The Exchanges

Q How did that impact how you think about the world?

A You develop a very healthy skepticism of People that are, that put themselves out there as knowing what they're talking about, because this was basically late eighties, early nineties. You had a simultaneous collapse of the banking system lending process to Latin America, and also the S and L crisis in the United States, and a lot of bad investment decisions that were made in the aftermath of the 1986 tax bill. So you just, you developed as a young person A healthy skepticism for theories that fit on cocktail napkins. You know, for example, Walter Riston was famous for saying, well, lending to countries is better than companies because countries can't default. They have infinite power of taxation. Yes, they do until they decide not to exercise it. And so all of these kind of cocktail napkin theories tend to fall apart. And so one of the very interesting things that I worked on at the same time was a bunch of insurance company demutualizations. Where you had a bunch of mutual insurance companies that had horrible returns in their investment portfolio, and they basically had to demutualize and raise money and buy the policy ownership back from the policyholders, and so seeing all of that stuff crumble at the same time made me realize that some of the simple rules of thumb people were applying didn't make sense. On the other hand, It also made me realize what an oversold investmen…

AI assessment note: “You develop a very healthy skepticism of People that are, that put themselves out there”

Q What's an example of one of those ideas?

A Usually it has the word leverage in it. Right, usually it's a leveraged LIBOR floater or leveraged accumulator notes, right, which are these Asian specialties where you promise to buy a certain amount of stock every month, and if the stock drops, you have to buy more, and the leveraged accumulator is when the stock drops, you have to buy even more, right? So those kind of lottery tickets are popular in certain constituencies around the world, but You know, as a global firm with a global reputation and with fiduciary mindset on, there were a lot of times when I said that we're, we're just not going to do that. And I, I understand this puts competitive pressure on you, but these things don't make sense.

AI assessment note: “Usually it's a leveraged LIBOR floater or leveraged accumulator notes”

Q And which, which are the ones that are at the worst end of the curve?

A New Jersey and Illinois, obviously, and because the bulk of their unfunded obligations are pension related. Places like Hawaii and Kentucky, Are a little different, because there, the retiree healthcare stuff plays a bigger role, but states, you know, municipalities can unilaterally make changes to retiree healthcare obligations that are unpopular, but a judge will allow, whereas unfunded pensions are inviolable. And one of the complexities is, there is no legal document that says there's a cross default as a bondholder between an unfunded pensioner and you, right, just because a pension isn't paid is not a cross defaultable issue for a bondholder, but guess what? In the real world, when pensioners lose money, bondholders lose more. And in the seven or eight restructurings that have happened so far at the municipal level, that's exactly what's happened. Every time there's been a pensioner and retiree healthcare write down, the bondholders lost more as a percentage of par. So we pay close attention to it and have used this whole series of analyses so that if a portfolio manager ever tries to buy one of the bonds that's coded red or orange, they, they get electrocuted.

AI assessment note: “New Jersey and Illinois, obviously, and because the bulk of their unfunded obligations”

Q And so to bring that through, I mean, I remember it at the time, but why don't you describe what the Brady bond was and what it was solving for?

A The banking industry had been lending wave after wave of capital unsuccessfully to Latin America. Commodity prices were falling, and productivity improvements were scarce, and eventually J.P. Morgan and Lou Preston And people like that realized that we were just going to be trapped in a cycle of renegotiating the terms around extending debt forever that people couldn't pay. So the idea was to do substantial debt haircuts, but then allow these countries to take the little bit of liquidity that they had to buy long duration zero coupon bonds so that investors took exposure to the country with respect to the interest payments, but had collateralized maturities and help stabilize the region. And I remember We were in a pretty good capital position then, and when we wrote off a lot of that debt, Walter Wriston and John Reed and the leadership at Citigroup were pretty upset because they felt that JP Morgan was setting a standard that some of the other banks couldn't meet.

AI assessment note: “So the idea was to do substantial debt haircuts, but then allow these countries”

Q Why did it take two to three years?

A It took two to three years because you're trying to change a business that had only operated with a certain business model in its entire existence, which In terms of the JP Morgan private bank might as, you might as well say is a 150 years, right? So it takes time to do that. And remember, you're also, by the time you're in 2002 and 2003, you're spending a lot of time cleaning up the wreckage from Enron, Adelphia, Tyco, Global Crossing. There's a lot of postmortems going on because a lot of the investment models That asset managers and private banks were using that are heavily based on value got caught in some of these value traps and weren't at all accounting for, you know, quality of management, board oversight, and all sorts of other things, and fraud, so, which are tied to the other two. So there was a simultaneous reckoning of how should our stock selection process Incorporate and try to elevate the importance of some of these corporate governance issues. So there were a lot of things that were trying to be fixed at the same time, and it was, if you remember, you had a 40% collapse in the equity market. It hadn't happened since the Great Depression, and the NBER couldn't even really figure out if there was a recession in 2001. They went back and forth. So it was a very, very odd time, because we were all picking up the pieces of an equity collapse that was really, for the …

AI assessment note: “It took two to three years because you're trying to change a business”

Q How did that transition happen in your career?

A I was managing money for J.P. Morgan Asset Management, and the J.P. Morgan Private Bank at the time was a closed shop, which meant it only distributed J.P. Morgan Asset Management products, and by the time you got to 2001, And the tech collapse was happening. The entire, the client base of the buy side started asking a lot of tough questions. Did you get this wrong because you had an honest view? Or did you get this wrong because you were trapped as a distribution agent for one asset management firm? And so the entire industry was forced through this reckoning where asset management firms had to be rebuilt, and I saw an interesting opportunity there, and I had a lot of respect for Mary Erdos, who's been my boss since then. So I've worked for Mary, you know, for over 15 years, and she came in and started the process of rebuilding the J.P. Morgan Private Bank, and I was her deputy on a lot of things related to strategy and investments.

AI assessment note: “I saw an interesting opportunity there, and I had a lot of respect for Mary”

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A There's an investment committee, right? So we do everything except security selection, right? So we're picking, do we like growth versus value? Do we want to do an ETF, or do we want to spend some risk on active management? What do we want to do in terms of duration exposure? Do we want to hedge our euro exposures or not? Do we think commodities have a place in the portfolio? What do we think about timber? How do we think about Hedge funds for clients that are taxable versus non-taxable because hedge funds generate enormous amounts of short-term capital gains to ordinary income. So the average manager of a college endowment has a certain degree of freedom in making asset allocation. Ours was much higher because we had to incorporate issues around domicile, taxation, and suitability, and so the chief investment officer is, is responsible for all of that, and You know, for 11 years, day after day, you know, I was responsible for all those decisions we made, and at the time, I was also responsible in that seat for the self-directed brokerage recommendations that we made. And, you know, some of the toughest discussions that you have are with people who are in a solutions chair who come up with an idea, and you, as the CIO, say, you know what, I'm just, I'm not comfortable with that.

AI assessment note: “the chief investment officer is, is responsible for all of that”

Q So if you're describing eye on the market, how do you distill what it is?

A I have the freedom to write Whatever I want, and, and to be clear, I have exercised that freedom on multiple occasions. It's primarily focused on the things that I think matter for investors, and that matter to me. You know, I'm on our global investment committee in the asset management business, so everything about, you know, stocks, bonds, commodities, alternatives, portfolio construction, and the things that affect them, whether those things are domestic politics, geopolitics, The renewable energy revolution, the solvency of state and local governments, and there's a lot of derivative places you can go with that. You know, for example, the other day I looked at the history of midterm elections going back to the 1910 and how you generally only lose a ton of seats if either employment is doing poorly or the equity markets are doing poorly. I think this is the first administration that's going to post a double bogey At a time of strong stock markets and strong employment with respect to the losses they sustain in the midterm election. So there's just lots of stuff that investors have to think about, and the eye on the market is free to go there.

AI assessment note: “It's primarily focused on the things that I think matter for investors”

Q So if we look out at the other side of this is, is there a way out of the problem?

A On the municipal level, look, we examined every outcome. We examined what if you eliminate COLA, cost of living increases? What if they become the best investors in the world? What, what of these, what of these public DB plans, the ones that are in trouble, right, which is the subset, to be clear, what if some of them start earning eight, nine, 10% compounded? That still doesn't get you there, right? So ultimately, there's The only question is, to what degree will bondholders in those entities be affected by the restructurings of pension and retiree health care obligations? And there are plenty of public plans at the state and local level that have the formula working fine. Employee contributions plus investment returns are funding payouts. So the notion that defined benefit is inconsistent with public plans isn't true because there's plenty of places where it's working. But there's a bunch of places where it's not working, and what tends to happen is, when it goes off the rails, sometimes municipalities give up, and at that point, they start not even making the annual contributions, and then once it gets that far behind, it's done.

AI assessment note: “That still doesn't get you there, right? So ultimately, there's The only question”

Q So if you are sitting back in your rocking chair with your wife, with no conflicts about parties or jobs in your waning years, and you look back at the most difficult decisions you have to make, what was one of the most difficult ones that you made that you feel great about today?

A A lot of the things that you do in life, time changes how they look, and It's like a vacation that you take where you, you have some fun, but you get horribly sick, and then several years later you only remember how much fun the trip was. The hardest decision was when I had, when I had to, I don't know how to phrase this, but I, I, I'm a big believer in the hierarchy of institutions, but I, I didn't adhere to it once. There was a, there was a bad actor in the organization. That at a large meeting to make a major decision as to who was going to manage a certain business going forward. There was a bad actor in the organization that presented false information to a large group. I was a VP or junior sitting in the back row at the time and, and I recognized that the information was false and made no sense. But the entire committee had no way of knowing that that was the case. And, and a major business decision was made based on the information that was presented at this meeting at very senior levels. And I wasn't sure what to do about that, because I knew that the information presented was false. And I put together a dossier. I mean, this is probably 15 to 18 years ago. I still have it. It's got, it's got charts and graphs and dots and all sorts of stuff. And I gave it to the person I worked for, and I said, what should we do with this? And the person I worked for felt, this is not …

AI assessment note: “The hardest decision was when I had, when I had to... I didn't adhere to it once.”

Q And how about some of the differences, if there are any, in some of the other core asset classes? Long-only equities, private equity, real estate?

A The average balanced private client who's got 50 or a hundred million dollars or two hundred million dollars is not that much different from an institutional client in terms of their long-term risk and return objectives. One of the interesting differences in a world that's characterized by these violent episodes every decade or so Private clients are usually better situated to take advantage of, say, you know, guess what? Last night something terrible happened. There's a billion dollar portfolio for sale of Texas munis that are usually priced at four. Now they're seven, but we have 48 hours. Like, that's the kind of thing you can do with individuals, that it's very hard to do with institutions that have investment committees and things like that. On the other hand, investment committees for institutional clients are much more religious about rebalancing. So, As equity, as asset prices go up, they are religiously rebalancing back to normal, and are also adding risk when markets go down, which is a much, it's, it's a healthier dynamic. Private clients tend to let it ride in both directions.

AI assessment note: “Private clients are usually better situated to take advantage of, say, you know”

Q So with the U.S. as a data set of one, what does that chart look like in a lot of other countries?

A It rhymes in some of the aging European societies, but it doesn't quite look as bad because of the lack of constraints on the consumption of healthcare in the US. And so that's the thing that in the early seventies, they set up a system which really doesn't have any constraints on the consumption of healthcare. And so of course it's gone out of control. And so that's the added fuel in this Gap between entitlement and non-entitlement spending. Look, a couple of years ago, they cut wind subsidies. Not the solar ones, they kept those, but they let all the wind subsidies lapse, and you could, at the federal level, and you can trace that back to the fact that there were budget constraints. So a lot of very progressive causes. That have to do with the future are being cut because of the pressure from entitlement spending.

AI assessment note: “It rhymes in some of the aging European societies, but it doesn't quite look”