Morningstar Advisor - April/May 2009 - 49

You can either choose the slow death by a thousand cuts or you take shock therapy. In every major credit crisis, it has taken shock therapy. Bob Rodriguez diversifying their diversification. Rodriguez: After successfully diversifying out their risk last year, right? (laughter) Gundlach: (laughter) What I’m saying is people shareholders, the preferred shareholders, the subordinated debt holders, and then turning the debt holders and banks into equity would go a long way to starting the process. Gundlach: That’s the way it’s supposed to Jacobson: Regarding this notion that we’ve got to wipe out some equity in these institutions that are being propped up, it’s the elephant in the room that nobody will talk about because it’s a political third rail. Gundlach: One thing that people in Washington fail to understand is that the public is slowly moving toward disagreement and disgust with the way that the government is handling these problems. We’re not far away from the “mad-as-hell-and-not-going-totake-it-anymore” viewpoint. At that point, we’ll have the wherewithal to address the elephant. Rodriguez: If I had to pick a year, when a lot of traditionally talk about selling stocks and buying corporate bonds. That’s not diversification, not in this market. Diversification in this market means moving away from dollar-based financial assets, if you really want to be serious about protecting purchasing power. Jones: What do you think it’s going to take to work! Rodriguez: Yes! Secondly, they have to fess up to what the problem assets are. What confidence do I have in the system when the $29 billion that the Federal Reserve took on from Bear Stearns has never been disclosed, nor has their valuation process ever been disclosed. Gundlach: That just shows you that there are get some form of stabilization? Gundlach: You have to let failures occur. If you want to get people to nod in agreement with you, make the statement, “They never should have let Lehman fail.” Well, I think they should have let a lot more than Lehman go under. Rodriguez: Absolutely. Jacobson: Isn’t there a better way to do it? Rodriguez: First, before you can start on the road to recovery, you have to correctly diagnose the disease. Otherwise, you give inappropriate treatment. In this case, you have to first acknowledge that the U.S. banking system, as it’s currently constructed, is insolvent. Then, even if you fix the U.S. banking system, you have to realize that between ’01 and ’07 for every $1 of credit created in the U.S. banking system, $5 was created in the nonbank banking system. So, you have another issue there. tremendous embedded problems. Rodriguez: But my point is that you can either these pressures come together and force some kind of a cathartic moment, I’d pick 2013. But I want to be optimistic and say that it’s going to get here faster. Gundlach: I think it’s before ’13. Rodriguez: I hope you’re right, Jeffrey. I would choose the slow death by a thousand cuts or you take shock therapy. In every major credit crisis, it has taken shock therapy. It is the realization of what the problems are and how bad they are, and yes, it disrupts the economy in the short run. What we’re doing is we’re doing an Americanized version of Japan, and it didn’t work. They wasted so much time, energy, and Treasury by going down the wrong roads. The first point of getting to stabilization is what FDR tried to do in 1933. Consider how he came into office, and in his first week, what does he do? It’s the bank holiday, and they address it. They had 4,000 banks shut down that year. Now, here we are into the second year of the credit crisis, and I think it was 29 banks last year were shut down. It’s inconsequential. As a result, the earnings expectations in the stock market are still way too high. be ecstatic to be wrong about this. What we’re witnessing is that the irresponsible growth of debt is coming home to roost. I’ll get on my preaching box and say that the baby-boom generation and the children of the baby-boom generation created this mess. Why should we be sticking our children’s children and the children in generations beyond with this mess? The pain should be accepted today, and we should fess up to it and just get on with the hard work. K Lawrence Jones, a contributing editor of Morningstar Advisor, is an associate director of fund analysis with Morningstar. We’ve had a lot of debates about whether there should be a good/bad bank or bad/bad bank, all of these things here. Wiping out the MorningstarAdvisor.com 49

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Morningstar Advisor - April/May 2009

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