Commercial Property Executive February 2011 : Page 26

Visionary ship of the GSEs, the introduction of TARP, the stress testing of the banks, the getting the plumbing of the system right, the re-start of se-curitization—all of these are results of actions that, when we look back upon them in later days, we’ll say, “You know what? There was a cohesion here. Yeah, it might have been done by bootstraps. But at the end of the day people did what they were supposed to do, and our sys-tem actually worked.” The flip side is that what happened during the period of extraordinary growth is there was excessive spending by everybody—the federal government, the state governments and the local governments. And you look at the bud-get deficits, and you start to wonder how could they have done that. That was pretty profli-gate. When you make money, you’re supposed to also save money. Nobody did. The federal government didn’t, state didn’t, local didn’t, the household didn’t, and most companies didn’t either, by the way. So we all participated in this period of extraordinary consumption for it looks like probably close to a decade and a half. And then it came back home to roost. … I would suggest that the biggest thing we have to think about (regarding) policy and government in the future ... is where is the job growth going to come from, in what sectors and what markets, and for what reason. … In real estate, we are heavily dependent upon the fact that there are jobs being created and workspace is needed and housing is needed. Otherwise, we don’t have work to do. risk, with potentially, as we’ve learned, some buyback risk. And now we’re sort of reverting back to a form in which you say you do need a balance sheet, but given the changes that are occurring in accounting rules and the world at large, how do we find capital players of different kinds to do one deal? … And then how do you aggre-gate this and do this? You’re going to need an extraordinarily interesting company that has capacity to hold some paper, to take some off-balance-sheet risk, and has capital market savvy to become the finance company of the future. And one of the most important things about that company is—and it will be a new hybrid—that it will have to have really strong risk management and control systems to be able to survive. Q. A. Q. A. 26 What are the key characteristics of finance companies that have stood out in your work in recent years, and do you see any patterns emerging among the fi-nance companies that you’ve been advising? We went from essentially balance sheet only to a form of contingent balance sheet where I still needed a balance sheet but I could sell it. And this is the evolution of the Fannie Mae DUS program, for example, or bank loan participations or syndi-cations or so on. I leveraged the balance sheet more—to securitization, which was essentially a way to sell off balance sheet, but in some cas-es with some residual risk, with some operating Do you believe many companies will be able to achieve that model? Sure. In the market as it is emerg-ing, you have a private market and you have a public market. … The private market is most of the finance compa-nies, most of the mortgage banking companies. You then have different kinds of capital in these companies. You have private equity, which has a particular focus. While many people in pri-vate equity say they are long-term thinkers and long-term planners and long-term doers, the fact is they all need an exit some day. So that’s what I call … patient equity with a clear objective. And you have regulated capi-tal, which is the market in which banks oper-ate, and where to a large extent how much cap-ital they have to hold and what they can pay in dividends is dictated by regulatory standards. And then you have people who have a balance sheet—a permanent balance sheet—and those who do not. So three broad characteristics. … Personally, I’ve always felt that the best mod-el would be one where you had a true mortgage banking company where you accessed multiple sources of capital for your clients, and those sources of capital both shifted and changed over time, but you also had an investment man-agement model inside of it where you raised third-party capital that was discretionary and potentially proprietary and you could actually utilize that to benefit your clients by helping in enabling them to be more successful. … A number of people are trying it. I tried it 15 years ago. Large-balance-sheet companies try it; non-balance-sheet companies try it; regulated capital companies try it. But the entrepreneur-ial model with a source of stable capital and a limited balance sheet strikes me as the best one. Because if you have a real balance sheet and you can keep growing it, you tend to, in my view— just over time—become less disciplined. … What this kind of company needs, where it can both create capital and deliver it itself … is it has to have a culture of its own. It has to know and believe this is a good thing and that’s not a good thing. The discipline of knowing that and managing that, in an environment where growth is seen as the only sort of driver of value, is a very, very difficult thing. All our systems—compensation systems, the kind of people we usually have working in these kinds of enterprises—are driven by growth—and often by growth of volume, of business, as opposed to just simply growth of profitability or recurring earnings. So to the ex-tent that we have mismatched in real estate fi-nance and not created these companies, it’s be-cause we haven’t measured them properly. And February 2011 | Commercial Property Executive

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