Government Policy: Opportunity and Peril

Lawrence Jones: Hi, I'm Lawrence Jones. I'm a fixed-income fund analyst here at Morningstar. Today I have the privilege of having Tad Rivelle, CIO of Metropolitan West Asset Management, visiting us today in Chicago.

Tad Rivelle: Thanks for having me.

Lawrence Jones: Thank you for being here, Tad. Clearly there has been a lot of government support and government policy that has sought to support certain parts of the fixed-income marketplace. At the same time, it has excluded support for other areas of the fixed-income marketplace. When Henry Paulson changed the rules of the TARP back in late 2008, it ended up causing a pretty bad price disturbance in certain assets that were thought to be supported by the original version of the TARP. Can you talk a little bit about the opportunities, and also the perils that exist with what might be called an activist government?

<TRANSCRIPT>

Tad Rivelle: Well, capital, as we well know, is inherently nervous. It is incredibly nervous under the conditions that exist currently. So a coherent policy and a stable rule making environment is essential in order to attract private capital back into the capital markets, to avail themselves of the opportunities that would be so lucrative to so many private investors and so beneficial for the economy at large.

We have gone through a succession, obviously, of rule making regimes, particularly with the TARP, one I think even as recently as this morning or yesterday afternoon. This is inherently unsettling to the investment community, and it has the effect of elevating and raising risk premiums that are demanded by capital.

That said, in a democracy, it's probably very hard for some of our public officials to say with complete certainty that they will be able to be in complete control of the deck, since so many new programs have been established. There really is very little precedent for flying under these turbulent conditions.

Lawrence Jones: Are there ways that you try to get a handle on the particular risks, policy makers possibly changing their minds or changing the rules midstream? Or is that just kind of part of the risk premia that you end up getting from buying the undervalued securities?

Tad Rivelle: I think, despite the extreme instability that the capital markets have experienced and this ongoing issue of where policymaking contours will develop over the course of time, the existence of the TAF program, I think, is particularly intriguing.

In effect we have an environment in which investors may have the potential to earn 20% or higher IRRs in connection with very stable, very well underwritten assets. So I think to some degree it's kind of in the soup a little bit. I think that our policymakers understand that the investment opportunity has to be made compelling in order to compensate for all of the various risks that you've touched on.

Lawrence Jones: OK. Going forward from 2009 and perhaps even into 2010, what are your biggest concerns about recovery potential for the markets? If there was something that keeps you up at night, what would that be?

Tad Rivelle: Well, there are many things, obviously, to keep one up at night these days. Largely, I think that we're in an environment where the traditional barriers that constrain the policy response, that is to say the will of the electorate for instance to deficit spend to the potential $2 trillion per year run rate that we may in fact be working our way into have largely fallen away.

So, I think that the will to address the problems is very strong and very robust at the moment. The real, ultimate question is on the one hand, will it be effective enough in a timeframe that's relevant for us, or many others, as an investor? The second is, what unintended and there always will be what unintended consequences will come with it? We would suspect that there may be a lot more in the way of inflationary afterglow that may occur after this situation dissipates.

Lawrence Jones: Tad, thank you very much for joining us today. It was very, very useful and helpful to hear from you.

Tad Rivelle: Well, thank you. We appreciate it; thank you.

[END OF RECORDING]