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President of BlackRock talks “Money” with Mia

While at CNBC this summer I had the opportunity to meet Robert Kapito, the Founder and President of BlackRock and a graduate of Harvard Business School. As he was getting ready to go on-air on Squawk Box, we chatted about Harvard Business School and the economy. When I realized Mr. Kapito would be on HBS’s campus to speak to Professor Ken Froot’s Investment Management classes and to an audience of finance students, I jumped at the opportunity to schedule an interview with him. Mr. Kapito was extremely gracious in accepting my invite. Over breakfast in Spangler Dining Hall we chatted about money and the economy. I am thankful to him for his time, candor, and enthusiasm in sharing his views with the HBS student population.

SAINI: What are your thoughts on the economy?

KAPITO: The economy is not described by the stock market. There is a pretty big disconnect where the stock market is and where the economy is. Unemployment is very high. If you look at something called shadow unemployment, which are the people who have cut down their hours or are working part time. These hours are not really included in the current rate, so the unemployment is very high. A lot of companies are not making money from the revenue lines; they are making money from cutting expenses. Last cycle they cut 2-3% and this one 9-12%. These guys are not reinvesting their capital in things that will help them grow their business. These companies are either paying down their debt or they are buying back their stock. And there is no inventory.they are running down their inventory.

So the economy, I think, is doing a little better. That being said at zero [percent] interest rates, people can’t live off that. Institutions can’t do that. They have to reinvest. So they are either investing in the yield curve or the stock market, where there is little stock. There are less IPOs. There is a disconnect here with the stock market going up and the bond market also going up. But the economy is not going up. There is much slower economic growth.

I also don’t think people have factored in how long internationally this will happen. Along with that you have plenty of issues with the dollar. You combine the issues with the dollar with the fact that we have a very large deficit, and that countries around the world need to attract their own capital so they can pay back their debt, we could be in for a very slow-growing economy. There is very low growth and that can take quite a long time.

SAINI: What investments look attractive to you?

KAPITO: I am not a big proponent in the type of high yield bonds being offered because they are on highly levered companies, that are only alive because of the absolute level on interest rates. I think there are opportunities in the energy area especially in the area of natural gas and green energy. There are opportunities in health care because of changing legislation. There are opportunities in some of the financial companies.

I think you have to do the work in order to find the actual opportunity. You got to be a student of financial history to go back and see what industries usually bleed in a recovery. And you also have to see which companies already have the growth reflected in them. I think there are going to be some opportunities going forward in real estate. It’s all about where you buy it and where you sell it.

SAINI: What developing country do you have your eye on?

KAPITO: It’s a little bit difficult, because some of the emerging countries have gotten hurt. Spain and Italy have major issues that they haven’t owned up to. The U.K. has major growth issues. Ireland is a disaster. Poland is a disaster. You know it’s really hard to point to the one country that will turn around the quickest. I think there’s some opportunities in China, although it is a little bit hard to access those. I think there are some opportunities in the Middle East countries. But the larger opportunities may be in Latin America. I think there is a good chance there is a quick recovery there compared to some of the other emerging markets.

SAINI: What are your thoughts on financial firms’ bonuses and compensation packages?

KAPITO: Companies will continue to pay for performance. And obviously the compensation, like everything else has gotten out-of-whack with the performance. I think there is no reason why the individual compensation should be tied to performance-their own performance, the company’s performance, and shareholder’s performance. And also the fact that some people are going to get paid a portion of their compensation in cash and a portion in stock is a good thing for a company. Everyone is on the same page, everyone should have the same interest, and also the fact that as the stocks vest and get paid over a period of time, it avoids someone from coming in and making a lot of money and leaving the company during a bad situation (which has happened).

So I can’t see why changing the compensation system to make it fair for the employee and the shareholder and the rest of the people in the company is NOT a good idea. The issue that people have to deal with is how that is done, and by who it’s done. Right now, unfortunately it’s being done by Washington, and it should be done by the shareholders. And that’s the disconnect. And unfortunately our system doesn’t allow the shareholder to have as much say as they really want to, so Washington has to step in.

SAINI: What are your thoughts on government regulation of financial products?

KAPITO: Whether people like it or not, Washington has done a really good job at handling what is called as “Armageddon.” Obviously the financial system couldn’t manage itself, so they [U.S. government] stepped in, and they did all the things which at the time seemed like a prudent thing, and actually it worked. So now going forward, it’s how do we return it back to the market’s control?

We understand interest rate risk, credit risk, and liquidity risk, but no one understands regulatory risk. There is going to be a lot of debate. Rather than complain about it, what people need to do is educate our lawmakers so they have all the tools that they need to make good decisions. So, they [lawmakers] are not bad people; they want to work. A lot of individuals lost a lot of money, and they want to prevent those things from happening again. I think that they are doing a pretty good job.

SAINI: In lawmakers’ efforts to prevent ‘Financial Armageddon,’ was it prudent to let Lehman fail?

KAPITO: I don’t think anyone at that moment in time was thinking about whether it was prudent or not. They were thinking about the realities of firms crumbling around them, and what they had the ability to do and not do legally. We were in a situation that was not unprecedented, but in fact unimaginable. I think people responded and did what they thought was the best thing to do at that time.

In hindsight, there were probably better ways to do it; but in hindsight, you are not under the pressure of the financial system crashing all around the world. So I think they did everything they could do. I don’t think anyone had the experience to know how deep the financial markets were in decline. Had they known that, maybe they would have come up with a couple of other suggestions. But, in hindsight, anyone can say that. It was a bad experience for everyone. It was a bad experience for the people at Lehman Brothers; it was a bad experience for Wall Street. The impact was much larger than anyone anticipated. No one sat around the table knowing that, or maybe they would have thought about other ways to help the system.

Happy investing!
Your HBS Money Honey,
Mia Saini

AUTHOR’S BIOGRAPHY
Mia Saini is a born and raised California girl. She is earning her MBA at HBS. She graduated from MIT and went straight to the sales floor at Goldman Sachs. She honed her journalism skills at CNN, WB, CNBC, and as a TV reporter at Jim Cramer’s www.TheStreet.com. She is the Founder of HBS TV and is a video host for MBA PodTV on www.mbapodcaster.com. Each week she writes a “Money with Mia” column about Money, Business, and Personal Finance, so email HBS’s Money Honey your questions, story ideas, and feedback.

November 2, 2009
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