarzman said.
The other members of the panel, however, objected to this view.
"What mark-to-market accounting did was expose that Lehman was leveraged 32-to-1," Canning said. "It is like blaming your police department for catching you driving drunk."
Gao noted that mark-to-market accounting is more transparent and more predictable. As an investor in institutions that practice such accounting, he noted that fair accounting is important for investors.
Gao also spoke about the difficult position that sovereign wealth funds have found themselves in. These organizations, which have come under fire recently for a lack of transparency, have played a big role in providing money for the bailout of financial institutions.
"[Sovereign wealth funds were] trying to catch a falling knife," he said. "If [the funds] get cut then everyone loves [them]. If the market goes up then everyone hates [them] again."
Although the current credit situation has improved over the past few months, it remains a large issue for governments and people around the world, panel members said. The future of financial institutions remains uncertain, though it is clear that private equity funds will be needed to provide capital for the economy to turn around, they added.
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