Medal of Honor: Top Analyst Josh Rosner Nailed the Crisis
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Josh Rosner is the inaugural recipient of our first annual Medal of Honor for Excellent Service Award. Like a Navy Seal who does the most elite work yet receives the least public spotlight, Rosner has for years consistently been one of the best analysts on Wall Street. Most importantly, while other false prophets had undeservedly taken credit for nailing the crisis (for the wrong reasons), Rosner and a small handful of other hard working analysts saw and called everything for the right reasons in real-time.
For this reason, Rosner deserves to be treated like a Rock Star. If you had invested money based on Rosner’s calls, you’d surely feel like one. So, while the circus freaks and high-powered public relations people garner all the attention, Wall St. Cheat Sheet is going to bring you the gentlemen who invaded enemy territory in the dark of night and emerged with the Truth.
I had the great honor of sitting down with Josh to discuss his career, the bias of traditional Wall Street analysts, the current state of the financial system, Goldman Sachs et al, the lost spirit of capitalism, and the good guys on Wall Street …
Damien Hoffman: Josh, tell me how your career on Wall Street started.
Josh: Totally circumstance. To make a long story very short, I started on Wall Street in the depths of the ’89-’90 recession. I couldn’t find a job except on Wall Street. I came from a legal family. Wall Street was the last industry I ever intended or thought I’d work in. I thought I was going to go into foreign service. I expected to work for or hoped to work in the government — ideally, in foreign service or international affairs.
Damien: So you thought you’d travel the world and now you’re stuck on a 9-mile long island?
Josh: I didn’t want to travel the world as much as I wanted to be a productive part of policy formation.
Damien: How did you stumble upon your first job Wall Street job?
Josh: A friend made a suggestion to talk with her brother who then was at Lehman Brothers. I interviewed there and they hired me as an associate. That was it!
Damien: Since then you’ve worked your way towards becoming an independent analyst. Can you tell us about that journey?
Josh: I was at Lehman for about 3 years. Then I left and went to Oppenheimer — which was bought by CIBC. I was there for almost a decade. The second half of it was focused almost entirely on financial service industry research. I got tired of the quality of research I was watching come out of the sell-side and the increase in conflicts of interest that were becoming more apparent in the dot-com period.
I think all of us are born either growth or value guys. I was born a value guy. So, the dot-com thing never made much sense to me. Some like-minded colleagues, both buy-side and sell-side, and I left to start an independent research firm. We did that until shortly after 9/11 when circumstance changed.
At that point, we offered KBW our research product until they got back on their feet after 9/11. Keefe’s response was, “We really appreciate it, but we can’t source from somewhere else. Why don’t you folks all you come over?” They wanted me to follow New York or New England thrifts and GSEs. I wasn’t very comfortable going back to the traditional sales side. My partners and I had differing views. We still remain very good friends. I simply wanted to keep going down the path of an independent financial research boutique. They did too, but they thought there was an opportunity to do that within Keefe. So, we went different ways.
It became very difficult for me to do it by myself and I was hired away to a firm called Medley Global Advisors. They asked me to run their financial services practice and focus on advising institutional investors on regulatory, legislative, and policy issues.
I was there from the beginning of 2003 through the middle of 2006. Management started heading down a different path than I. So, I continued to do my thing at Graham-Fisher. That brings us to today.
Damien: What exactly has you diverging toward the independent analyst route?
Josh: One is the most obvious potential conflicts of interest between investment banking clients and research — right where perhaps analysts puts a more favorable spin on the securities of companies they’ve got a banking relationship with. Furthermore, the willingness to be pressured by large institutional clients who want you to consider stocks or securities that they’ve got heavy exposure to.
It seems to me that the independence of your view is really paramount. In the largest and most complex financial institutions, the institutions themselves do not offer levels of disclosure and transparency that make them truly analyzable.
Damien: Is it hard to get access because you don’t play the game?
Josh: I have to rely solely on the cold hard facts of their filings and public disclosures coupled with my macro-economic analysis. Wall Street is so soiled it becomes hard for an analyst at a traditional Wall Street firm to actually have an economic outlook. The guy who’s covering the mortgage bankers is not covering the mortgage insurers. The guy who’s covering the mortgage insurers is not covering the GSEs. The guy who’s covering the GSEs is not covering the thrifts. However, changes within a sector occur where all of these sub-sectors meet. So, the traditional sell-side analyst is stuck relying much more heavily on management to give them macro guidance and highlight structural changes in the industry. Consequently, their independence ends up jeopardized.
Damien: Speaking of macro views, we all know one of the prongs for a sustained recovery is fixing the banking system. Can you update us on which inning we’re in and what you think the banks have done well so well so far?
Josh: In terms of fixing the banking system, there’s a couple ways of answering the question. That question also needs to be asked as the banking system distinct from the real economy, and the banking system distinct from the credit markets. There are really three different things related to each other with interplay, but they’re separate.
Damien: I was thinking specifically about the banks because they went through the process of giving out loans to people who couldn’t pay them back and it’s been the heart of the problem. But when you delineate it that way, the credit markets have also been in disarray and need to be healed as well.
Josh: Our large banks have taken some level of government support. They’ve raised some level of capital. I think it has bought them time. I don’t think they fundamentally dealt with a lot of the troubled assets they continue to hold. That’ll have to be dealt with. We still have a significant number of smaller banks that are going to fail. Depending on how you define ‘fail’, we probably have north of 600 and potentially as high as 1100 failed banks. More realistically, I think 600-800 banks are going to fail. But let’s not look at the issue in terms of banks. We should look at it in terms of assets.
Part of the problem is the banks are still by and large undercapitalized to perform the financial intermediation that bankers are expected to perform. In 1989, banks and savings institutions were responsible for providing 65% of consumer revolving credit. Since 2000, they’ve only been responsible for 30-40% of that consumer revolving credit. However, securitized pools as a percentage of total revolving consumer credit were 6% in 1989. Since 2000, they’ve been somewhere close to 50% — declining only since the beginning of the crisis.
Damien: So, there’s been a swap of providing credit?
Josh: Right. Commercial and savings institutions were 54% of total non-revolving consumer debt in 1989, and then only provided 30-34% since 2002. I bring it up because even if we make our banks whole, even if we plug the wholes in their balance sheets, provide them capital or force them to raise capital, create new demand for borrowings, and create a steep yield curve, the reality is we’ve lost the system by which we funded a trillion dollars of collateral in this economy in 2007. And that’s 2007 alone.
What have we done to fix the issue? We haven’t fixed either the banks nor have we fixed the credit markets. Fixing would actually be a fundamental repair — not a patch like we have now. We’ve put up scaffolding to make sure when bricks fall off the buildings they do not hit people below. In our case, the scaffolding has names like Commercial Paper Program, TALF, PPIP, the TGLP, and quantitative easing.
Damien: Is this perpetual scaffolding or is there hope that while the scaffolding is there the building will be remodeled?
Josh: That is the issue. We’re starting to talk about already pulling away the scaffolding, but we really haven’t done anything meaningful in terms of repairing the building. To extend the metaphor, we have not even fully surveyed the building.
Damien: Then are we going to experience some sort of lost decade like Japan if we have all this fixing and surveying left to do?
Josh: I warned about that in July of 2007 in a very important paper. I think that’s a very real risk. I think it’s actually tied to the third piece of this puzzle. We’ve discussed the credit markets and banking system, but we haven’t touched on the real economy. The real economy was a different crisis. Typically, we think of this as ‘the crisis.’ There are actually two different crises: first, the credit market crisis or capital market crisis, which includes ‘too big to fail’ institutions, the blow out of credit spreads, and the problems in the structured securities and derivatives markets; and second, we have the real economy component, which I view as a separate crisis.
This second crisis contextually began in the ’60s when the relationship between real wages and asset prices changed. At that time we saw further distortion in the real economy with an aging population — meaning the baby boomer generation — moving past their peak earning years and the democratization of consumer credit.
We’ve drained quite a lot of equity out of our homes. What used to be the single largest retirement asset for the average American family has actually been in many cases completely gutted at a time when the largest population we have ever had in this country moves toward retirement. There will be a huge impact and burden those people will have on the social safety net — meaning Medicare, Medicaid, Social Security. Those are real economy problems.
Damien: I discussed this with John Mauldin during our interview. What do you say to those people between the ages of 18 and 45? Will they simply work through their peak earning years to pay the debts of the elders?
Josh: That’s part of the reason Obama was elected. People hoped we would have a visionary take us down a new path and address some of these imbalances through technological innovation, educational advances, etc. We certainly haven’t seen that full vision anywhere, but I think that was the hope.
At the end of the day, we have to make significant changes to our continuing education. We need to have real changes in terms of immigration policy. We need to attract a highly skilled workforce in numbers. If we do so, then we’ll replenish the pool and things will be okay. We have an aging population. But it’s not aging as quickly as other places, and there are still a lot of people who would like to be here. That’s one of the positives.
I would suspect that for a while those trillion dollars will get bigger. No matter what we want, the government will become a bigger component for a retiring population. On the flip side, government is going to have to support economic achievements such as retraining and retooling. Government is going to have to support the creation of a post-industrialized economy.
This is not terribly different than the transformation that we’ve seen before in this country. However, a lot of people seem to forget at the end of the 1800s we had a depression — at the end of the 1800s! That was a transformative depression driven by the shift from an agrarian society towards an industrialized society. The excesses of that initial transformation were partially what we felt in the ’20s and the disastrous depression. We are moving toward a post-industrialized economy in which we don’t need the same urban centers or physical infrastructure. Inventory management has had huge advances over the past decade and all of those positive productivity changes are starting to trickle through into the real economy. They create displacement and problems, but we have to absorb those changes. It will take a while.
Damien: Do you think we will have a quicker turnaround now because we have the internet and the ability to start businesses and transfer ideas quickly?
Josh: No, because we’ve got international flows of capital as well which makes it a very difficult challenge for us. We’ve got a population that has among the highest wages in the world, and that puts us at a competitive disadvantage unless we were moving to an isolationist environment. That is not attractive or tenable to anyone at this point.
I think we’re going to go through a period when some of those productivity gains will be passed through as income losses or a loss of some degree of purchasing power.
I would point out that unlike the recovery in the early 1980’s in which we had two unprecedented secular tail-winds supporting our recovery, those same winds are blowing as head-winds. Namely, in the early 1980’s we were still at the very front end of the democratization of consumer revolving credit. Most families purchased based on savings and limited lines of credit — mostly in the form of installment or charge cards. Today, we have over-lent and the opportunities to exploit consumer credit for economic growth is again tied to quaint concepts like wages.
The second difference acting against a quick and sustainable turnaround is the baby boom generation. The largest generation in U.S. history was at the front end of prime earning years in the early 1980’s. Today those same boomers are nearing the end of their earning years. That has real implications. Just think about the implications for housing and healthcare.
The other risk is that 50% of total employment and 44% of total payroll are tied to companies with less than 500 employees. These businesses are seeing some withdrawal of credit availability, mostly from smaller banks. If that trend accelerates we will see another leg down in employment, another leg up in consumer bankruptcies and defaults, and another risk to asset values in real estate.
Damien: Are we already seeing some of that with wages stagnating for all these years as India and China sucked up a lot of the labor force?
Josh: Yes. There has always been this great notion that globalization will help all ships rise. However, in a closed system that is an unsupportable argument.
Damien: Do you buy the assertion that Americans are going to get frugal and increase savings on a permanent level? Or, is it in our culture blood to inevitably swipe the plastic and inflate our standard of living as soon as things get good again?
Josh: It depends where we are. There will be a necessary increase in frugality. The savings rates are going higher. For many, the lessons we’ve learned are very serious lessons. It took almost three decades for our nation to begin to lose the effect the depression culture and ethos. That said, we didn’t have consumer revolving debt at that point. We didn’t have international trade flows and capital flows. It was a different world.
Do I think we are going to have some increase in consumer savings rates over the longer term? Absolutely. Do I think that our cultural values are shifting back towards traditional American values of frugality? We often forget the whole Protestant ethic and spirit of capitalism included frugality.
Damien: The Calvinists.
Josh: Exactly. Thrift is a real part of capitalism’s spirit, and we’ve forgotten that. I think we’re going to start remembering that. But we’re also going to recognize capitalism in its “purest” form is a non-workable option — but that’s a whole other discussion.
Damien: Moving on to a domestic issue, do you think Goldman Sachs played the three-card monte and passed the taxpayers money to AIG so they could get paid on their default swaps? Or, is that kookie conspiracy theory stuff?
Josh: The most despicable lesson — and I wouldn’t relate it to Goldman as much as I would to 5 or 6 institutions — was in a time of national crisis we had institutions that were unwilling to put aside their lobbying, put aside their will to power, and recognize they had a greater obligation to the country. This is part of why I said capitalism in its purest form doesn’t work because they would assert their primary duty is their fiduciary obligation to their investors. However, I would say part of fulfilling your fiduciary obligation to your investors is to make sure there is a playing field on which to bring your ball and bat every week.
Do I think they tried to maximize their returns in this crisis and minimize the losses they would have to recognize? Absolutely, no question. Is that wrong? I’m not an ethicist, so this is one man’s opinion: Yeah, I think in some sense it is wrong. How do we square that circle? That’s for the government to determine. But I do question whether our Founding Fathers intended for corporations to have the same rights as citizens.
These are some of the same problems I have with the concept of loan modifications on the mortgage side. It’s an issue legislators have to be bold enough to address. If you’re on the government’s dole, should you be able to lobby them? I would say no. If, on the other side, you are a mortgage company that is modifying a mortgage, and you know damn well there’s a 50% or 60% chance the mortgage is going to re-default, are you actually helping the borrower? I would argue, “No.” You’re actually taking two years of incremental cash flow from him or her before he or she re-defaults. That is predatory lending. However, our government is now sanctioning and trying to force that type of predatory lending. Is that appropriate? Well, I would say, “No.” If there is an “acceptable” level of redefault, that social policy decision needs to be decided by legislators rather than the executive branch.
We need Congress, our elected officials, to be grown ups and meet their responsibilities. They need to stand up and say, “That’s a policy issue.” So, the question is, “What is the socially acceptable level of re-defaults?” That hasn’t been defined. So, how could we have an effective modification program if we haven’t even defined what is socially acceptable? The entire root of this crisis boils down to a breakdown of the social contract. So, to get back to your question, was Goldman a part of that breakdown in social contract? Absolutely.
Damien: Do you think it was a pre-meditated strategy that was imposed by some of these financial firms to take on issues and get involved in markets they knew eventually would bring down the whole system?
Josh: Do I think it was pre-meditated? Do I think they understood the risks? Well, if they didn’t, they should be out of business for poor risk measurement and poor risk practices. So in that sense, I do think they understood the risks they had in front of them and chose to ignore them for the longer term. No question. Do I think they pointed the moral hazard gun at our heads intentionally? Yes, a couple did.
Damien: Moving on to a personal issue, what does the future hold for Josh Rosner?
Josh: I love what I do. There’s really nothing I’d rather do at this point. I’d like to believe that in some sense I’m helping the financial and economic literacy of both policy makers and market participants. I’d like to believe that I’m tempering some of the self-promoting or lobbying by market participants. I’d like to hopefully have a greater impact on helping to be a productive part of finally coming around and recognizing the fixes that need to be put in place for the banking system and the credit markets.
Damien: Josh, if your son came to you and said he was inspired to follow in your footsteps, what advice would you give him?
Josh: I would want my son to pursue his own world in his own way. The reason that I did not go into law like my father was I never wanted to find myself at some point in my career wondering whether my achievements were the result of my father’s excellent reputation or help.
However, I can’t say I did it all by myself. Meaning, there are some phenomenal people on Wall Street who take care of other people they think are doing the right things for the right reasons. For example, in my case, I was helped a lot by the two men who used to run Oppenheimer and General Counsel Bob Kleinberg at Oppenheimer. There were some phenomenal people at Oppenheimer. The sense of family, purpose, and social importance was really culturally something I picked up at home — but it was also reinterpreted with the Wall Street meaning for me at Oppenheimer. It was a rare place.
So, I would tell my son to find the good people on Wall Street. Figure out a way to help them help you understand how to do your job in the most ethical and positive way. After 9/11 I really questioned the value of what we do on Wall Street and, after much reflection, accepted that if we do our jobs we will drive capital in the most productive direction for society first and foremost.
On Wall Street there really are two types of people: those who rise solely because they are shrewd, and those who rise because they have earned the respect of their peers. I would encourage my son to figure out a way to be in the latter group.
Damien: That’s great advice! Well, Josh, this has been a very intellectually stimulating conversation for me. Congrats on all your great work and achievements. I hope you can help our policy makers set things straight sooner than later.
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