KGB: S&P Dow Jones Indices' David Blitzer

David Blitzer, managing director and chair of S&P’s Index Committee, tells Business Spectator’s Alan Kohler and Robert Gottliebsen: 

– Indices for bank cards, first mortgages, second mortgages and auto loans all indicate Americans' credit quality is back to where it should be, with the last few years’ round of defaults over.

– Record and near-record US company earnings reflect the fact that corporate ills are being addressed, with costs under better control and spending less crazy than it had been.

– A US bond default would have triggered “massive dislocation”, and brought the world close to another financial crisis.

– House price growth in the US is beginning to decelerate, and are more likely to be at 4-6 per cent than the current 12 per cent nationally, over the next year.

– How the Federal Reserve’s tapering program will impact housing and the auto industry. 

Alan Kohler: David Blitzer, welcome to Business Spectator.  Thanks for joining us.

David Blitzer: My pleasure. Nice to be here.

AK: Perhaps we could start by explaining the ownership of your company, as Standard and Poor’s or S&P Dow Jones Indices, because it’s not actually owned by Dow Jones, which is the company that owns or is associated with Business Spectator now.

DB: Maybe we should start with the Dow Jones side of the history. Dow Jones publishes the Wall Street Journal and traces itself back to sometime in the 19th century.  News Corp, which I think everybody here in Australia is very familiar with, had acquired Dow Jones including the Wall Street Journal and then subsequently sold the index business to the Chicago Mercantile Exchange, which runs futures trading in Chicago and is one of the biggest exchanges anywhere in the world. 

The Chicago Mercantile Exchange focused on running the exchange and the index business was sort of an extra bit. What they did was join up with McGraw Hill, which has owned Standard and Poor’s since the 1960s, and we put the two index businesses together and that forms S&P Dow Jones Indices, which in round numbers is three quarters owned by McGraw Hill and one quarter owned by the CME. 

It is very much one business. Among the indices that we include, there’s got to be hundreds of thousands if you add up all of them. S&P ASX 200 and the other S&P ASX series here in Australia, which we’re proud to say the 200 is the key equity index in Australia. Back home in the United States, there’s the S&P 500 and the Dow Jones Industrials, which are the two key indices in the US.

AK: And you also have the Case-Shiller housing index, don’t you?

DB: Yes, we do. Another index on home prices in the United States called the S&P Case Shiller Home Price Index focussed on twenty cities’ international index. For the last week, week and a half, this has been all over the news. I’d love to say we did this, but the truth is Bob Shiller did it.  Bob Shiller is a professor at Yale and he’s one of the three economists who got the Nobel Prize in Economics shared among them for 2013, which we’re very pleased with. 

AK: You’ve not only got the housing index and the equity indexes, but you’ve also got some consumer sentiment indexes, as I understand, or some consumption economic type indexes?

DB: We have a couple of others. We work with a credit reporting bureau to provide indices that look at default consumer credit, so we look at what you might call bank cards, like Visa, Mastercard, that kind of thing, first mortgages and second mortgages and auto loans. Looking at those, we could see very clearly what went on in the financial crisis. The really good thing is that all four indices on an international basis are back to the levels of default that were before the financial crisis.

In terms of consumer credit in the US, credit quality is really back to where it should be.  We’re passed this huge round of defaults over a few years.

AK: What are the housing indices telling you about what’s going on in the housing market in the US?

DB: Prices are going up quite strongly, in fact. Over the last year or so, prices are up about 12 per cent nationally and that’s a pace that I don’t think will be sustained year in and year out. I don’t think I want it to be sustained because we’d be back in the same craziness that we had in 2005, 2006.

But looking through the details, a majority of the cities in the last report saw prices rising, but more slowly than they had in the previous months. So, I think we’re beginning to see a little bit of deceleration. My sense is that over the next year home prices in the United States will be up, but it won’t be by 12 per cent. It will be a third to a half that rate or something, so we’re going to gradually come down.

Robert Gottliebsen: Is that sort of steadying in the rate of rise of house prices partly a result of the big movements in the Treasury bonds in the US, which are partly also triggered by the possibility of tapering of US bond buying?

DB: Yeah. We have seen interest rates, including mortgage interest rates, move up since sometime late May or June of this year, and that has definitely slowed mortgage applications. But the biggest slowdown has come in applications for refinancing.  People who are sitting there, saying “I’ve got a mortgage that I got several years back at 6 per cent, maybe I’ll reprice it with a mortgage of 4 per cent and have more money in my pocket.” The increase in interest rates has really squashed down the applications.  Applications to purchase are down, but they’re probably down 4 per cent, 5 per cent, 6 per cent over the last six months, whereas refinancing is down 40-50 per cent or some big number.

RG: What effect does that have on the US economy when the refinancing is down?

DB: It’s a problem because all these people who suddenly find out or if they do this and their monthly payment goes down, they’ve got extra cash in their pocket.  They’re going to have to pay $US800 to the bank this month and now they have to only pay four hundred bucks.  I don’t know about Australia, but Americans tend to spend the money, so it’s a good thing for the economy.  We have less of that or we’ll have less of that going forward, because interest rates are going up and some of those mortgages aren’t worth refinancing because there’s not enough of a gain in the rate.

RG: So, we could see a slowing down in consumer sentiment and consumer spending in the US partly because of what you say?

DB: Yeah.  I think that the contributing factor in the short term in the US is going to be the superior performance of the United States Congress in the last two weeks which is, frankly, I think something of an embarrassment – or should be an embarrassment – to most Americans. 

All the estimates say that the government shutdown and all the politicking that went on around it has quite clearly damaged sentiment. It’s likely to mean that the GDP numbers for the US for the fourth quarter will be worse than they would have been. The estimates of a half a per cent or more off the grid of growth for the fourth quarter seem to be very common and very widely accepted.  We’re talking about $US20 billion, $US30 billion dollars of activity that’s missed.  You know, not only didn’t we refinance mortgages but for close to two weeks, government employees didn’t get paid.  While they will get their back pay at some point, that’s a lot of spending that didn’t go on and so on.

AK: And it’ll never come back.  I mean that’s gone, right?

DB: Yeah. That’s gone. I mean that’s like, you know, television airtime. If you don’t sell it, it’s gone.

AK: Is it possible that all the politicking and what went on over the last few weeks with the shutdown will end up being good because it actually means the defeat of the Tea Party?

DB: It’s too early to say that they defeated the Tea Party, but I think there is among what’s now being called the traditional branch of the Republican Party and, you know, this is the party that historically believed in sound finance, balancing budgets, you know, doing things on a reasonable basis. 

Apparently that group has decided they really have to push much harder against the Tea Party. What’s come out in the press is that the Republican Party now realises that a lot of its longstanding supporters in business look askance at all this kind of stuff. They scratch their heads, you know – how could these people ever dream of threatening quality of the US government and that kind of thing? 

There seems to be more of a push to really reframe things somewhat. It will take some time and it’s not guaranteed, but I hope it does come back. There’s some strange rules buried in this. I think going all the way back to Newt Gingrich in the ‘90s. When the Republicans controlled the House of Representatives, they would not bring a vote to the floor unless a majority of the Republicans were in favour of the Bill, so they essentially locked up their situation by forcing all their members to vote as a block, instead of their members voting however they felt. And that kind of rule was one of the problems, because it was clear that we could have avoided the whole shutdown in the House had the Democrats plus some moderate number of Republicans voted together to, you know, raise the debt ceiling and so on, but the Party wouldn’t let them do that.  If they get back to thinking every member representative can think for himself, it’ll be a big advantage.

AK: Is there any sign of that happening?

DB: There’s some grumbling in the paper, especially from the Republicans in the Senate who feel they had to ride to the rescue at the last moment. You know, it takes a long time to get anything done in politics, so it’ll keep stewing for a while.

RG: Of course, it does mean QE3 will continue longer than it otherwise would, and therefore keep interest rates lower than they may otherwise have been kept.  It might help the housing market and consumers.

DB: I think that’s the case. There has been some talk that the Fed would begin its tapering in late this year in December. We haven’t seen most of the economic data that was missed. Most of it has been rescheduled for this coming week, including the employment numbers for September. It seems more than likely if the estimate that GDP growth is slower in the fourth quarter is accurate, likely that’s job improvement and that kind of thing, that the Feds are likely to take a pass this time and they will be talking sometime in the first quarter of next year.  The whole schedule will slip out.

RG: So what you’re telling us is that once the taper starts to come and interest rates rise, it will affect consumers in America in a number of ways – particularly by the refinancing of their houses.

DB: It will have a lot of impact. As rates rise, there are fewer and fewer mortgages that you can refinance at a profit.  It is also going to probably be a pretty serious test for the auto industry. Traditionally, one thing the auto industry would do is when sales slid back, they just give very generous financing arrangements.

It was a way to make sure they hit their annual sales target was give you cheap money and that kind of stuff. Well, the economy slows a little bit and people see it’s going to cost more to lease a car or finance a car, then the pressure will be on the auto industry.  Do they try and twist the arms of the financing side to keep up the auto sales?  This kind of stuff has got them in trouble back, you know, before their most recent rebirth, so that will be another interesting challenge to see how all this plays out. Hopefully the auto industry takes a slightly longer view and doesn’t pile up too many inventories.

AK: But overall your sense of the US economy is what? That it’s recovering gradually?

DB: Yeah. And unfortunately, the word gradually has got to be emphasised. It is recovering gradually, but I think next year will be a little bit better than this year. The unemployment rate is coming down, but this is all very slow and very frustrating.

There’s really an issue with investment.  One of the strange things in housing is existing home sales have rebounded pretty much to their pre-financial crisis levels; new home sales have not. 

Now, I sell a house to you, the broker makes money, that’s nice. But it doesn’t really do much for the economy compared to if you were to go out and build a house.  That adds to the economy. We’re creating something and we’re hiring workers and creating jobs.  So, new home construction has been the weak part of the housing industry. 

Business capital spending – and there’s a lot of debate as to why this is – but business capital spending has been slower in this recovery than most other recoveries. As somebody said, that’s because the recovery is slow.  But it may be that the recovery is slow because capital spending is a little bit slower than it would…

AK: The recovery is slow also because of the budget sequester of the government, which after the last few weeks, maybe that’s going to come to an end. I mean, apart from anything else, the budget is getting back into shape on its own.

DB: The budget, and here unfortunately I don’t remember all the numbers off the top of my head, but measured as a percentage of GDP, is very much getting back in shape.  In fact, it’s probably at the point it would look good if it was George Bush in the White House, but he’s no longer there and so on.

AK: You’d soon fix that though, wouldn’t you?

DB: No, no, no. And you know it doesn’t look like it was when Bill Clinton was there because briefly it was all in black ink, which is amazing.

RG: Is the reason the new homes have not rebounded as much as the existing homes that they’re simply more expensive than the existing homes and that people are buying existing homes rather than spend more money on new homes?

DB: I think there’s a whole range of different issues. In some areas it’s a question of what the supply looked like. In some areas there was a lot of supply from foreclosed homes.  It may be a question looking at the overall economy, how aggressive and how confident builders were at different times and their confidence definitely improved in the 12, 15 months leading up to May and June or this summer. With rates going up, they get reasonably a bit nervous.  But it’s a pattern that’s been there for three or four years now, so it is something that’s been around for a while and it is a factor.

RG: We get the impression that American companies have done pretty well.  They’ve lowered their costs. They’ve increased their profits. Their performance amongst their peers in Europe or Australia has been very high.

DB: The earnings in the S&P 500 have been at record or near-record levels. The stock market has obviously done very well. I think that a lot of the ills that we all saw for many years have really just started to be addressed. So the costs are more under control, spending is a little less crazy than it had been and that kind of thing.

There were a lot of debates about executive compensation, usually arguing about the ratio between the compensation of the top five officers in the company to the average compensation across the whole company.  Those numbers over 40 or 50 years have shifted pretty dramatically to much more concentration at the top.  Probably more compensation is stock-based in one way or another, and the stock market has done very well, so that that’s reduced some of those issues.  So, there are still some issues to be shaken out and maybe there will always be issues.  But generally I think US industry is in better shape than it was 10, 15 years ago. It has improved. Clearly the auto industry is completely different than it was; it’s profitable, it’s making money. By all accounts the cars get a little more respect around the world than they did at their worst.

AK: What do you think of the JPMorgan settlement of $US13 billion?

DB: This is a lot of money.

AK: It is that.

DB: That’s the first impression. The legal fees, which knocked up at $US7 billion in round numbers, that’s either a lot of money or a lot of lawyers.

AK: And it took five years.

DB: It took a long time.  I think that there’s a sort of political undercurrent in the background. A lot of Americans were upset that it didn’t seem like anybody paid for the financial crisis except the average guy who lost his job or his neighbour lost his job or who really suffered. But what big entity, what big organisation, what chairman had paid for it? 

I think the administration recognises that undercurrent of aggravation and so forth, so they have gone out pretty aggressively and JPMorgan Chase was clearly their number one.  For one thing, it has a leader in Jamie Dimon, who tends to get out there and talk a lot.  Everybody knows who he is and it’s one of the biggest – if not the biggest – bank depending on how you measure it.  It became the one with the target painted on it. 

If you go back, five, 10 years, the target was painted on Goldman Sachs. I can’t take you back target by target, but I’m sure there were other targets.  It is, by all accounts, a huge settlement, probably at record levels.

I did notice in the press that I think it’s Bank of America that is now showing up on certain lists and so on. The number is a little smaller, but it’s not only JPMorgan Chase. If the whole thing of ‘too big to fail’ was the big issue that came out of the financial crisis, we haven’t solved that.

AK: They’re even bigger.

DB: They’re even bigger and, if something like that happens again, and I guess you wait long enough that it does – long enough is decades now –  they’ll be too big to fail as well. I remember when in March of 2008 Bear Stearns collapsed and, in fact, JPMorgan Chase acquired them, initially paying $2 a share, but then they were talked into making it $10 because $2 just looked too small. Six months later, Lehman went down and that was the whole game, but we went into that…

Bear Stearns wasn’t the first. It was probably the hundred and first firm to drop off.  It was clear that you get to some point when it was too big. Either it was a massive collapse or that was it. There was going to be a limit. I think the government’s mistake was not that they didn’t save Lehman Brothers, it was that they did save Bear Stearns, or somebody earlier on in the game.  Bear Stearns was smaller; it would have been less of a disaster.  That they saved somebody that was like the corner candy store, nobody would have noticed.

RG: Just finally, in the theoretical event that the US had have defaulted on its bonds, do you think that would have knocked the derivatives market around the world?

DB: If we had defaulted?

RG: If. 

DB: I think it would have been a massive dislocation. This is also something that comes out of the financial crisis.  A huge amount of short-term lending is done with repurchase agreements.

RG: Repos.

DB: Repos. And to make repos work it depends on the collateral because that’s what’s being bought and sold and passed back and forth.  In the financial crisis, a lot of the collateral was traced back to mortgage-related securities. What happened was instead of haircutting it by 10 per cent, everybody haircutted by 20 per cent or 30 per cent. When the haircut goes up, the amount of credit in the economy just shrinks down. 

Nowadays a lot of repos are backed by Treasury debt because everybody got burned with the mortgages. I think you would have had people – even though this sounds like something that could never happen – haircutting Treasury debt on a credit basis, I think you would have risked the same kind of thing.  The amount of what you might call ‘floating credit’ in the economy would shrink overnight by 10 per cent, 15 per cent.

AK: Is this because of downgrades by all three rating agencies?

DB: Yeah. Downgrades. Not just downgrades, but people looking around and saying: “I’m not going to take that bill because it matures on the end of October. Maybe I’d accept a repo on a bill that doesn’t mature until the end of January, they’ll fix it by then.”  

And the prices of some of the very short-term Treasury paper reacted that way.  The yields went up and the pricing went down because, you know, Mary said “Geez there’s a little chance I might not get paid”, or “I’ll get paid two weeks late”.

RG: If the whole thing had have fallen to pieces as it might have, we would have risked another global financial crisis?

DB: We would have been real close. They settled this thing with about six or eight hours to spare.  I think the Bill was signed at 12:30 in the morning on the day, so you know they had I guess twenty-three and a half hours because it would have gotten to midnight. 

RG: Yeah, yeah.

DB: But there was this real problem of if they lose sense of time, they just wouldn’t have had enough time to sign all the paperwork.

RG: Were you scared?

DB: I was worried that all these politicians would talk just a little too long.

AK: Thanks for joining us, David.

RG: Thanks, David.

DB: My pleasure. Thank you for having me.