Reuters Insider - Breakingviews: Predictions Panel 2014

Great American Financial

27/04/2014 12:08

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 Source:             Thomson Reuters                                   
                                                                       
 Description:        Rob Cox is joined by Kevin Warsh, Tony James, and 
                     Paul Taubman to discuss what to expect in the year 
                     ahead from global markets, economies and corporate 
                     finance.                                          
 
 
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Transcript (May be auto-generated)

 Good morning, I'm Steve Adler, Editor-in-Chief of Reuters. And I'd like to 
welcome you to this morning's program celebrating Breakingviews 2014 
Predictions. You all have the Predictions Book at your table. I see many of you 
have already leaped through it and then few of you have put in some suggestions 
about trades you'd like to make this morning. That's appropriate because it is 
public. I'm looking forward to this morning's program because the Breakingviews 
team is really good at making predictions. And if you're not that familiar with 
Breakingviews, it's a group of about 30 correspondents all over the world who 
provide expert, agenda-setting commentary on what's going on in the financial 
industry based off the most important financial news stories everyday. This 
morning's program will look ahead and we'll take a peek at what's going on in 
M&A and the stock market, what's going on with corporations, what's going on 
with governments. We have an expert panel to talk about all of this with you 
today. Our host, as you know, is Rob Cox who is Editor-in-Chief of 
Breakingviews. Rob is a Co-Founder of Breakingviews- co-founding it in London in
2000. And Rob came over here and developed the US part of Breakingviews. In 
2004, became the US editor- Reuters purchased- Thomson Reuters purchased 
Breakingviews in 2009 and Rob became Editor-in-Chief in December 2012. I must 
say Rob is doing a terrific job and he's a wonderful host. And I'm looking 
forward to this morning's program. So without any further introduction, I will 
give you Rob Cox. Thank you, Steve. Thanks for everybody coming out today on 
this rainy January day. When people ask us, Breakingviews editors, of what- how 
our predictions have performed, and everybody does ask that question. I have a 
simple response which is basically that we nailed a few, we missed a couple but 
they were all interesting. And I think this year, that guiding philosophy I 
think we hit that mission. Last year we argued that US stocks would best the 
world. That was indeed correct. We said central banks will need to fight to 
retain their independence from politicians, and you can look no further than 
this summer's tussle over who would lead the Federal Reserve for evidence of 
that. We predicted that the Japanese Yen would crest above the 3-digit mark 
against the Dollar. And we have Kuroda san of the Bank of Japan to thank for 
that. Not all of our views hit the mark. 

I think we said that the CEOs of Goldman Sachs, JPMorgan and Credit Suisse might
see their tenures abruptly come to an end. That of course did not happen. George
Osborne still reins as the British Chancellor of the Exchequer despite our 
skepticism a year ago. And while we predicted a great American newspaper would 
change hands in 2013, we should have opted for the Washington Post which was 
sold to Jeff Bezos. We chose the New York Times. This year our views which 
you'll find in the books in front of you, which I hope you'll take home and 
cherish forever, have been divided up into six broad sections: money and 
markets, people and power, buys and sells, fees and fortunes, mergers and 
manias, and odds and ends. I thought we'd structure our conversation a bit 
around those six broad themes today. And I have with us - I'm really delighted 
to have them here - three of the most astute practitioners of the dark arts of 
finance, whose skill sets and experiences offer us extraordinary range to tackle
all these topics. 

To my right is Kevin Warsh is an Albany, New York native who worked at Morgan 
Stanley for many years before taking a job in the Bush Administration's National
Economic Council. In 2006, he became the youngest appointment to the Fed board 
in history where he lurked- worked alongside Ben Bernanke to fight all sorts of 
fires during the crisis. He left in 2011. He's enjoying civilian life, teaching 
at Stanford, helping Stan Druckenmiller invest money, and I believe truly 
enjoying civilian life. True. Tony in the middle I believe- I first met Tony 
when he was a Corporate Finance Chieftain at the most entrepreneurial Wall 
Street firm of its day, Donaldson Lufkin & Jenrette. After it sell the Credit 
Suisse, Tony ran its global investment banking business and eventually moved to 
Blackstone, today the largest alternative asset manager in the world. Paul 
Taubman was the Co-Head of the institutional securities business at Morgan 
Stanley until November 2012, and he's been very busy since. Last year, Paul 
managed the extraordinary feat of becoming one of the top 10 M&A advisors in the
world. I think if you look in our - another plug for Thomson Reuters - our lead 
tables, you'll see Paul Taubman in that list of top 10 for his work on Verizon's
buyout of Vodafone stake and its wireless business. So without further ado, 
let's get to work. I'll start with a story on Sunday. 

I installed a Nest thermostat in my home. I actually didn't do it. I had a 
friend who actually knows how to operate tools do it with me and in recompense I
offered him a Manhattan which I made with Maker's Mark Bourbon. We went upstairs
and then watched a football game on Time Warner Cable. Yesterday, Nest, Time 
Warner Cable and the owner of Maker's Mark Beam Inc. were all acquired. It was a
big day. I think it was $16 billion for Beam, $3.2 billion for Nest, Time Warner
Cable was a $60 billion deal. So either my consumer habits are highly 
predictive, in which case we shall see what happens today when the maker of - I 
don't know, I won't say - is acquired depending on what I ate for dinner, or 
there something going on in mergers and acquisitions. So I thought, Paul- I'll 
start with you on this. We've had four flat years pretty much of M&A. We've had 
a pretty good start to January. It's- are you prepared to predict that- I should
say like many people in your industry who've predicted every year that we'll see
an uptick - that this year will be different and we'll see a big boom? Well, a 
couple of things. Every year it seems that there is a flurry of deal activity 
and then everybody wants to jump on the bandwagon. 

And the reality is M&A is lumpy. Many of the transactions that you read about 
have been on the works for a significant period of time. And I don't rush to 
extrapolate from that. Having said that, you do start to get a little bit more 
momentum given how the market has traded the stocks of the acquirers. And what 
I'm most focused on is the fact that the stocks of the acquirers have gone up 
appreciably upon announcement. And that does create a virtuous circle. That does
get others into the market. So if you think about M&A and try and look at it 
top-down and bottom-up. 

If you look at it top-down and there's 30 years of history for M&A activity, I 
think you need to throw out the TMT bubble and the credit bubble and sort of ask
yourself where there is a steady state. And if you look at it on that basis, I'd
argue we're probably 30% below where a steady state M&A environment should be. 
And I think the reason we haven't gotten there in large part is that there is a 
risk aversion on the part of many CEOs. And the fact is that if they're not 
leading into transactions, it's very hard to create activity. And I would argue 
that 10 or 15 years ago, you'd have CEOs leading the charge and boards of 
directors holding you back. Today, it seems to some extent the boards of 
directors are pushing management to move forward and it's the management teams 
that are holding back. And I do think that that's starting to change as we get 
further and further from the dark days of 2008-2009. So is there a reversal then
or a shift in the sense that it used- in the boom years, it was the management 
that was pushing rather than the board or was it, they were- I think managements
were much more comfortable, sort of daring to be great, and I think it was the 
boards that were trying to provide some oversight. I think, today, the 
managements are just in exactly the opposite position which is they don't want 
to stick their necks out. They want to make sure that the transactions they're 
thinking about have been properly vetted, that the marketplace has weighed in, 
that they're very comfortable there's a path to real value creation, that it's 
looked at not just on whether its earnings are created on day one, whether it's 
sustainable, whether the transaction- the acquisition could be appropriately 
integrated. They're looking at it with far more filters today which I think is a
good thing. And that's one of the reasons why, when these transactions do 
happen, they're much better architected today, they're better thought out, and 
that's why the market is reacting positively. So from the bottom up, I think 
that increasingly CEOs are getting more comfortable looking at M&A as a growth 
tool today than they were before. That's important. I think the market is 
validating that which will coax others out. And in an interesting way, I think 
that as interest rates move higher, I think that's actually a good thing for 
M&A. And I know it sounds counter intuitive but the reality is hurdle rates for 
management teams are very sticky. And when you the Fed pushing rates down, 
hurdle rates have not come down, and as a result, there's a little bit of a 
mismatch between the prices of companies in the stock market and how long term 
buyers are prepared to value of those assets. And as you get more into 
equilibrium, I actually think that will create a bit more of a catalyst. So if 
you would have asked me in the last three years, I would've been reasonably 
negative on M&A growth. So I've not been surprised. Today, I think if I had to 
bet I think you'd probably close that 30% long term gap over two- two and a half
years. So it's slightly counter intuitive what you're saying because one would 
think that is cheap money flowing from central banks would increase animal 
spirits to some degree. I mean are you seeing this as well- I mean Blackstone is
a very big M&A business as well. Well, I think to Paul's point, I think the risk
aversion is fading. A lot of what drove the cheap money was economic problems 
and as those economic problems heal, the cheap money goes away, people get more 
confident, the economy's better. I do think there's a little bit of a sense of 
the train leaving the station. So on the one hand, if you're an acquirer, your 
stock is up, you can still have a lot of access to a lot of fairly cheap money. 
Rates are up a little bit; that's a lot. And yet you're watching that target 
stock move up too, so there's a bit of a sense of the train leaving the station.
I'm feeling pretty good, my stock's up. I'll be more adventurous. So I think it 
is fine. And Kevin, I mean as someone who was involved in the monetary policy at
the Federal Reserve, I mean how do you see this? I mean do you think that this- 
we are starting to get out of this point where cheap money is sort of, as you 
said I think in an op-ed piece, it was creating a distortive benchmark rate? 
Right. So a couple of things. 

First, full disclosure: Paul was my old boss at Morgan Stanley many years ago so
I hesitate to disagree with him unless we're on TV. It's not cable so you're 
going to actually agree. So a couple of things. First, I would say in the old 
days, we'd think from an economic standpoint, about a growth in mergers 
pipelines as being really good for confidence. Because at some level, what we're
looking to to help the real economy in 2014 is to see capital expenditures take 
off. Business fixed investment has been chronically low during last four or five
years. Most forecasters, including the Federal Reserve, predicted that the 
economy would be stronger in each of these years in part because animal spirits,
that Tony and Paul know about and work with every day, would come back. And I'd 
say in the old days, we'd say merger pipelines are a good proxy for capex. 

A CEO would ask a question, "Am I going to build it or am I going to buy it?" So
this is on the margin good news, but if you look at the underlying fundamentals 
on capex, I would still say it's more hope than data. Some modest improvement in
my sense of what the Fortune 500 executives are doing going into this year, 
capex is likely to be up some. But whether this turns out to be a breakout year,
monetary policy aside, is still I'd say more of a hope than born out of the data
over the course of the next few months. I can't help but think - and again these
two are more expert at this - that the world's biggest CEOs have been asking 
themselves a question about their share performance. Fortune 500 companies are 
doing well. Their share prices are high. 

At some level, they've got to be asking themselves how much of that is because 
of me and what I've done to drive productivity, take out cost, be more 
competitive - which is extraordinary, and how much of it is because of the 
world's central banks. How much of the increase in risk assets is because of 
free money that you spoke to, Rob? My senses is, as we get through some of 
tapering of QE, the world CEOs will have a better sense about what they're 
unaffected share price is. What's the share price they can count on over the 
course of the next several years? And between now and that moment, maybe what 
these guys will find will be more stock for stock mergers. That is our prices 
might not be- we might not know where they are, but relatively us and our peers,
if we're going for a stock for stock deal, we ask that guy worth 40% of my 
company. So I think those are the challenges. And the M&A sign is a good sign 
but I wouldn't get too carried away. Of course, we've also seen a big spike in 
stock buybacks by companies and this is one of those- we've seen this story 
before where stock prices go up, people get excited, they buy a lot of the 
stock. And of course, over time, it doesn't look like the best time to buy 
stocks. Well, that's one of the changes I think. I mean one of the reasons, you 
didn't- you had less M&A activity before is the cheapest thing – people could 
buy with their own stock, they thought. That's changing now. So they're, instead
of looking inward, they're looking more outward. But there's still a lot of 
buybacks. I think if you look at the S&P earnings it would be- there has been 
some earnings per share growth in the S&P because of buybacks. Without buybacks,
there would have been no S&P earnings growth. Right. Actually, Tony, I mean when
you think about- I mean you're the biggest private equity firm in the world. 
You're buying companies not stock for stock but with cash. Are you wary of stock
prices today as a result of that? Well, when it comes to buying public companies
or selling public companies, we're more on the sell side now. It's a good time 
to exit. You can take big companies public. The market is receiving them well. 
They're trading well in the aftermarket. So that you get that virtuous circle 
like what Paul was talking about with their reaction to the M&A when the stocks 
were going up. So we're much more selling assets I'd say publicly than buying 
public companies. It's hard now. Prices in private equity land are high. There's
still too much debt out there. The debt's cheap. There isn't much in the way of 
merchandise for sale. Usually, private equity when there's an M&A boom, private 
equity benefits because there's a lot of ancillary deals that are spun off from 
that. We're not seeing that. So there's a lot of money, high prices, a lot of 
debt, not many sellers - a tough environment to put new money out. Interesting. 
And yet, I saw a report last week that said that private equity firms raised 
$431 billion in new funds which was the most since the global financial crisis. 
So I mean how are you guys going to spend all that money if prices are so high? 
Are you going to find new ways of- We like to think we're investing it and not 
spending it. Well, the industry hasn't raised much at all though for five years 
so it ebbs and flows. We have six years typically in a typical fund to invest 
the capital. And one of the things you're seeing with LPs is they are starting 
to get so much money back now that you have- you not only have the reverse 
denominator effect - their public securities value, debt and equity from what 
Kevin was talking about are going up - so they're becoming underweighted private
equity. But now all of a sudden, they're getting all those private equity 
capital return from their managers. Most of them are having net inflows from the
private equity. So they're becoming less and less invested in private equity and
that causes them to want to put money out. So you get that- the pendulum swings 
very fast because you have those compounding effects. I mean we have seen of 
course- I mean private equity investments in public companies. Is that something
we'll see more of as a result of let's say managements or boards not wanting to 
sell their businesses for long? I don't think that's going to be a big part of 
the industry. Prices are too high. Companies are too well-managed. There are 
usually cheaper sources of capital particularly in the ebullient securities 
markets. Why go to private equity when they're looking get 15% to 20% returns? 
When you go to the public where most studies say the returns will be 5% to 8%. 
Right. Let's turn to the banking industry a bit. So I saw- and particularly Wall
Street business models which all of you have got a point of view on. I noticed, 
for instance, that boutique- I'm talking about the M&A market- that boutiques 
took 30% of the M&A market, and the five biggest banks grabbed an even bigger 
share than the investment fee pool this year. Is this trend, is this the kind of
thing that makes big, I don't know, the sort of other banks obsolete, those who 
aren't huge and those who aren't niche? I mean, Paul, you're- Well, look, the 
boutique phenomena has been around forever and they've always been smaller 
firms. I think what has changed is that the degree to which boards of directors 
and CEOs are prepared to rely on boutiques has changed meaningfully from 10 
years ago. And I think you can't help but conclude that it is in part a 
reflection of the financial crisis and how banks are viewed. So I think there's 
a bit of a tipping point as far as the frequency and reach of the smaller firms.
You pick up the paper and you see that there are three advisors on a 
transaction. You may well see now that two of the three are small firms, stapled
to one very large firm that is bringing the capital. There are some deals that 
are quite notable where it's all smaller firms. Now, I don't think that makes 
the large firms extinct. I think that it's really just- there's a new 
equilibrium that is being formed where increasingly, clients are wanting a 
broader array of services, and they're going and creating a team which can give 
them all that they want. They're getting market intelligence, they're getting 
capital, they're getting advice, they're getting all sorts of services packaged 
in a different way. To me, the more interesting question is not whether that 
model continues, because I think it will. The question is at some point, do 
these smaller firms, if they can create real traction, try and build out more 
capabilities or did they want to just remain very small niche players. And I 
think none of this is going to be revolutionary. It's all going to be 
evolutionary. But if you ask me, does it look different 10 years hence, you have
to believe that some of these smaller firms try and build out not all of the 
capabilities but some of the more specialized capabilities and try and pair up 
with capital providers to essentially disintermediate the banks in some part. I 
don't think it will be massive but I think you'll see some refinement in the 
model. So, Tony, you were at DOJ, which I think was the first Wall Street from 
being at public. I mean, you're quite ahead in many respects out of real sort of
ownership culture in the place, merchant banking business that everyone shared 
in. Do you think we're going to see another round where banks buy these middle- 
or smaller-sized, I wouldn't call DOJ boutique, but do you think we're going to 
see history repeat itself? Well, history has a tendency to do that. Of course. 
But I think there's a secular trend if- when I came on Wall Street, I don't know
how many major firms there were, but go get an old tomb stones, there were 
dozens and dozens and dozens of them, and it just slowly shrinking down to like 
four or five. And that's, you know, the financial crisis accelerated that in 
some ways. So in that wake, you're getting so relatively few large firms, you'd 
expect a number of boutiques to pop up just because a conflict from wanting 
another. The other thing is, I think, the pressures on the big banks to push up 
the return on equity is going to mean they have to pressure compensation down, 
what the government couldn't do, I think the markets are going to do overtime. 
And I think, you know, talent drained, Paul made maybe evidence of that, from 
the big banks to the boutiques where they can do their own thing and not be 
constrained by the regulatory and a wrap bureaucratic stuff that comes with 
being a big bank today. And that will create more robust boutiques too if you 
have more talent there. For a long time, the talent went to the big banks and 
now, I think, is kind of going the other way. I think when that happens, 
inevitably, to come back to your question, you'll have some big banks that say, 
"Gee, you know, there's a lot of talent over there and I'm kind of struggling a 
little bit and maybe I'll roll up some of the boutiques." I think you'll see 
some of that, but usually it takes an M&A boom before they start to want to do 
that. I don't know that we're going to have a boom for a while, but at some 
point in the next few years, you might see that. You might see banks that are 
trying to fill in their weaknesses particularly international banks. You know, 
you might see Chinese come over here and want to have some stake in the market. 
Oh, boy, we've seen this before. Have we? Well, not the Chinese bank but you 
can, you know, the German bank. You know it's quite difficult to acquire a 
people business like that. Yeah, but it's even harder to build one. That's true.
These are businesses with real franchise. It's not easy to start from scratch 
and build something. Yeah. 

Very, very few institutions have come from the outside of the United States have
successfully built by brick at a time. In fact, I can't think of any that have. 
Yeah. Kevin, you've written a lot about the impact that regulation, a lot of the
banking regulation will have on, let's say, you know, the entrepreneurial part 
of banking. So you've worried about creating utilities out of banks and banks 
being the engines of credit from the economy, being a bad thing. I mean, how do 
you see that shaping out this year? 

So, I think the merger advisory business is probably one of the few businesses 
that Washington isn't prepared to show up and tell them how to run their 
business. So those businesses are safe. I would say broadly, Rob, I am concerned
that coming out of Washington and coming out of a lot of national capitals, 
there is a brand new financial architecture that is just finding its shape as we
get through 2014. And it's likely to have very few firms, as these guys 
described, at the top of the pyramid that I worry very much overtime and it's 
probably happening in real time become public utilities. What do you call firms 
where compensation and returns on capital and the businesses they're permitted 
to be in and not be in and continued regulation by a dozen institutions that are
poorly coordinated? Well, you call those public utilities. And in the business 
that Tony and Paul are in, talent doesn't often want to stay at the low and mid 
levels as they're ascending in a public utility. So this matters for Wall 
Street, but I'm afraid it also matters for the real economy. We've had 9,000 
banks in the US for most of the post-war era. Though there's been some 
consolidation. That is in stark contrast the economy is virtually everywhere 
else in the world where they have had a public utility model. Think about the 
German banks, the French banks, Japanese and Chinese. I worry that we are moving
in that direction and in so doing, credit, innovation, competing for our 
products, competing for customers, is less what marks public utilities. So I'm 
not afraid of having big banks, but we want to have a churn, we want small 
businesses and small banks be able to grow up and become big ones and big banks 
that can fail, and all of a sudden disappear and lose their market share. I 
wonder whether the banks at the top now have decided and the government has 
decided that they're going to be there for a very long time and what the 
consequences are for credit to the real side of the economy. So basically, that 
it's easier to manage and keep your foot on the neck of a few very big banks and
make sure that they behave is an easier regulatory structure to some degree than
allowing great competition where you have socialized losses. But maybe if we fix
the too-big-to-fail problem of course, nobody can save to fix it, but there are 
some signs the resolution authority, things like that, will have an effect. I 
mean, do you think those- a lot of the reforms that are part of Dodd-Frank that 
do address that issue, rather than some of the other stuff, will have an effect?
So in a word, no, what would happen today if one of the largest banks were to 
call to their favorite regulator in Washington and say, I'm having a hard time 
opening for business tomorrow. What do we think would happen? What would market 
participants think would happen? Do we think under Dodd-Frank and thousands of 
pages of new rules and new regulators with new responsibility and a new 
financial stability oversight council, the government would say, okay, we've got
it covered. We'll just let them disappear and move on tomorrow. I don't think 
so. More important, I don't think markets think so. So if you look at market 
prices, it looks to me as though a whole set of creditors and other folks that 
are in the capital structure of our largest banks or to some significant degree 
still relying on the government, on the dark day that none of us can anticipate 
to stand behind these institutions. I have to think that's very bad news. You 
say markets, so bond pricing of- the pricing of credit from banks, for instance,
does not trade at a great premium to where it should relative to the risk 
involved in a wind down? 

Correct. Yeah. And you do see that in deposit rates as well which are the big 
banks seem to enjoy and extraordinary cheap money through the deposit rates. 
That's interesting. Let's talk a little bit about government, because you raised
it a little bit here. People in power I think is the moniker of the book. Let me
ask you, I'll start with a simple question. Actually, I'm going to give you a 
crown and let you be king for a day, and give you an opportunity to sort of set 
out your policy agenda. What would you do and this can be economics, it can be 
social, whatever it is. What would you do this year assuming you were king, 
Paul? 

The first thing I would do is, Tony said this before, he made a distinction 
between investment and spending. There is no distinction in government between 
investment and spending. You spend $100 billion for bridge, so a 40-year 
investment. It shows up at spending this year, it relates the deficits today and
I think as a result, because we can fuse investment and spending, we are doing 
harm to the economy in a significant way. You would think that in a world where 
rates are close to zero, where the government can borrow at the cheapest rates 
it's seen almost in its history, and where there is such an infrastructure gap, 
and where we have such high unemployment, that just to simply move forward that 
investment to the here and now should pay remarkable dividends, but it all gets 
caught up and it's not investment, it's spending, deficits and the like, so to 
me, one of the things I would do is to change the way in which everyone talks 
about it and think about it as a business. We all say we want to run government 
more like a business, I'm not sure we want to run it exactly like a business, 
but there are certain things. And when General Electric spends money that has a 
long, useful life of 20 or 40 years, they don't think about it as all just one 
year, one day. That to me would be the first place I'd start. Tony, what would 
you do? I think of the infrastructure is going to be everyone's first place 
because it's not- it puts people to work right away and pays long-term 
competitive dividends both. And I got to think that's the place to start. But 
beyond that, we have to kind of get some progress in Washington and some things 
going on. 

I think we need immigration reform. I do think we have to, which I think would 
be, we'll get in pieces, maybe coming in House, but we'll get it. I do think we 
need to worry about the inequality gap. I think that's the kind of thing that 
pulls societies apart and you can't just disenfranchise a substantial majority 
of your people. There are various ways to do that but one I think has to be a 
higher minimum wage. I think we'll get that too, although the Republicans will 
probably damage themselves politically while they lose that battle. I do think 
we have to do, enhance our long-term education. 

I think that means more teachers and better teachers in the schools and there 
are some easy ways to do that. But those would be the things I'd push on. Kevin,
what would you do? So after 10 years in Washington, I would say nothing is easy.
If you really think about the contrasts between our government and the private 
sector where these guys spend their time, the private sector or the Fortune 
1000, the next million small businesses, from the crisis to this moment had made
tough choices. Households have made tough choices about what to do with the 
mortgage, what to do with a second job, how to think about whether we need a 
second car. All of their companies and clients from the darkest days made tough,
even brutal choices, drove productivity, and so that we have a corporate sector 
that is really poised if the economy can actually turn this higher level, take 
huge advantage. The US multinationals are in better shape anachronistically, 
coming out of this crisis than any of us could have anticipated. Contrast that 
with the lack of tough choices that have been made in Washington, and I worry 
very much that the financial crisis and the reaction of government, even the 
necessary reaction of the Federal Reserve in the darkest days, have made it so 
that the tough choices can be made, put off until tomorrow. So broadly speaking,
I would say there is a critically important role for the executive branch for 
the Congress on things that Tony talked about a robust serious trade agenda, 
where the US goes to the G20 and pounds the table on the virtues of free trade. 
Instead of stepping back and losing its voice and giving some license for others
to turn in or to protect their industries, we haven't had a robust free trade 
agenda for a dozen years and we need it. And I'm afraid that Washington 
politicians – Democrats, Republicans, doesn't matter – they come to the view
that the Federal Reserve could pull a rabbit out of the hat in the financial 
crisis and they'll just figure out how to turn this economy around. So I'm 
afraid the Federal Reserve continues to be on the front pages. One day the 
Federal Reserve needs to be back on page C-12 of the business section. The 
Federal Reserve met today and they raised rates or cut rates by quarter. But the
Federal Reserve has been playing more than its fair share of roles and 
responsibilities and I'm afraid the rest of the political actors have been 
standing back. We cannot grow unless they step into their role of him. 

So monetary policies has done everything fiscal policy has failed to do over the
past many years. Monetary policy has- Has stepped in to try to do. So monetary 
policy is not a very good substitute for a real trade agenda or a real 
regulatory agenda, a real growth agenda, for real tax reform. But it can pretend
to do things. It can pretend to move asset prices up on a sustainable basis. It 
can move asset prices up for a time. But only if the rest of Washington allows 
there to be a dynamic private sector. The Federal Reserve is not a very good 
repair shop for broken tax policy. And my sense is the world's central banks 
have been asked to do too much. And when they look around at their alternatives 
and they see the rest of the politicians standing back, they have continued to 
fill that vacuum. And our powers just aren't that great. This is probably a good
segue to ask you a bit more about or to talk a bit more about monetary policy. 
And you recently said of your former colleague at the Fed Janet Yellen that she 
will marshal her strong intellect meticulous preparation and ample experience to
lead the bank successfully. But you also called quantitative easing which she 
has obviously supported quite heavily untested and an incomplete experiment. How
do we reconcile those statements and what would you expect from this change in 
leadership at the Fed? We reconcile those statements delicately. That's why I 
asked the question delicately. And so I'd say listen, I worked with Janet for 
five and half years. She and I had spent a ton of time together. She and I spent
about two weeks in China and in Asia every year. And so we've spent a lot of 
time. She has got all the background in the world for this job. She has seen the
Fed from all angles and most important, she's seen the Fed and Washington at 
different points in the business cycle. Times where it's right for policy to be 
loose and accommodative, time when it's right for policy to be restricted and 
pulling back, pulling the punch bowl out. So she's got all the background do the
job. She happens to be taking over what I think is a critical moment both for 
the US economy and the global economy. And I've got every bit of hope and 
optimism that she and the team at the Fed will be able to in some sense allow 
the economy if not drag the economy, allow the economy to the next level. On the
question of the substance of policy, I guess my judgment on this hasn't changed 
for a while which is if you go to the darkest days of the financial crisis, even
a guy like me says, we got to do QE because QE at that moment was to try to get 
asset prices to clear, try to get bid and ask so they could at least look at 
each other, so that original motivation of QE was quite different than what is 
being thought to be used today. So while a big supporter of QE in the darkest 
days, I think it's quickly outliving its usefulness. And my sense of my former 
colleagues is they've come to that view as well. They are now trying to pull 
back on the purchases of treasuries and mortgage-backed securities and 
substitute something which is quite popular in the academy, forward guidance. 
The Federal Reserve doesn't have to buy stuff, we're just going to tell you, 
we're going to try to convince market participants that we will keep interest 
rates very low. And here's our intellectual structure for doing it. I think the 
open question is whether markets think that forward guidance, what we used to 
call open alpha operations, is equivalent to actual $85 a billion a month 
purchases, quite a tricky test for a new chairman, but she's got the background 
to pull it off and we'll see. 

What we wrote in our book that everybody knows that tapering as it were is going
to be the story of 2014. But I'm just wondering if people have really thought 
what a higher cost of capital will do in markets, what it will do for companies.
Tony, what would- if we had 10-year treasuries at 4%, say, how would that affect
your portfolio companies or your investment decisions? Well we think we're going
to first of all, and I think what drives markets is reality versus expectations 
is not where things go. And I think one of the reasons that she'll get away with
tapering is because people have the expectation that there's going to be 
tapering. So I think what- economy in our view has a usual amount of momentum. 

I mean it's absorbed in the last years, absorbed sequestration and absorbed 
payroll taxes and absorbed one thing or another and just kind of drowned on 
through. So if anything is picking up in steam I think and you're just beginning
to see I think the early stages of energy diligence, energy subsidy to the 
economy and the beginning stages of residential and commercial real estate 
construction coming back while there's a big pocket of unemployment. So I think 
you got a lot of strength in the economy. I think in that context, higher 
interest rates, 4% treasuries and what goes with that which could have narrower 
spreads by the way over treasuries, so all that doesn't get passed through to 
corporate cost of capital. But I don't think there's a problem. For one thing, 
corporate have very liquid balance sheets; for another thing, any treasury in 
the right mind has pushed out their financing and done as much financing as they
possibly could. One of the questions I never understood, why the Treasury didn't
do more of that just like a corporate treasury would the way Paul was talking. 
So they have very strong balance sheets, they've got all financed and they're 
expecting higher rates and they're expecting higher rates in the context of a 
stronger economy. If all that happens, I think it will be positive, not 
negative. Bankruptcies do you think we'd see a spike, or- I think bankruptcies 
go down. Huh, interesting. You got the combination of very forgiving markets so 
even troubled companies can finance out their problems and you've got better 
fundamental businesses coming. So bankruptcies should go down. Alright. 

Paul, you mentioned the reticence of CEOs to do deals. I wonder to what extent 
activism plays a role in that? And just broadly, I like to sort of shift to that
topic because certainly one of the predictions we have is that we will see more 
of it and that's not exactly a startling prediction but we did name one or two 
companies including General Electric which had been immune from such cage 
rattling. We saw Apple, Microsoft and they're the biggest companies in the world
basically were taken on by activists. How do you think that will shape corporate
behavior? Well it comes back to the risk aversion that I was talking about 
before. If you look at the tenures of CEOs, they've gotten shorter, not longer. 
And the fact is that more CEOs get into trouble or lose their position because 
of deals that they did, acts of commission not acts of omission. And that I 
think has heavily weighed on a lot of corporate executives. And that's why when 
Tony talked before about the increase in share buybacks to me, it's the natural 
healing process which is okay, I'm no longer just pricing my liquidity. 

I have ample liquidity, next step is I want to deploy it, I want to take 
advantage of low-cost capital. M&A, may be a bridge too far, this is kind of 
low-risk M&A and you keep moving out. And there's no doubt that shareholders 
have points of view and shareholders have made deals more difficult to get done.
To some extent, you've created one-way optionality on a lot of deals. If you 
think about it, the way our construct is corporation enters into a merger 
agreement and they're locked up and they really have no outs. And they typically
have no financing outs, they very narrow regulatory outs, they're in. And then 
it goes to a shareholder vote for six months later. And the world changes, the 
world is a dynamic place. And to the extent the deal becomes less favorable for 
the buyer, more often than not, they're stuck, It's their deal. They can't 
renegotiate it. All of a sudden, the market continues to move and there's 
another bite at the apple. And you just saw that with the McKesson deal. So I 
think that also adds to all of this. And my view about activism generally is, 
it's a wonderful tool used by the right individuals in the right way. If what it
is, our shareholders in a democracy making sure that managements are doing the 
right thing and keeping them honest and being constructive, I think there's no 
doubt that value gets created. And if you just look at the deal yesterday with 
Suntory and then you go back to Bill Ackman being a catalyst. There's no doubt 
that he unlocked significant value and that was constructive. And if you look at
what Dan Loeb did at Yahoo! and if you look at the ability to change the 
management and create value, it works but there are times when it just seems 
sometime that it's not a very well-founded platform but you just need to spend 
just as much time defending in that instance and you do elsewhere. So I expect 
that activism and the desire to really press corporations and boards to unlock 
value and to do the right thing and to be disciplined, that's not going away. 
That is just going to continue. What's happened is increasingly that's just 
another discipline that boards and corporate executives are using to try and get
ahead of the curve. I just want to argue that private equity has always been an 
activist shareholder, it's just a totally different kind, we're not out there 
rattling cages. It's to control shareholders. So it is fundamentally different. 
But effective change is what drives private equity returns, 80% of the returns 
or so come from effective change. In fact, we can effect change, we don't try to
buy something. We can't buy it cheap enough. Companies are too well advised, 
prices are too high. 

The friction costs of buying, paying the premium that coming out, IPO'ing at a 
discount kill you. So you have to be able to effectuate change. But I just want 
to comment on the activism. I mean it used to be in the old days that boards 
worry about the hostile takeover. Now they worry about the activist. It's the 
dominant concern on the boards today. And as you point out, whether it's Apple 
or Microsoft or P&G, no company is too big. And so boards, in my view, sometimes
to in excess, worry about activism and the disruption that comes from that. They
don't worry about hostile takeovers anymore. So that fear has changed and I 
think activism will continue because the successful activist investors have 
pretty good returns up and their returns are uncorrelated with the markets. So 
they continue to attract capital. And as long as that happens, you've got 
growing capital there and they'll be active. It certainly sounds like a 
lucrative business line for our investment banking. Firms advising on the new 
hostile takeover activism. Before we close and open it to questions, had a 
couple of sort of big one for you, Kevin. Just what do you – and I'll pass 
this to all three of you - softball question, what are the sort of biggest 
opportunities in this coming year for growth, whether it's for an investor or 
the kinds of things you counsel the students at Stanford as they head towards to
coming months? Well I'd say on that piece, the history at least of most of the 
big business schools is they all tend to be chasing jobs late in cycles. So I 
know that the history at least that Stanford where I do some teaching is that 
for the last several years, you only want to go to a start-up, the newest and 
sexiest, et cetera. And I happen to actually think for business school graduates
being late in the cycle is not so bad. You show up, it ends poorly but you've 
learned a lot in that period of 12 or 24 months. And you're pretty well 
positioned for the next bubble. 

If the world's central banks keep interest rates far lower than Tony suggests 
where they are I think unnecessarily fearing normalization of the Treasury 
curve, a normalization of sovereign yields, you can continue to see the 
possibility for capital misallocation and malinvestment. But again, I think for 
younger folks, there's nothing wrong with that. Secondly, I'd make an 
advertisement actually for some of the big banks. I think there's very few 
places that are good places to train when you're coming out of school as these 
programs that are still these big institutions that I might have described as 
public utilities early. But for the right part of your career, probably not a 
bad thing. 

I think for the more broadly in terms of opportunity, in spite of the challenges
the three of us have talked about in the US, the US looks like it is a continued
chronic relative outperformer around the world. At some level, I would say our 
government across administrations has done its level best to kill this economy 
but it has fit. Despite their best efforts to have myopic policies that lasts 
for three months, they're trying to fool people into buying a car before a 
subsidy for a clunker ends. The underlying dynamism of this economy exists, not 
just in New York and in Silicon Valley but you see it on factory lines, you see 
it in all across the Midwest. So the US, in spite of, I think, maybe a 
difference of opinion on how strong the 2014 growth path is, the US to me looks 
on a relative basis like a pretty easy call as likely to outperform our big 
trading partners around the world. I happen to not think the US can decouple 
from the rest the world. You'll recall the commonality for many years from sell 
side firms talking about a decoupling of the BRICs. The advanced economies are 
not going to do so great but not to worry, Brazil, Russia, India, China are 
going to do well. Well that didn't work out so well. We have one integrated 
global economy. I am convinced that the US can chronically and relatively 
outperform but we won't get to fundamental escape velocity until the rest of the
global economy gets with it. And if I look on either side of the US across 
oceans, it looks to me as the 2014 will be another reasonably disappointing year
for growth. So the US is, for the reasons Tony and others have described, they 
likely outperform in this environment. Tony, where are you investing or 
allocating capital globally? Where do you see opportunity? Well first of all, I 
agree with Kevin that the US is the best place to be. And in fact, if you look 
over just about any holding period in our business, which is alternatives, 
you've always made money, more money in the US than any other market. And the 
further you get from the US, the less you make. And partly that's because you 
don't need a lot of growth to make a lot of money because we use leverage. So we
can get very high returns in a modestly growing economy as long as it's stable. 
The problem with of course leverage is you need stability or the tower topples 
over. So but in general anyway, I think the US is the best place to put money. 
For me, I sort of like real assets. I think the equity markets are reasonably 
valued that they've had a pretty good run. But we do very well in real estate. 
We do very well in actually owning hydrocarbons, things like that. And so, and 
frankly if you talk about real assets particularly real estate, there's some 
very interesting opportunities in Asia and in Europe right now that are actually
more interesting than the US, not because the economy is better in general but 
because it's worse and because credit's constrained there and there's a lot of 
distressed sellers. That's what we live on, so that's what we're putting on- 
Where specifically in Asia are you looking at, like India or- India and China 
are both interesting right now. India because of the kind of governance turmoil 
and all the things go with it, China because they're actually in bad credit, so 
you got a lot of developers that have buildings with nowhere to go. Both are 
very for someone with capital. And then in Europe, you got a lot of, again, 
distressed sellers of real estate based assets. And what about Brazil, just out 
of curiosity? Brazil is an interesting market. I think you have to think of 
Brazil not as a growth market, so not like other emerging markets, but not as a 
protected market, that if you invest in the national champions because it's so 
protected you can make very higher returns on capital. So for the right entity 
in Brazil, it's excellent. But you're not playing necessarily Brazilian growth. 

Right. Why don't we open the floor to questions? I think we have microphones 
around. If you raise your hand, a microphone will be deposited in the palm of 
your hand. Back there. We have a very polarized political environment in this 
country at the moment. Do you see any prospect for some kind of sensible 
compromise on tax reform on- immigration reform and the other desperately needed
policy initiatives? Who wants to- why don't you Kevin, most recently is- So this
won't take too much time to answer. You have to be more optimistic or I'd say 
not having spent 10 years in government to say, yes this is the year that 
there's going to be reaching across the aisle on both sides and they'll do 
sensible long term programs. This is an even numbered year in Washington. Even 
numbered years tend to be bad years for good long term policy. Even numbered 
years divisible by four tend to be worse. So perhaps 2014 is better than 2016 
for this. It does not look as though there is going to be much incentive for 
either side as they perceive their electoral interest to be focused on long term
sensible structural reforms of the four of us up here might be able to agree to.
I'm a little- I have a slightly different view than many. I don't actually think
that the real economy has been paying as much attention to Washington as most 
commentaries suggest. Real folks that run real businesses and real households 
have sort of given up on these guys a long time ago. They are focused on their 
daily P&L, the structure of their balance sheet. So if we look at the morass 
that was Washington in the fall going into winter and the breathless headlines 
in the newspapers and on television, if you look at the underlying real economy,
it's really hard to find too much change in what was happening. So I think the 
American people and businesses have more or less decided to move on and they 
have figured out quite rationally that perhaps someday these challenges will be 
dealt with but not anytime soon. And it's not easy to place blame on these 
things on either side. There's plenty of reasons to doubt. What I'm hopeful for 
is the president in his state of the union needs to sort of grab his hands 
around not just issues that exacerbate a polarized country and a polarized 
congress but things that where he's prepared to spend political capital. 
Washington needs to be led the same way that their businesses need to be led. We
have one leader, he's the president. He's got three years in office and I am 
hopeful, I don't know whether it's for good reason or not, that he decides that 
he wants a second term legacy around tax reform and a robust trade agenda and 
real immigration reform. It won't be easy for him to do. There'll be fights in 
his own party. It may or may not be good politics, I know it would be good 
policy. What do you think Tony? Let me ask you- I basically agree with Kevin 
that long term structural painful things will happen. A Democrat and Republican 
are agreeing right here on this stage. 

The time to happen, the time when you had to make painful change and when the 
pressure was huge and when you had the sequestration and the debt ceiling and 
everything coming together, they didn't do it then. Now the deficit's gone from 
10% to 4% on its way to 2%. There's no pressure on the system. In a democracy 
liker America, you can't really make hard, painful decisions without massive 
pressure. So that won't happen. However, I'm a bit more optimistic maybe than 
Kevin's comment on this. I think we'll have some more small things that get done
than we're used to. I think the Murray-Ryan budget agreement was one. I do think
as I said immigration agreement. I do think we'll have a minimum wage. I do 
think we'll do some things like that. 

I don't think there's any chance we'll have a major new tax policy. So I think 
we'll have small stuff it'll seem somewhat better. I think politicians will be 
rewarded for that in their approval ratings going into the election. But I don't
think they will make hard decisions. Paul, you were I think were involved in the
Obama reelection committee in New York. Where would you be putting your bets for
the midterm election this year? I think it's an eternity away and I think the 
conditional wisdom has gone back and forth. And I'm not sure. 

I still maintain that this country wants a divided government period fully stop.
They want a divided government, they seem to enjoy it. They complain about it, 
but they consistently vote for dividing government. And I think they're not all 
too fussed when nothing gets done. I think when they do get upset is when they 
unnecessarily take us to the brink and they really create damage. And I think 
issues like the debt ceiling and all that's where do you get some pushbacks. So 
to Tony's point, I see some green shoots of bipartisanship but it's the small 
stuff that's going to get done. And even something like minimum wage I suspect 
there's going to be one heck of a tussle on that and it may get moved a buck or 
something and a lot of this is going to back to the states. 

And something like tax reform is just so difficult to imagine that it can get 
done, that you can somehow thread the needle without there being a much 
different working relationship in Washington. So if I had to bet, I don't think 
there's going to be any change and we're going to end up with the same dividing 
government come November as we sit here with today. One of the legacies of the 
sort of collapse in demand we have is that we have a lot of really old assets in
this country. The average car is about 10 or 11 years old. There's a thing in 
The Journal yesterday about the average corporate asset is now 20 years old. 
Consumers are- have been breaking down and saying, "You know, I got to replace 
my car," and we've seen car sales start to rise. But capital expenditures, 
business investment have been pretty weak even though companies have record 
profits, record cash, and can borrow for essentially nothing. So the question 
is, is this the- so, the first question is, what is holding back the replacement
of old equipment stuff, buildings, factories, et cetera in this country and is 
this the year that you know, that starts to reverse? Okay, let me comment on 
that. Sure. Because Kevin mentioned capital expenditures as well, the problem 
with expecting a lot of capital expenditures in America is we don't need 
capacity. You know, if you look at the capacity utilization, America is in the 
low 80s. And usually, you don't get a lot of capital expenditure spending until 
it gets up into the 90s and we don't have the fundamental unit growth in America
to need capacity where most companies want to go where they need capacities and 
it's in emerging markets where you have rapidly growing markets. So, I don't 
know why they'd go, do a you know, a spending boom. And you know, it's not- at 
least with our companies they have gone up and they've upgraded their 
technology. One of the great things about zero interest rates for five years is 
companies have- the money is free. So I think a lot of companies, certainly the 
companies that we work with have significantly upgraded their plants where they 
got any kind of economic return on that at all. And they've- and I think it's- 
Kevin talked about QE having some funny effects. I think when you get and I 
think this is one of them, what you've really done is you substituted capital 
for labor in American business so a lot of them have gone through and done 
labor-saving devices and they think that's you know, and I think that's less 
stimulative of the economy than perhaps the lost jobs that come with that. So, 
and I think when Japan got zero interest rates for a long time too, it didn't 
really work. I think you get down to zero interest rates and the whole stimulus 
is good it drives economic activity, is questionable. But, so I don't expect 
there to be a capital expenditure boom. Unless there is a demand boom and unless
capacity utilizations get higher, and I don't see that happening for a long time
at that kind of 3% growth that we're, maybe 3.5% that we're looking at for the 
economy. Steve. Someone, a microphone here. So McKinsey just did a study that of
surveying CEOs and found out that a vast majority of CEOs feel as if their 
companies would be much more successful and more profitable if they could invest
on a longer term perspective but also a very large majority of the CEOs said 
that they were under enormous quarterly pressure from their boards to deliver 
results and since the average CEO in less, about three years now, all of their 
incentives have looked very short term. Do you agree that companies would be 
more successful if they were looking longer term and is there some way for them 
to get out at the hump of that seeming dilemma that they face? Open to anybody 
who wants to answer. Well, I don't. You know, what I found around, in the 
businesses that I've been involved with and run, if you make an investment that 
doesn't pay off for five years or six years, if they can know the payoff will be
10 years from now, forget about it. The world changes. And so, whatever premise 
is based on some investment that will pay off in 10 years, there's too much of a
chance that something intervenes and it's very different and that investment 
never pays off. I also think that you know, being slaved to quarterly earnings 
is destructive. And I actually think one of the things that actually makes 
private equity successful is it has a medium term, her investment horizon. 
Typically, private equity investors, they buy a company, they have to make- they
can't make investments without regard to the near term quarterly impact but they
also will only make investments that and you know, will probably pay off in 
their holding period is five or six years. So that ability to make you know, to 
both make those kinds of decisions but not be too, not be too long term in your 
focus, I think, is one of the reasons the industry is successful. And just to 
follow up on that, to plug Tony and the private equity world, if you loo