Money Is Everywhere, But for How Long? Alan Murray Wall Street Journal January 3, 2007
It may be time to put away the bubbly. The New Year's forecasts are so unrelentingly sanguine that you have to wonder whether a tanker of strong, black coffee is in order. The U.S. economy will keep growing. The housing market will recover. The Federal Reserve will cut interest rates. And financial markets will soar. The world, it seems, has become intoxicated by the steady flow of what my fellow financial writers call "liquidity." Money flows freely, like the vodka from Dennis Kozlowski's infamous ice-hewn David, filling every dark and desolate crevice of the financial world. There is a steady stream of resources to the most perilous of emerging markets, the most hopeless of troubled companies and the most overextended of home buyers. That's great fun while it lasts. But does anyone seriously think it will last forever? Forecasters are all expecting credit to continue to flow freely to whoever wants it. But will it last forever? Let's start with private equity. Private-equity fund raising set a record last year, as did private-equity deal making. This year will be even bigger. Look for a precedent-breaking $50 billion deal to be announced before the big ball falls in Times Square again. The private-equity geniuses would have you believe this is because they've discovered a superior form of running companies. Perhaps some of them have. But mostly, what they've discovered is an amazing gusher of money. Take the Employee Retirement System of Texas, which runs $23 billion in pension-fund assets for state workers. Two weeks ago, the Texas fund announced that it was going to divert 7% to 8% of its funds to private-equity investments. That's not because the Texans have a crystal ball telling them great private-equity investment opportunities lie ahead. Rather, it's because they see what they've already missed. Savvier pension funds and endowments that made private-equity bets five or 10 years ago have enjoyed huge returns, and everyone else is now scrambling, belatedly, to get in the game. "It's important for us to keep in mind we're looking in the rearview mirror," Trustee Craig Hester told the Austin American-Statesman. Yes, indeed. In the meantime, big public companies such as General Electric, whose plodding shareholder returns have put them out of favor with the pension-fund crowd, are selling off poorly performing businesses to -- who else? -- private equity. At his company's annual outlook meeting last month, GE Chief Executive Jeffrey Immelt expressed wonder at his ability to sell off the company's dogs. "You know, there is just money everywhere today," he said. "So you've got a lot of options." Does it make sense for pension funds to push GE to sell off weak businesses and then finance the private-equity funds that buy them? That game has worked well in recent years, largely because the privatized companies have been loaded up with cheap debt that ensures highly leveraged returns to their owners. If the bubbly stuff dries up, however, the game returns to basics. Do private-equity firms really do a better job running these companies than the likes of GE? That remains to be seen. The swollen river of liquidity is also behind happy predictions that housing will recover later this year. Despite rising default rates, mortgages remain cheap and easy. Lenders are still willing to let borrowers bury themselves in debt to buy a new home. The money gusher also helps explain why the federal government in Washington can keep spending away, without regard for projections of an exploding federal deficit. And why the dollar remains relatively strong, despite swelling trade deficits. Or why the Dow Jones Industrial Average has managed to go for more than 912 trading days without a 2% daily decline -- the longest such stretch in its history. Perhaps this flood of money will continue through the new year. Fed Chairman Ben Bernanke has argued the money flows are the result of a "global savings glut." Newly enriched investors in the developing world need to put their money somewhere, and apparently, even the most risky assets will do. But as long as the good times are rolling, don't expect Mr. Bernanke to cut interest rates. That's a tool he'll only use when the economy takes a serious turn for the worse. Those who predict otherwise haven't been listening to what he's been saying. And don't be fooled into thinking that more drinking will ease the inevitable hangover. At some point, something -- a string of big defaults, a sharp decline in the dollar, or, God forbid, a major terror attack -- will cause the intoxicating stuff to stop flowing. The world is still a risky place, and liquidity, at the end of the day, is just another name for confidence. Eventually, this confidence game will end.
