Avenue Capital chairman Marc Lasry sees leverage as the main culprit of the economic downturn. The secret to recovery: a cap on leverage.
Question: Who or what institutions were the cause of this crisis?
Marc Lasry: I don't think there were any institutions that were the cause of the crisis. I think the cause of the crisis was the excess leverage. And I think we were all responsible for that. And you probably had some institutions who used more leverage than others, but ultimately everybody was at fault, and nobody wants to really admit that. I mean, you ended up having the regulatory agencies that allowed firms, whether it was investment banks or banks, to have anywhere between 35 to 40 times leverage. I mean, imagine yourself, if somebody would lend you -- or if you could lever up something 40 times. I mean, if it works you do phenomenally well, and if it doesn't work, you lose; but most people would love to have that amount of leverage, because think of it: all you have to do with 40 times leverage is, if you make 2 percent, you've made a huge amount of money, right? So you can make half of a percent, and you've still made a 20 percent return. So it's just the -- what ended up happening is, as each year went by, the amount of leverage that institutions were allowed to have grew and grew and grew, and everybody felt that there was this excess capital and there was never going to be an issue. But a day of reckoning came, and when that came, that's what ended up setting the system literally on the edge of collapse.
Question: What are the biggest misconceptions the American public has about the crisis?
Marc Lasry: Well, like I think there's a misconception, right? I think the issue that's out there is, most people look at it and say we've spent $800 billion to save the system, right? There was a stimulus package. Yet people look at it and say they're out of work, or they've got issues, so why did you save Wall Street and not me? And I think ultimately what people don't fully appreciate or understand is that if the system wasn't there, that would have affected every single person. So it wasn't -- I think the government has done probably a poor job of explaining that by saving the banks you ended up saving everybody, as opposed to the perception that saving the banks only saved the people who work at the banks.
Question: When dealing with large financial institutions before 2008, did you assume they were too big to fail? (Scott Sumner, The Money Illusion)
Marc Lasry: I don't think anybody's too big to fail. I think the -- I think if what you've got is sort of a large number of institutions who are going to fail, then that ends up affecting the system. I think if what you had was just one financial institution, I think the government or the markets would be able to handle that very well. And that's sort of what happened with Lehman. I think with Lehman Brothers, people believed they're not too big to fail. The problem is, was Lehman going under -- did that end up creating then issues for everybody else? And what you found was that the financial system is one really based on trust and sort of a belief that the money's going to be there, and when everybody wants their money at the same time, that's what ends up creating sort of these runs on the banks. And I think once Lehman went under and people started worrying that other institutions could go under, then it's not really is an institution too big to fail; it becomes, is the system going to fail? And that actually ended up being sort of the fear or the reason we had all these problems.
Question: What regulation do you think needs to be in place to prevent this from happening again?
Marc Lasry: I actually think if you want to prevent this from happening again, it's not that complicated: just limit the amount of leverage, right? I mean, it's what caused sort of the real estate crisis? The fact that somebody could go out and put 1 percent down and borrow 99 percent, or put no money down and borrow 100 percent. Well, the more amount of leverage that you allow somebody to do -- it used to be, at least maybe it was 10 years ago, you had to put 20 percent down. So that means people were borrowing four times, right? Four or five times. Then it became 10 percent, then so you're borrowing nine, 10 times. Then it became 5 percent, and then it became 2 percent, and then it became no money down. So if you're not -- if nobody's got to put capital at risk, people will do a lot of crazy things. And it's the same thing -- I mean, everybody talks about Wall Street, but you saw it happening with people buying homes. And you saw that everybody was buying investment properties because they didn't have to put any money down. So I think the cause of all this is leverage. Leverage is great when it works, and when it doesn't work it creates a lot of issues. So I think if you limit the amount of leverage that people can borrow, or that banks can borrow, I think you'll find that you'll have a lot less issues going forward.
Recorded on December 4, 2009