Mutual Funds

We are not in a financial crisis at this point of time: James Gorman, Morgan Stanley

The Narendra Modi government’s clarity of action is evident in the bold reforms that are necessary to underpin India’s ambitions of global financial leadership. As New Delhi heads toward the $3-trillion GDP milestone and races past the UK in the process, India is likely to witness more M&As in the next decade, Morgan Stanley CEO James Gorman tells Joel Rebello and MC Govardhana Rangan.

Edited excerpts:

The last time you didn’t generally agree with forecasts of turmoil in the financial markets, your assessment turned out to be prophetic. This time some emerging markets are in strife, coinciding with the 10th anniversary of the Lehman collapse. How do you see it now?

We are definitely not in a crisis mode. Financial markets go into crisis either because there are systemic problems in the banking system or the economy at large is troubled because the banks finance the economy that causes problems. I do not believe there are systemic problems in the financial industry and I do not believe that the global economy is in trouble. In fact, the global economy is very strong. So, we are definitely not in a financial crisis at this point of time.

So, where is this noise coming from? The US 10-year is rising, unemployment is at record lows. Is the tightening cycle the worry?

There is always something to worry about. It’s a bit like the Indian cricket team when they go on tour, are they going to have a good season or not. How are the Australians performing in various Tests? There is always something you can worry about, that’s human nature. But I don’t worry about people giving general statements; I worry about fundamentals heading south. You can look at the US raising rates as a negative thing because of the potential issues with the credit or you can look at it positively because the US economy is incredibly strong and if they don’t raise rates, you have the potential for an asset bubble. My own view is the reason is the latter, the economy is doing too well to keep rates this low. That said, there are things to be concerned about – tariff wars, protectionism, anti-immigration are not positive for global economic growth. But at this point, there is no indication that we are heading for a new crisis.

In the past four-five years, a lot of money has flowed back to developed markets. Is that a blip, or a part of a long-term trend?

I think it is simply a reflection of the strength of the developed markets. We went through a phase of profound weakness during the financial crisis and the last five years have shown a recovery. Capital flowed into the developed markets because assets were cheap. Generally, there is greater risk and return in developing markets; it’s the nature for those markets. There is less liquidity, it’s more volatile, and they are exposed to currency risks.

But over the last 30 years, a lot of investment went into emerging markets and returns have outweighed the risks. This decade has been unusual, the developed markets have been the epicenter of the crisis, perhaps for the first time. Not Russia or Asia or Mexico but the US and continental Europe and UK. It involved the developed markets and asset prices were materially affected for five years and as they started to recover, smart money came back to those markets to take advantage. But things are now starting to normalise. The emerging markets will continue to be very attractive because that’s where outsize growth tends to come from. Right now, it has been hampered by what’s happening in the currencies but that’s a short-term impact.

A lot of this growth was fuelled by zero-interest rates carry trades. In a scenario when these trades unwind, how will that play out for emerging markets?

You have to see the tightening in the context of abnormally low interest rates – zero in the US and negative in Japan, which is not normal. The tightening is getting you back to normal and not to high interest rates. When I came to the US, I borrowed at 24%. An unsecured loan in New York would be between 15% and 20%. These were high interest rates: We are not in a high interestrate environment, we still in a low-rate environment. This is getting back to normal. Obviously, with the unwinding, there will be more turmoil in the global markets, we will see more volatility, but not at the level we have had through much of the last three or four decades.

You have come to India after seven years…why now?

Our organization is structured regionally; so other executives have been coming. Right now, I am spending more time in Asia broadly and I thought it was important to come to India and I will be here a number of times over the next several years. We have several thousand employees and India is an important focus for our organization.

Your main businesses in India are M&A, advisory, investment banking, brokerage, private equity and real estate funds. Will that change?

Yes, that will be broadening. On the fixed income side, there is a push by the central bank to deepen the debt capital markets here and I think debt trading is something we are very good at and infrastructure finance is something we are very good at; so they are the two things that I would point you in the general direction of.

There has been a lull in M&A activity in India after 2008. Is there a way that can change?

The policies that have been put in place by Prime Minister Modi’s government have ensured a lot of energy in the Indian economy right now. India has had over the last 50 years a number of starts and stops but it is a much larger economy now. It is on the cusp of becoming the fifth largest economy in the world, replacing the UK. The changes to bankruptcy laws, the opening up of more foreign direct investment, (and) efforts being made to put a much larger percentage of the population have banking account relationships…. The technology being developed to identify people through thumb prints and eye scans, the building of infrastructure across the country.

Just driving around in Mumbai, the bad news is traffic is awful but the good news is that part of the awfulness is because the new metro system is being built. So, there are a lot of things that are changing in India which are durable and are not going to change back because of political party changes. I think this time things are a little bit different here. Once you are getting into the $3-trillion-level economy and getting some of the reforms in infrastructure and bringing banking to a broader population, these are huge positives for the economy and this is going to attract foreign players interested in participating in this market – some through M&A. It will create a lot of free cash flow for Indian companies, which will in turn be aggressive in consolidating and developing skills in this market. So, I think we will see more M&A activity over the next ten years compared to the last ten.

US banks are looking at new opportunities for investments due to the new bankruptcy code… How are you looking at it?

Having a strong bankruptcy regime is obviously essential to having a robust credit banking system. It builds trust. Basically, what financial institutions always want in the market are transparency and certainty. They want to know why things are working the way they are working and when things go bad or good, there is some certainty about the outcome. And I think the bankruptcy code is integral to that.

What are your views on the performance of the Narendra Modi government?

The clarity of action is very exciting. Decisions have been made. Although I have not come here very often, I have met with Indian business leaders and politicians many times over the years in Davos and New York and so on. The clarity and willingness to make decisions, the foresight to recognize that you can through technology jump over various stages of development…I think these are very positive. The government brings a business mind-set of getting things done inside the social fabric of ensuring that the society stays a cohesive society. Internal security has to be strong, external military presence has to be strong. India has to be respected on the global stage and is. I think they have done a really good job. Apparently, the approval ratings of the Indian population would affirm that. We will see when the elections come. We will have to give them a very strong report card. Even the GST, once it’s put in place cannot be taken away. These are fundamental and long-term changes that will affect the Indian economy very positively for many years.

How does the Make-in-India campaign appeal to foreign investors in times of trade war and protectionism?

I just came from Singapore. If you asked 50 years ago why Singapore? A tiny city state around much more populous nations with much more land and resources – why would Singapore be successful? A part of the success of Singapore apart from the incredible leadership of the senior mentor over many decades and the decision to require English to be learnt by school children which immediately gave them the ability to trade globally, they picked industries that will be made in Singapore – logistics management, port and shipping, some of the technology industries, financial services, foreign exchange, wealth management.

I’d Vote for More Fed Rate Hikes over Next 2 Years

This is what they wanted to do and by definition some they didn’t want to do. So, you can choose to have things made in your country but there has to be a natural competitive advantage why that makes sense on a global stage. Because you can try all you like but is somebody else making it better and cheaper? People are going to buy their goods and not yours. India is unique because it has a massive population so the domestic market is large enough. If you build a manufacturing base rather than buying it from offshore, that makes all the sense in the world. But if you want to make things to export them, you better make sure they are things you have a natural advantage in. Every country has to figure out where its natural advantages lies.

The Indian rupee has hit record lows, and the decline is being taken as a reflection of not so good economic management….

I don’t read the move in the currency as a reflection of economic management at all. The rupee trades on account of what the dollar is doing and not on account on what the rupee is doing right now. It’s the tail wagging the dog. At this point, the reality is that what is going on in the US – all the potential tariff war is roiling all the emerging markets. It started with Venezuela and Turkey and is now affecting all emerging markets. So, I do not take that as a criticism at all by the financial markets of the economic steps taken by the government. It is an unfortunate consequence of what is going on outside India…

In one of your interviews, you spoke about infrastructure funding, that you have raised about couple of billion dollars, and about the need to develop ports and roads. India also needs huge infrastructure development. Is Morgan Stanley also interested in participating in this and if so, what are your plans?

We have an infrastructure fund group that invests globally. They raised 4 billion dollars through their first fund and they’ve raised 4 or 4.5 billion dollars in their second fund and the irony is that most people think of infrastructure fund as either providing basic infrastructure to developing markets or providing alternative sources of energy through solar and hydro and so on. And what they tend not to think of is developed markets with depleted infrastructure. If you have been to NY and seen the roads and the airports, even in developed markets there is a lot of infrastructure needs. So we’ve raised this money, invested it all over the globe.

For India, all I can say is it’s an important focus for us right now as there are tremendous needs and opportunities given the growth in the population and economy.

What is your view on China….

China is the second largest economy in the world with $11 trillion, the US is $18 trillion and the third largest economy is about 30% the size of China, which is Japan. On any measure, China has been an extraordinary success story. When we are saying that the rate of growth is slowing, the rate of growth last year was 6.9% which has not been seen by any developed country for a very long time. So, you have to put in context the size and the absolute growth.

I think 25% of the globe’s economic growth comes from China. Is China moving from a developing to a developed market? No question. The increased urbanisation, the building of domestic consumption versus savings, a stronger domestic demand driven market versus export market, all of these things are a natural consequence of success. China remains extremely stable economically. It is now in the middle of tariff discussions with the US but it remains stable and has been stable politically for decades. Xi Jinping has created a long term economic plan….These are all positives but China is not immune to rising oil prices and tariff discussions. These are pressures but they won’t materially slow China’s progress for the next several years.

You had mentioned higher rates, low taxes and easier regulatory regime as positives for the US economy. How do they sit with the trade war?

There are certain realities. One reality is that the US runs a trade deficit with China: That’s not surprising considering the cost of goods produced in China. The other reality is that the US runs a trade surplus in services, the deficit is in goods and services are growing faster than goods. That is not necessarily a bad position to be in. President Trump is initiating tariffs to try and redress some of these imbalances. I am personally not a fan of tariffs. I think the strength of the US economy and its position in the global markets suggests that for certain industries, the playing field may not been level but in aggregate, the US economy has been a beneficiary of globalization. So I am not a proponent of a tariff war which we seem to be heading into. Will it cause to slow the US economy? That’s not clear at this point. I think it will increase prices for some areas for US consumers but it really depends on the action, reaction between China and the US and how they manage. It is too early to predict but the first round of the battle has not hampered economic growth so far. Obviously, at some point it becomes negative.

If prices go up because of the trade war, will it accelerate rate increases?

The challenge the monetary authority has in any country is to balance what is an appropriate rate to ensure that an economy does not overheat. Often they over-exceed and drive a country into recession. There is no real reason why this necessarily has to be the case. I think the Fed has been more patient than I would have been. I would have raised rates quicker. But evidence would say that the Fed has got it right. The US economy is continuing to grow consistently while rates have been growing. I am not concerned about rate increases. They are a natural part of an economic cycle. I don’t know how many rate increases are needed. These are natural economic issues and not crisis level issues. This time what was different was as the US economy was recovering, there was enormous tax stimulus put in which the monetary authority could not have anticipated. Corporate taxes dropped from 35% to 21%, which is an extraordinary stimulus to put into the economy. That stimulus would lead economic growth to be higher and in turn cause the Fed to move faster than they might have done.

You think this is a natural cycle…

History is not our friend when you keep interest rates too low. The risk of an asset bubble at this point is a larger risk than a risk of recession from raising rates and if I were voting on the Federal Reserve board, I would vote for more rate increases over the next couple of years.

The last time the leverage was in mortgages and retail. This time, where is this sitting and how will that unfold?

There is leverage in governments and there is leverage in corporate sector. The leverage in corporate sector is higher than people would like. I don’t think there is a lot of consumer debt leverage. Corporate sector and governments can absorb leverage better, the US can keep printing money which can solve their problem. We are starting to see signs that the corporate sector is starting to deleverage. They are recognizing that they are at the outer limit of leverage that they are comfortable with.

How are you preparing Morgan Stanley for the next 10 years?

The problem is we don’t know what the next problem is going to be. It is like a known unknown. How do you prepare for it? You learn lessons from the past, you make sure you have strong liquidity, strong capital and reduce leverage. Our leverage pre-crisis was 44 times today it is 11 times, our capital was $30 billion, today it is over $70 billion and our liquidity was $80 billion and today it is over $200 billion. So, we have learnt the lessons, de-risked the business. So whatever problems come, we are much more liquid. We were a lot more illiquid going into the last crisis. When bad things happen you can do something when you are liquid. The third thing we have done is to create various business models with various stable revenues even in difficult times and we did not have that pre crisis. That was through the acquisition of Smith Barney. The most important thing we focused on is culture of our management team to never put our shareholders or society in the kind of jeopardy like in 2008. Our management team is very stable. We have been together ten years and are determined to behave prudently, not to make reckless decisions and put our employees, shareholders or clients in any financial danger.

If you have to leave one word of caution for financial markets, what would that be?

I worry when I see fundamental things that cause me to worry. When I see banks levered at 44 times I worry, when interest rates are kept artificially low for too long, I worry. I don’t worry when the S&P reaches a record. By definition, the S&P should reach a record every single day. If you had economic growth at the same earnings mode, companies by definition are growing. Therefore, every single day the S&P should close at a record high. I worry when it doesn’t; I don’t worry when it does. Logically, you should worry when it doesn’t, and not when it does. Now I am worried about the loss of confidence that the populations have had in their political communities and the potential for rise in nationalism, protectionism, anti-immigration….We are in a much more enlightened world now so the solution can’t be simply to say these people are threatening me so keep them out. The solution should be how to create a balanced society from within. So, if I am forced to worry, I will worry that the trade discussions don’t escalate into something leading to true protectionism and that would be very bad for global economic growth.

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