Wilbur Ross builds from the bottom up

"I don’t think it is a Great Depression, I don’t think it’s Armageddon but I think that it’s purely wishful thinking for people to be forecasting a sharp V-shaped recovery" Wilbur Ross

In 1997 he established a private equity fund at Rothschild. Shunning the dotcom bubble that was inexorably being inflated at the time, he managed to produce triple-digit annual average returns from old-economy-type companies such as Plains All-America Pipeline and AES Thames.

In 2000, after 24 years at Rothschild, he bought out the fund and set up WL Ross & Co, with $440 million in investor money aimed at exploiting opportunities in a range of industries including steel, coal, textiles, automotive products, telecoms and financial services. Backers included Goldman Sachs, GE Capital and US pension fund Calpers.

In 2005 Ross entered into one of his most successful-ever transactions when he sold Ohio-based International Steel Group to Lakshmi Mittal for $4.5 billion. It is thought that Ross personally made $300 million out of the deal after paying just $3 a share in equity for all the assets that made up ISG. Mittal’s offer worked out to about $42 a share. Ross also maintains a stake in Mittal Steel, now Arcelor Mittal, sits on its board and advises the company on acquisitions.

Ross is a big investor in financial services too, most notably in Asia after the financial crisis there. In 2001 he bought a failed bank in Japan called Kofuku Bank for ¥30 billion ($257 million), which at the time was his biggest foray in financial services. He renamed it, turned it around, and sold his 80% stake two years later for an undisclosed sum. He also has numerous interests in the property insurance industry in the US.

Ross was an early sceptic about the US sub-prime mortgage bubble and began openly questioning it two years ago. He reckons that the ensuing financial crisis has already led to $1.1 trillion of asset destruction – more than even the IMF estimates. And for Ross, the crisis is far from over.

Since the onset of the credit crunch he has begun to bottom-fish in the US mortgage and consumer-finance industries. His recent acquisitions of American Home Mortgage and Option One make his company the second-biggest mortgage service provider in the country.

Ross has also made an initial $250 million investment, which will eventually rise to $1 billion, in Assured Guaranty, one of the few triple-A rated bond insurers left. However, the Bermuda-based monoline has struggled this year and posted a $169.2 million net loss in the first quarter. The loss on credit derivatives reached $175.8 million. The worse-than-expected results were due to problems in the bonds that it insures that are backed by home equity lines of credit. The firm had to make much higher-than-expected loss provisions.

How far through the financial crisis are we?

We’re still in the early days. At best we’re in a period of stagflation of some duration, at worst in some kind of recession. I don’t think it’s a Great Depression, I don’t think it’s Armageddon but I think that it’s purely wishful thinking for people to be forecasting a sharp V-shaped recovery in the second half of the year. The second half of this year is barely 60 days away. So the only questions are: how deep and how long?

For us there are two big dimensions to the problem.

First, the credit crunch. If you took the 10 biggest banks in the US and Europe on a composite basis in the three years up to June 30 2007, those 10 big banks doubled their assets. Now every single bank wants to reduce its assets. So we’ve gone from an environment where risk management was out of the window, no lender was afraid of anything. Now every lender is afraid of everything. It’s a total psychological shift. Not only is there the problem of net-worth erosion – the IMF estimates $950 billion of erosion from the credit crunch. Well they didn’t have anything for high-yield bonds, which I reckon adds another $150 billion to that total. So really the figure is $1.1 trillion of asset and therefore net-worth destruction. If you think that a lending institution has perhaps $1 of equity supporting $12 of assets, that would be $13 trillion of available lending capability extinguished. That’s a huge number. That’s almost the GDP of the US.

Similarly, property values in the US are really down. People can debate whether they are down by 10% or 15% – it’s something like that. Residential real estate at its peak had about a $20 trillion value in the US. So every 5% fall is $1 trillion of net-worth attrition for the American public. Economies differ as to how much the rate of [wealth destruction] affects spending – let’s say it’s $7 for every $100, which is what it seems to be in a lot of economies. For each trillion dollar fall in property prices there will be a decrease of $70 billion in consumer spending. Since we’re all agreed that there’s been at least a 10% decline in property prices, that’s a $140 billion hit to consumer spending or 1% of GDP.

Plus the property markets are in free fall. If anything the rate of decline in prices has accelerated.

How much further will property prices in the US fall?

Another 10% or 15%. You are getting more foreclosures in a typical month than sales in residential real estate, so the backlog is building. Nationwide it’s more than a six-month backlog. However, in real estate you have to look at it market by market. Look at Miami, Las Vegas, parts of California, Phoenix – that’s where things are really getting killed. There you are talking about potentially years of supply, not months of supply. So we believe the recession is being led both by the compression of credit availability in general and then more specifically by the consumer.