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Bob Rodriguez and Jeffrey Gundlach

Let failures occur, Rodriguez and Gundlach say. Only then can a fundamentally transformed economy prosper.

Lawrence Jones, 04/01/2009

We value your feedback. Send comments, questions, and criticism to advisorquest@morningstar.com.

Although 2008 was a brutal year for many segments of the fixed-income markets, to bond managers Jeffrey Gundlach, who runs TCW Total Return Bond TGLMX, and Bob Rodriguez, who runs FPA New Income FPNIX (both Morningstar Fund Analyst Picks), it was a chance to shine. Both managers have long maintained among the most sober of assessments of the credit markets, and their caution at their own funds redounded to their advantage last year.

Gundlach, who won Morningstar's Fixed-Income Manager of the Year honors in 2006, is the chief investment officer at TCW and works with comanager Philip Barach at Total Return. Rodriguez serves as chief executive officer at FPA and is aided by Tom Atteberry at the New Income fund. Rodriguez and Atteberry took Morningstar's Fixed-Income Manager of the Year honors in 2008. Rodriguez was also honored in 1994 and 2001.

From Chicago, we invited the pair to participate in a conversation, via conference call, about the state of the fixed-income markets and the economy. On Feb. 17, Gundlach called from his offices in Los Angeles and Rodriguez from his home in Lake Tahoe, Nev. Morningstar fixed-income specialist Eric Jacobson also participated in the call. The discussion has been edited for clarity and length.

Lawrence Jones: You both were prescient in your analysis of the troubles that were coming down the line over the past couple of years. What's your view of the situation today?

Bob Rodriguez: I'm still very much depressed about what I see going on in our economic environment and, in particular, the responses by the Federal Reserve, Treasury, and the most recent stimulus plan. I'm working with the assumption that the stimulus plan will have minimal impact upon the U.S. economy in this year and next. It would not surprise me to see them have to do another plan.

As such, the optimism that occurred toward the end of last year, be it in the equity market with the rally or in the high-yield market and some other areas, was premature. It was predicated upon a second-half economic recovery and earnings recovery, neither of which will occur. This, then, sets the stage for considerable disappointment in 2009 going into 2010.

Finally, the pandemic breakdown in underwriting standards is still unfolding. The next area that will hit will be in the commercial real estate market, beginning right now, throughout this year, and into next year.PAGEBREAK

Jeffrey Gundlach: I agree. I certainly am very negative on commercial mortgage-backed securities and commercial real estate. I don't think you could possibly paint a worse fundamental underpinning than is in place.

There are a lot of bond managers parading around the world saying--to use a hackneyed phrase, but it's one that they're using-- that this is a "buying opportunity of a lifetime" in many fixed-income sectors. Frankly, I think they're saying this because it's the only way they can explain why they shouldn't be fired for all of the bad decisions they made in the past. They're taking a global dart-throwing approach. They've wrapped a too-cheap-to-sell argument in a more-forward-looking viewpoint. Certainly, there are cheaper markets today than there were some time ago, and I would say there are decent buying opportunities from time to time in the credit markets, but it's my view that the corporate credit market will end 2009 at a lower price than it began the year.

There's also a misplaced belief in the bank debt market. I've done more traveling in the last four months than I've done in years, because I'm interested in taking the temperature of what's going on out there. Almost without exception, everywhere I go, the bank debt market is viewed as a compelling opportunity. I think it's being priced to the dream. People quote a high discount margin of the price of the bank debt market at about 75, even pushing 80 on the good days. People think that's a great buy. They point out that it's a high yield spread. What they're missing, though--and I would also make this point for CMBS (commercial mortgage-backed securities), which share the same problem--is that those are yield spreads to refinance or to par payback, and those par paybacks are based upon a balloon payment or, in the case of bank debt, somebody else rolling over the financing, so that the existing investors can be paid out.

Hey, wait a minute! That sounds a lot like a Ponzi scheme, doesn't it? That the people who are in the pool right now have a good outcome only if other people come into the pool to take them out at a profit. That's what bank debt is. In these balloon markets, you're not going to get a check on maturity date; you're going to get a meeting to discuss how much less than par you're going to be willing to accept.PAGEBREAK

Rodriguez: On the commercial side, if you look at the total commercial and multifamily debt outstanding for '05, '06, '07, and '08, you had almost $1.2 trillion in new issuance on a base of $2.3 trillion. What was so amazing in this process was to see cap rates go down to 3%. I was watching it in California and several other areas. We're just now starting to see the break in the fourth quarter of '08. So with rents coming down and cap rates now up into the 8% to 9% range, you're looking at price declines on commercial properties in the neighborhood of 40% to 50%.

Thus, using a rough calculation, when you look at CMBS outstanding--it's at $758 billion as of Q3 '08, up from around $410 billion--and then you take the balance as other commercial and multi, it would not surprise me to see a hole from that area in the neighborhood of $400 billion to $600 billion.

Again, we keep going back to the banking system and shadow banking system. As I commented more than two years ago, the holes are so big that effectively the U.S. banking system is insolvent.

Gundlach: The banking system's been insolvent for a long time. Bob, you call it the shadow banking system. I've coined another phrase: the "bogadollar" system.

Rodriguez: I call it "hope springs eternal."

Gundlach: I call it bogadollar for bogus money, from auto leases to home equity takeout to derivative market value growing by $15 trillion.

What is the loss in the banking system? If you take the number of bogadollars, which is in the tens of trillions, and you realize that the loss on most asset classes already is, let's be conservative about it and say 25%--50% might be more of the number--you're talking about multiple trillions of dollars. The situation is like a kid down on the beach, digging a hole in the sand and trying to fill it up with seawater. He fills up his bucket, runs back to the hole, and dumps in the water. But every time he comes back to the hole, all the water's gone. We're doing the same thing. We're throwing buckets of cash into a hole that is so enormously large that even with the multiple trillions we've spent so far we don't have anything close to a solvent banking system.

Rodriguez: When I look back at the commentary and the testimony of Fed chairman Ben Bernanke in March and April of '07, when he commented that there will be no contagion for subprime, and Treasury secretary Henry Paulson figuring that he could supersize the SIVs out there to contain the problem. Then, they went to the idea that it's not just subprime; it's now housing. Now, the issue is stemming the price fall in housing. They keep underestimating the problems.PAGEBREAK

The Fed dropped rates by 125 basis points in two stages in January--the biggest drop in the history of the Fed--and they basically got no traction. It had to set off alarm bells in the Fed. In my opinion, the Fed, Treasury, and the government have been on totally the wrong road. In this crisis, there have been no decisions made other than ad-hoc decisions, and this says that they don't have a picture of what they're dealing with. They can say one thing, but I'll just look at their actions. They've destabilized the banking system. I use as my metric, which is very independent, the KBW Bank Index, and on the Thursday before Bear Stearns went under, that index was just slightly north of 80. Now, think about all of the guarantees, all of the capital infusions, both by the government and by third parties, into the system. The KBW index has set a new low today at 23.80.

Jones: Bob, I know you've had the buyer's strike for risk assets in FPA New Income since at least 2005.

Rodriguez: Actually, for high-quality assets, since 2003, June 11.

Jones: Jeffrey, I know in TCW Total Return, in contrast, you found some opportunities in 2008, specifically in the nonagency mortgage market. These are highly rated securities that have been beaten down. Are there little slivers of hope for investors in an area like this?

Gundlach: I think there are, but it comes down to two different categories of markets: the bogadollar markets and the real markets.

The bogadollar markets still should be avoided, and that's just about anything that came into existence to satisfy bogadollar demand, which means leveraged demand or synthetic trading demand--all of this LIBOR plus seven, LIBOR plus 20 garbage that started out life as triple A rated that has dropped from 100 to 90 to 80 to 70 to 60 to 50 to 40. At every single one of those downward increments, there was a parade of owners of those assets saying that these are too cheap to sell. They're actually still not too cheap to sell.

Then, you can go to the nonagency mortgage market, which has its bogadollar components, and they should be avoided--subprime triple A's at 40 cents on the dollar that pay LIBOR plus seven and option pay ARMs that pay 1% over T-bills and have a negative amortization feature and all kinds of legislative risk because those are the homeowners that claim they were tricked and, therefore, may get legislative relief of some type down the road. All of these things are a danger for those assets.PAGEBREAK

But then you can go to the prime mortgage market, which is where we've been playing around in. These are fixed-rate mortgages--the standard, garden-variety, 30-year-amortizing, first-lien residential mortgages on high-FICO-score borrowers that have traded as low as 50 cents on the dollar. Now, those where you're carrying at 15% cash flow to nearly 20% cash flow on some of those assets are fairly compelling opportunities.

Jones: Bob, what do you think about opportunities in the market today?

Rodriguez: We haven't been prospecting down where Jeffrey's been talking about. We're finding what I would call "pockets." Because of the nature and size of our operations, we're more like a PT boat, and we've found some pockets in the prime mortgage area, in seasoned mortgage product.

We entered this year with the expectation that this would be one of the most difficult years for the fixed-income manager. At the high-quality end, the yields are, shall we say, wanting. Thus, there isn't a margin of safety to a high degree to any appreciable rise in rates. Secondly, if you don't get it right on what I would call the credit-spread area--either in the high-grade corporate credit area or in the high-yield area--it will come back to haunt you in the second half of the year. Thus, this could be a very difficult year. To exit the year with a positive rate of return will be a challenge.

So we're working from a very defensive position, with the idea that default rates are going to be rising in '09, '10, and into '11. There's just been too much of what I would call "professional investors" trying to kick off the bottom, whether it's been in equities or banks or mortgages. "Gee, the mortgage market is breaking, and there are a lot of these alphabet-soup securities around. We'll go out and buy that." That was their thought process back in the fourth quarter of '07, and it was premature.

We're walking very gingerly, letting others be smarter than us and, hopefully, destroy themselves.

Gundlach: The secular environment that most bond managers are accustomed to was one of increasing leverage and increasing debt/GDP ratios. That environment has left the building. Debt and leverage tremendously increased the velocity of market trading. It was routine for sectors to recover very sharply and stay depressed for very temporary periods. Most bonds managers just don't understand that they have to go back to a cash-flow-based investment program in credit and not the price-based investment program of the past. A lot of people have gone into an area way too early or they've become disillusioned too quickly because they haven't gotten the type of price payoff that their experience told them they should get.PAGEBREAK

Also, I agree with Bob. Default rates are going higher, particularly in the corporate credit market and the commercial market, where they've just really gotten started on the upside. It reminds me a lot of where the nonagency mortgage market was one year ago.

Let's take it back to St. Patrick's Day 2008. Bear Stearns went under and was taken over by JP Morgan. It was a cathartic moment that had trashed out the nonagency mortgage market with massive liquidations occurring in the SIVs, REITs, hedge funds, and bank balance sheets. There was a big rally after the Bear Stearns takeover that took us into May. A lot of people were claiming that that might be a bottom in the credit market and, in particular, in the nonagency mortgage market.

I wrote in May 2008 that the rally was very near its end and that we would be looking for much lower prices, even taking out the lows of the Bear Stearns day. The reason I thought that way is similar to what I think now about the corporate credit market.

After prices got low in the nonagency market and they started to rally in March and April 2008, a lot of people said, "Well, the market has gotten itself reconciled to high default rates now." At the time, there was a new idea, which was certainly appropriate, that Alt-A type of mortgages--the ones right below prime that have limited documentation programs--were no longer going to see the single-digit default rates modeled in by most investors. Instead, they would experience 30% default rates. To this day, it's not clear whether default rates will go higher than 30%. I think they will, but they're running at about 20% today. But this recognition was a good sign in March and April 2008. Where the market got it wrong was that people said, "Hey, it's an all-clear signal now that this high default rate is reconciled into market thinking." To me, that's an intellectual argument, and intellectual arguments run into trouble when emotions start to come into play.

It's one thing to say the market's reconciled to a bad outcome because it's assuming a 30% default rate. But remittance reports in March 2008 were saying that about 6% or 8% of these mortgages were in trouble. So 30% looks like it has what I call the "comfort cushion." You take comfort in the fact that rates are at 6% or 8%. You say, "It can double, it can triple, and my 30% number that I'm thinking about intellectually will still protect me."

My point at the time was that once those default rates got above 20%, the fear factor would take over the intellectual comfort factor and the market would crack to the downside. Indeed, that happened pretty dramatically in the second half of last year.PAGEBREAK

Today, the corporate credit market is in exactly that same position. Some of these rating agencies have gotten themselves reconciled to the idea that default rates would be--I think one of the rating agencies said that the 12-month default rate would be 14%. Yeah, that sounds much higher than what people were using, and yeah, that sounds like there's some cushion built into it, but right now, that's the intellectual argument because the default rate is running at 4%.

It's exactly the same comfort cushion the Alt-A nonagency market had one year ago: 4% to 14% and 8% to 30% are almost identical ratios. People might feel better that there's this higher number being bandied about, but they take too much comfort in the fact that there's this cushion. That cushion is for sure going away, and when it does, people will freak out and those prices will go down.

Rodriguez: I'd only add one other item in here to what Jeffrey's talking about. Yes, there's a deleveraging on the corporate side, but there is a massive releveraging on the governmental side. My work shows that at the end of this year, we'll have debt/GDP ratios north of 80%, and in 2010, they'll be north of 90% to 95%, just with the massive Treasury issuance that is coming.

The $64 question is how is that going to be financed. I don't think a lot of my contemporaries out there have really given a lot of thought about how this all plays out, other than that there's going to be a considerable amount of printing of money by the Federal Reserve. In the short run, they can manipulate the market as they've been attempting to do on the mortgage market, as well as on the commercial paper market and a host of other areas. In the long run, the underlying fundamentals will play out, and that's why I wrote in last year's shareholder letter that it's not years one and two that concern me, it's years three through 10.

Jones: Both of you have argued that the government's actions will likely result in higher long-term interest rates and, very importantly, in higher levels of inflation. How are you trying to manage in an environment where governmental action is disrupting what you might call natural market dynamics?

Gundlach: Certainly, you have to pay very close attention to market-based indicators that are less manipulated, to try to figure out what the inflation risk really is. Bob's right that the financing implications for all these government programs are enormous, and it's a real issue as to how that's going to resolve itself. In my view, there's really only two ways it can resolve itself.PAGEBREAK

One is a massive inflation rate due to tremendous printing of money. In a sense, you change the rules and you're not really borrowing the money anymore; you're just printing limitless amounts of it. That would be an inflation problem for sure.

The other way it could play out is in a massive societal default. You try to prop up all the private institutions with the risk transference going to the government, and ultimately, the government has to default.

So you have an inflationary outcome and you have a societal default outcome, and both decimate the value of dollar-based financial assets.

Watching for potential inflation is worth doing. One of my favorite things to watch is industrial commodity prices. If they were showing any signs of life whatsoever, then maybe you'd have to start worrying about inflation appearing. For the time being, commodity prices are absolutely in the basement. There doesn't seem to be any telltales right now for the coming inflation problem, if that's the way this is going to resolve itself. But you have to keep a very close eye on that.

For the time being, the deflation trade and related low Treasury interest rates do look wanting, but that is the part of the market that has worked the best during the credit crisis. Although Treasury rates retraced a lot of their big rally of the fourth quarter during the first six weeks of 2009, my view is that Treasury rates are probably going to be headed down in the near term and not up.

Rodriguez: I've been doing a lot of thinking on this whole issue of Treasury debt issuance. I started writing about it last fall in the shareholder letter. I came out with a number that incremental Treasury issuance in the next year would be in the neighborhood of $2.5 trillion to $3 trillion. The fourth-quarter annualized rate of Treasury debt issues was $677 billion, or an annualized rate of $2.7 trillion. This was before [Treasury secretary Tim] Geithner came out with what I would call his outline without detail of spending upward of $2 trillion to address the issue.

The second thing is foreign demand for Treasury securities. Three countries accounted for $510 billion of the $750 billion of incremental Treasury demand. Everyone can name number one: China, which was at $204 billion. People typically say Japan was number two. No, they lowered their ownership. Number two was the U.K., which came in right behind China, and the third one was Caribbean Banking Centers. One of the things I've been looking at has been Chinese power production. In the fourth quarter of 2008, Chinese power production declined in October, November, December--first time ever in the modern era for China. There's a lot of estimates running around about how Chinese GDP growth is going to expand, etc. Well, the power production numbers would say something differently, and that raises questions in my mind about incremental Treasury demand by the Chinese, especially when they turn inward to their own economies. The more that we do not finance through the foreign sector means the more we have to finance domestically, or . . .

Gundlach: Or just print it.PAGEBREAK

Rodriguez: Yeah, I hadn't gotten to that one, yet. But for this year, I was assuming that U.S. personal savings rates would rise from 2% to 8%. Americans haven't done that in the last 50 to 70 years, and if they did that, it would only generate about $650 billion of incremental personal savings. So I keep coming up with numbers that are north of $1 trillion of the Fed printing money.

Now, in the short run, I agree with you, Jeffrey, that it wouldn't be a surprise to see the Fed terming out and buying longer-term bonds issued by the Treasury, and they'll try to manipulate their rates downward and the economy weakens for a period of time. But I think in the long run, as these pressures keep mounting and the size keeps mounting, we will hit some stress points.

I sent a commentary out to my associates just this morning suggesting that the post- World War II worldwide economic model that worked from 1946 to 2007 was predicated and based upon the back of the U.S. consumer lifting out all of these countries that were very mercantilist in their trading. That ended in 2008, and we are in the process of establishing a new model. Any time you establish a new model, it is fraught with volatility, uncertainty, and many surprises.

A lot of these things still have not been factored into the debt markets, and even into the equity markets. It leads me to believe that we are going to be maintaining a very high-quality portfolio going forward, and we probably won't start taking on what I would call credit-spread risk in any appreciable degree until later this year or probably more like into 2010.

Eric Jacobson: Bob, you said China may turn inward to focus on its economy. Don't they have to maintain a pathway to the U.S. consumer and do whatever they can to continue to pull our money over?

Rodriguez: They should do whatever they can to export, but that's not what they're going to be doing. They're going to be turning inward to try to develop their internal economy at a faster rate. There's an example of a country that turned their entire economy 180 degrees in one year. You know what country that was? The United States of America, and it was 1942. We went from a consumer economy to a complete defense-oriented economy in barely over one year.

When a country has a major challenge on its hands, it can reorient and redirect. It would not surprise me if China did that. In fact, a friend of mine recently had several high-ranking officials from Shanghai at her home. They talked about last year's 600,000 university graduates who haven't found employment. This year, it's going to be 1.2 million. Their whole focus is what can we do to get these people employed. It's about governmental utilization of their reserves in the domestic economy. It is not about how can they export more to the United States, because that game basically has ended.PAGEBREAK

It is a real transformation that's going on. In the United States what's so disturbing is that consumption got high, 70%, 71% of GDP. It's going back to 65%, 66%. Thus, when you look at the components of GDP growth, you must ask what's going to fill it. Well, we have an administration that says government is the answer during this period of trouble.

There is another answer, and this is related to the world that I see coming forward over the next decade or so. The U.S., unless we're going to be totally dependent upon government as the purchaser of last resort, is going to have to become much more oriented to export as a means of attacking the trade and current account deficits that have been out of control for three decades.

I'm watching to see what policies and prescriptions the government is going to direct to see how we go in this. Right now, when we can't even define what the mortgage contract is going to be or how we're going to rewrite the rules in banking, it is not a time for me to deploy long-term capital. It's still about preservation of capital, and, hopefully, preservation of purchasing power, and that's a difficult one. Whereas we were looking at a credit crisis before, we're now looking at a transformation of international trade.

Jones: Jeffrey, do you think what we're seeing here is a fundamental transformation?

Gundlach: Absolutely. The past 30 years has been an outlier in terms of tremendous debt-financed growth of the economy. It has been crescendoing in the past 10 years, when basically all economic growth was nothing more than bogadollar-accelerated consumption. The unwinding of that absolutely is transformational, and people need to understand that they're dealing with different variables. In fact, they're actually dealing with almost exactly the opposite variables that they're accustomed to dealing with. Some of the decisions that would be made in a knee-jerk way under the old paradigm will take you in exactly the wrong direction.

Rodriguez: In this stimulus plan, they talked restarting consumption and lending. I've got a news flash: It was excessive consumption and excessive credit growth that got us into this mess!

I've termed it in my e-mail this morning: We've come to a Y. We can go to the left, which is doing the stimulus, more consumption, more borrowing, etc. Or we go to the right and take a direction that has a totally different set of responses and policies. Look at what the key issue was right at year-end--how do we avoid bankruptcy in the automotive companies. They put money into GMAC at 8%, and what does GMAC do? They go out and start making loans, so GM can sell cars at 0% to 2.9%. They lowered their FICO score from 720 down to 621, one point above subprime!

Gundlach: And if you go to the left in the Y, what you're going to find is that that road is actually a circle that takes you right back to the Y again. You ultimately have to go to the right.

Rodriguez: Eventually, but until then, as they waste time and resources going to the left on the Y, GDP is substandard, subgrowth, frustrated, and nothing gets real traction.

Gundlach: That's exactly right. The government so far is still in the hope phase of . . .

Rodriguez: ... and denial.PAGEBREAK

Gundlach: Yes, denial and hope, when they get dashed, lead to despair, and you will not see a bottoming in any important financial market--the equity market, the credit market--until this veneer of hope is replaced with despair, and it's not even close to happening yet. As you correctly point out, Bob, using the example of the auto companies, the idea that you're going to resuscitate them and get the genie back in the bottle is clearly not going to work. But the first attempt, based upon this veneer of hope, is to try to make that happen.

Rodriguez: We're still early in this crisis.

Gundlach: I agree. Until that changes, the investment decisions that have been the successful ones so far in the credit crisis will continue to be, which argues for conservatism. Bob, you talk about preserving purchasing power. There's a real risk that you have major debasement of the dollar currency.

Rodriguez: Jeffrey, I call it the ugly contest. Who looks the least ugly of the currencies out there, and there are some debatable points on that right now between, let's say, U.S. and Europe . . . .

Gundlach: And pound. They're all ugly.

Rodriguez: They're all ugly, and what you can say is that even though you referred to the commodity area of not showing inflation, there is one commodity that is doing very well, vis-à-vis all other currencies . .

Gundlach: That's gold. But that's why I say industrial commodities when I talk about commodities, because gold obviously is simply an anti-dollar play.

Rodriguez: I would say it has been an anti-dollar play. Whether it is now becoming an anti-fiat currency play is another question.

Gundlach: Oh, I think it is, and I think it will continue to be. We're going to see investors diversifying their diversification.

Rodriguez: After successfully diversifying out their risk last year, right? (laughter)

Gundlach: (laughter) What I'm saying is people 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 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?PAGEBREAK

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.

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 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 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 tremendous embedded problems.

Rodriguez: But my point is that 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. 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.

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-to- take-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 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 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.

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