An analysis of the current global economic crisis was one of the key items on the agenda of this year's annual AFIRE meet in Washington, DC, writes Kathryn Hamilton
Amid a panoply of discussions ranging from "green" real estate, to an explosive retort from former US Secretary of State, Donald Rumsfeld, regarding an excerpt from a new book on the war in Iraq, the current financial crisis took centre stage as the keynote address at the annual membership meeting of the Association of Foreign Investors in Real Estate (AFIRE).
John Plender, senior editorial writer and columnist on the Financial Times, blamed the current state of the global economy on a precarious US economy unseated by the housing crisis and unsoundly financed, riding on swollen real estate commissions and market-related bonuses.
"Global borrowing and spending require that the asset side of the US household balance sheet grow, but current conditions in housing and financial markets suggest this is not going to happen," he said.
Other threats, according to Plender, include a shift away from dollar assets by official reserve managers, the continued risk of a sliding dollar, a reduction in savings among the Asian and oil-producing economies, and slowdowns in the export-dependent Japanese and Chinese economies.
"There are a number of ironies within the current situation," he said. "Alan Greenspan and the other central bankers welcomed the high degree of financial innovation because they expected the risk would be dispersed into the hands of those best able to bear it and that securitisation would remove liabilities from bank balance sheets.
"Only as the liquidity tide recedes and we see that the liabilities to balance sheets have not in fact been removed, in many cases with special investment vehicles, do we see that we are pretty ignorant about where the risk has ended." He further criticised the central banks' management role in failing to recognise that the sub-prime problem was a harbinger of a wider credit bubble.
"The irony is especially striking since Ben Bernanke's academic work heavily focused on the relationship between the financial markets and the real economy. Yet his response to the present situation has not been terribly reassuring."
As a consequence, Plender said he hoped that bankers would realise that monetary policy-making which focuses exclusively on retail prices had not served the economy well in the current credit bubble and that in future, it would be more focused on the behaviour of asset prices "which have been telling us some very important things that have not been as considered as they should have been".
Saying "we have just gone through the biggest credit bubble of all time", Plender predicted a 12 to 18 month recovery.
"The good news is that unlike Japan after the bursting of its economic bubble in 1990, the US will not face a lost decade. Policy makers have learned the lessons of the 1930s. I feel confident that the leaders of monetary and fiscal policy will prevail against deflation, loosen fiscal policy, and initiate tax cuts."
In what he described as an overview rather than a comprehensive analysis, Plender provided the following insights: the July and August results delivered a near terminal blow to hedge funds. "There is a crisis of credibility in the hedge fund business," he said. "Are they really an asset class or a reward system for greedy managers?"
He said the degree of disillusionment with more complex and exotic instruments in the more remote reaches of the market would preclude their return for "at least five years".
Plender called private equity a genuine and interesting asset class which, nonetheless, would be affected by the re-pricing of risk.
He characterised private markets as having a lesser degree of diversification to equity, but a better alignment of interest than the quoted markets. "It's hard to perceive a real correlation between performance and reward when you look at all the stock option rewards and bonuses."
On the downside, according to Plender, are both the wide swath of institutional investors with huge disparities in returns and problems of access.
"I think it's very hard for institutional investors coming late to the party and the institutional investors who don't command large fire power to get access to the best private equity houses. For anyone who hasn't been there for years and who isn't a favoured client, this is not an area which will deliver terribly happily."
Plender said he regarded mainstream investment as encouraging because equities have been resilient. "P/E valuations don't look particularly stretched. But the earnings side is vulnerable. Both the US and the UK have an excessive share of earnings coming from financial side, which will inevitably slow down.
"More fundamentally, US and UK equities have been supported by the corporate sector, which has been channeling a surplus of savings-over-investment into equities, particularly private equity M&A. This is alarming because part of that support will now be withdrawn, making a lot of M&A equity harder to finance, thereby eroding this prop to both the US and the UK economies." And, with inflationary pressure emerging, he rejected bonds as an attractive investment opportunity.
Despite a decline in leveraged buyers and concern about the vulnerability of the secondary property market, Plender said he remained "modestly optimistic" about the real estate market.
"In considering the crisis, it's very important that its origins don't lie in speculation and excessive supply," he said.
"Yield compression wasn't exclusively a function of the credit bubble. After years of being out of fashion as an asset class, property came to be recognised as an alternative asset with a genuine diversification context that was far better than many alternative investment categories. Given the extraordinary uncertainty we are living through at the moment, I think the defensive quality of a prior charge to income is particularly attractive to some investors.
"The real estate market has been hostage to all sorts of things which have nothing to do with property but rather with distortions in the credit and capital markets. Amid some transitional uncertainty, property will retain a well-merited place in the process of asset allocation.
"The worst we are looking at is some of the froth being blown off the cappuccino. I'm
excited that a bit of normality is coming back which will create new and interesting opportunities. In this crisis we have a great deal to be cheerful about."
There is no shortage of potential either. Like other countries, the US has suffered from underinvestment in infrastructure and the deficit is now too great for the government to finance on its own. The American Society of Civil Engineers has estimated that US infrastructure needs updating to the tune of $1.6trn (€1.1trn) over the next five years.
Kathryn Hamilton is a US-based marketing consultant and writer
