Don Marron is the Chairman and CEO of private equity firm Lightyear Capital. In a candid interview, the former CEO of Paine Webber and board member of Fannie Mae explains why good stocks are falling along with the bad, what you should do with your money, and what’s wrong with Obama’s tax plan.
Can you list the most important financial challenge facing the next administration?
The most important job is to insure that all the federal money invested in our banking system is used to make loans and not just kept as a cushion. People are only beginning to discuss what will actually be done. Banks must get back to their core business—making loans for individuals (e.g., mortgages) and small businesses.
Joe Nocera of the New York Times referenced an employee-only conference call quoting an executive of JP Morgan Chase suggesting that the money would primarily be used not for loans but for banks to merge. I can’t vouch for the authenticity of that but if it represents current thinking, it is misguided. The Treasury Secretary is naturally concerned about this potential and should become more active. The British Treasury has specifically set targets for sound loans; we should, too, or we’ll delay the recovery unduly.
What is the explanation for the wild gyrations of the stock markets?
This is the first 401(k) crisis. The difference between this and past crises is that in the past the average citizen was really a spectator. He didn’t have his life and his retirement tied up in the markets. Today, 50 million Americans do. What they think about now is very different from before and when you ask them what they think now, they’re scared to death (poll after poll shows that the direction of the U.S. economy is far and away the biggest of voters’ concerns).
Are you saying it’s not the panic of the hedge funds that caused the market to collapse—it’s the ordinary investor?
No, I’m saying the ordinary investor has been hit by the gyrations. Why is it such a roller coaster? First, this is a truly global market. Secondly you have information continuing to come out that changes people’s perception of what’s happening. Third, there isn’t much transparency. And finally there is a huge amount of money in hedge funds and in other funds that are partially based on leverage, which is coming down, and partially based on a set of principles which are being challenged right now.
When people watch the TV are they being well advised?
Trust has taken a body-blow. The public reads and hears that the whole financial system has collapsed and the concept of having authority figures that you can trust has been eroded.
Is that why the public falls back on the TV figures like Cramer?
Well, yes, television personalities are part of it. But they have always been part of it. This public, I think, probably changes their mind every couple of days depending on whom and what they hear on television.
What’s the quality of the advice they get on the tube?
It is well meaning. But there are two kinds of advice. Advice on the environment is generally very acute. Advice on the stock market right now is of a wholly different quality because we have a market that is not reacting in terms of the normal parameters of price-earning ratios and such well-understood markers. Take a look at the financial services stocks that compose the S&P 500—compared to a year ago, together these stocks have lost about 40 percent of their value, that’s over $1 trillion! Secondly, in a crash like this, hedge funds and other institutional investors that have a portfolio can’t sell the bad holdings. So they have to sell the good holdings. So the good holdings go down for reasons that having nothing to do with its underlying quality. Because that’s the only thing that’s liquid and the only thing that can be realized.
So an attractive price earnings ratio has no effect?
Well that’s not relevant if you have to meet a margin call and when half your holdings are not saleable and half are salable, what do you sell? You sell the holdings that are saleable which usually tend to be the good holdings.
So that explains why some of the good stock has gone down?
Exactly, because what takes over is the need for liquidity and the best stocks usually are the most liquid. I was in London ten days ago meeting with one of the top hedge fund managers in the world and all he wanted to explain to me was why his stocks were so good and of such good value and they were all down 30 percent.
What does that mean for the 50 million Americans with their 401(k)s and IRA’s or whatever. If I have a very good stock like Microsoft, or whatever, are you saying I shouldn’t panic and sell even though these hedge fund guys are having to sell because of the margin calls. So I should close my eyes and not look at the market?
In general this is a market where it’s too late to sell and too early to buy.
Taxation on Joe the Plumber, etc. seems to have come to the fore of the campaign. What’s your view of the issue of increasing taxes on small businesses?
It depends on what kind. If Obama uncapped social security, that’s going to be a big direct hit on small businesses as we saw when they uncapped Medicare. I don’t see how either candidate can sensibly raise taxes on small businesses, especially not with a recession looming.
We’re going to have to fix things so it doesn’t happen again, so how do you see the origins of the crisis? Alan Greenspan has said that “Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity (myself especially) are in a state of shocked disbelief.” Are you in a state of shocked disbelief?
Not quite because I’ve lived through crises before. Historically, the normal checks and balances of a lender are that they are ultimately responsible for the loan. In the last [ten years] the investment bankers in these banks wanted to generate fees. The banks went from thinking about lending for 30 year to lending for 45 days since that’s how long it would take to securitize these loans. What does this mean—simple, there was more profit if the mortgages were held only long enough so they could package them up and sell them off by securitization—completely different business model and risk assessment culture. If they had been forced to keep them, they would have had a wholly different credit point of view.
The people bundling the securities were eager to pass the baby, yes?
With a Triple-A stamp, yes, they were now in the business of not making loans and keeping them. They were in the business of creating loans and packaging them and selling them to somebody else. So their time horizon was very short. That in turn meant that the normal standard of credit control were eased because there was such a rush to generate as many loans as possible. The other normal checks and balances of raising the interest rate on bigger risks didn’t work because of this bundling process.
Because of politics?
Well, that may be part of it, but also because the market didn’t react. Why? Because the market didn’t know much about mortgages. Now it has learned a lesson—well, we’ve all been hurt.