PUBLISHED:December 03, 2010

Major investors assess global economy during panel discussion at Duke Law

A panel of leading investors assessed the state of the economy after two tumultuous years during a discussion titled “The Global Credit Crunch: What's Next for Private Equity and Sovereign Funds?” at Duke Law School Dec. 2.

Gao Xiqing '86, vice chairman, president and chief investment officer of the China Investment Corporation; John A. Canning Jr. '69, chairman of Madison Dearborn Partners; Tony E. James, president and chief operating officer of The Blackstone Group; and David Rubenstein T’70, co-founder and managing director of The Carlyle Group, offered their perspectives. James D. Cox, Duke’s Brainerd Currie Professor of Law moderated the public discussion.

Recalling the discussion that he moderated with Canning and Gao in December 2008, as the enormity of the global economic turmoil was becoming apparent, Cox reviewed revelations and developments since.

“We’ve learned more about the crisis going forward,” Cox said. “The estimates are that the amount of commercial floorspace has to be shrunk by about 20 to 25 percent in the U.S. We overbuilt that. Home ownership, which historically has been about 62 percent for families had gotten close to 70 percent, beyond a level that is sustainable for any sort of a well-developed economy… We thought now was a good time to come back and talk about what lessons we’ve learned, where we are, and how this has impacted business.”

Canning described the massive boom in private equity activity preceding the recession.

“In 2006 and 2007 more private equity deals were done than in the entire history of private equity,” he recalled. “Firms in the US alone wrote over $650 billion worth of private equity deals. There were 17 buyouts of more than $10 billion. Before that time the only buyout of that size was RJR, and that didn’t go very well. Since that time there has only been one of that size.”

All the panelists reflected on the lessons they’ve learned as the economic downturn slowly reverses, and academics and journalists try to tease out the myriad causes of the collapse.

“There were several lessons that Madison Dearborn’s partners learned,” Canning said. “The first was that, although everybody does significant downside tests on companies, our severest downside cases were not severe enough. … The strain of the significant drop in business was way worse than our worst-case… We have since corrected that, and stress test all of our portfolio companies to the disaster scenario.”

James said he only realized in retrospect the degree to which the private equity industry lacked perspective and discipline during the bubble.

“We’re never as smart in good times as we think we are,” he said. “Those times are really dangerous because you start to think you have the answers, you start to get cocky, and that’s when investors make most mistakes.”

Even after predicting, in late 2006, that there would be a downturn in the near future, he said, it was hard to pull away from being a part of the massive deals happening until the abrupt downturn. “We’ve learned that it’s very hard to stay disciplined when everyone around you is not very disciplined,” James said. “That was, in some ways, the hardest lesson.”

Rubenstein said that the lack of preparedness in the political and economic spheres should serve as a lesson in the future.

“We didn’t really have a mechanism to deal with the debt problems, we had to struggle and we muddled our way through it,” he said. “The problem was much deeper than anybody recognized.”

Rubenstein predicted a shift in investment from well-developed markets to fast-growing markets in India, China, Brazil and other major emerging markets.

“The big shift over the next couple of years is going to be the enormous wealth that’s going to go … into the emerging market countries,” he said

Gao echoed that sentiment, adding that the effect of the downturn on China has been an amplification of China’s prominence as the world’s premier emerging market..

“This financial crisis has taken China, all of a sudden, into a very different world,” he said. “Foreigners from outside, Americans, are telling us, ‘Okay, you’re a major economy, we have to deal with it in a different way.’”

Gao suggested the change in China’s economic place in the world has happened “almost too quickly,” leading to a kind of national elation that has emboldened overly optimistic and simplistic commentators, especially in the blogosphere, whose voices are drowning out more traditional and academic economic minds.

“The mainstream economists, and the best reformers and best theorists have all shut up [because of attacks from bloggers],” he said. “It can be a mob mentality. This is an unintended consequence of the crisis.”

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