Sense on Cents

Whatever Happened to Financial Regulatory Reform?

Posted by Larry Doyle on September 14th, 2009 7:18 AM |

Whatever happened to the grand plans to implement real financial regulatory reform? Has Wall Street received the proverbial ‘get out of jail free card?’ Has our media been an unwitting enabler of lax regulatory oversight and limited transparency? Has Washington once again been ‘bought’ by Wall Street?

In my opinion, America continues to remain at real risk because the answers to all of the above questions is a resounding “Yes!!”

The Obama administration, in the persons of Tim Geithner, Joe Biden, and Larry Summers, is consistently declaring victory in the battle to ‘rescue’ the economy. The fact is, victory is not assured nor will it be enduring when the mechanisms which detonated our nation’s economy largely remain in place . . . and they do.

The administration is ‘selling’ a Fed-induced and Fed-nourished rally in the equity markets as reason for a victory lap. Who is holding them to account? Who is questioning the other ‘wizards in Washington’ as to what has been done and what will be done to prevent a similar meltdown in the future? Regrettably, the American public has allowed both Wall Street and Washington to frame both the debate and the outcome without a serious probe into the failures in policies and procedures which caused our economic crisis.

Today President Obama will make a campaign stop on Wall Street to promote his calls for financial regulatory reform. We will receive the standard platitudes. Obama will likely recruit a few high profile Wall Street executives to support his initiatives or lack thereof. The fact is, Wall Street has been working diligently to make sure that ultimately “business as usual” carries the day.

Will Obama be able to mandate that the largest banks significantly increase their capital ratios? Will Obama be able to mandate that ALL derivative transactions are reported and properly exposed? Will Obama be able to mandate that the regulatory bodies, specifically the Wall Street self-regulatory organization FINRA, are totally transparent? Will Obama be able to mandate that Wall Street compensation is fully aligned with the accompanying risks embedded within these financial behemoths? Will Obama be able to mandate that the reform of the ratings process on Wall Street have real substance?

The answers to these questions will very likely be seriously diluted by the massive Wall Street money machine which largely owns Washington. In order for the American public to receive real regulatory reform, we need legislators and regulators unshackled from the Wall Street lobby.

The American public does not need campaign stops, photo ops, and platitudes on this topic of financial regulatory reform.

I maintained on May 18th, “Future Financial Regulation: Not a Question of Sufficiency, But of Transparency and Integrity.” I wrote:

If Washington truly wants to address the regulatory failures in this area, I strongly encourage them to incorporate FINRA Is Supposed To Police the Market andNASD Knew Auction Rate Securities Weren’t Cash as compelling evidence of a massive regulatory failure which has had enormous costs, monetary and otherwise.

Will the media give the Wall Street, Washington, and regulatory triumvirate a pass as they pander about sufficiency when in fact the real regulatory question is one of transparency? In my opinion, the very future of capitalism and free markets lie in the wake.

My feelings and opinions on this topic are even stronger today.

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Sense on Cents Asks Again, “Who Regulates the Regulators?”

Posted by Larry Doyle on September 13th, 2009 11:25 AM |

On June 19th, in writing, Who Protects Investors from Regulators? I concluded,

Sad but true, as we enter the Brave New World of the Uncle Sam economy, investors need to remain diligent and should not assume that regulators are necessarily protecting them.

In my commentary that day, I specified shortcomings at the SEC and FINRA.

This morning, I am both heartened and dismayed by Gretchen Morgenson’s article in the Sunday New York Times Business section. Ms. Morgenson writes, But Who Is Watching Regulators?

I commend Ms. Morgenson for addressing a topic which receives little focus by the media at large. As such, I strongly recommend reading it. Ms. Morgenson pens:

Senior regulators who stood idly by for years as financial firms built their houses of cards have been rewarded with even bigger jobs or are jockeying for increased responsibilities. The Federal Reserve Board, for example, wants to become the financial system’s uber-regulator, even though its officials did nothing as banks made deadly decisions to lend recklessly and leverage themselves to the max.

Awarding increased power to those who failed in their oversight duties flies in the face of all notions of accountability.

Additionally she asserts:

Yet those in the public sector ask us to believe that regulators who snoozed during the credit bubble will be alert to emerging problems on their beats when the next mania begins.

That’s asking a lot, isn’t it?

Here’s a novel thought. Instead of creating more regulations to try to prevent this kind of mess from recurring, why not figure out how to hold regulators accountable when they perform as poorly as they did in recent years?

I am with Ms. Morgenson and pulling for her to ‘finish the job’ and call out specific regulators and specific regulatory bodies. I was so hopeful that this was the article that would call out Mary Schapiro (current head of the SEC), and Richard Ketchum (current head of FINRA) and take them to task for not providing real transparency at FINRA (Financial Industry Regulatory Authority), the Wall Street self-regulatory organization. Read the rest »

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NoQuarter Radio’s Sense on Cents with Larry Doyle, Sunday at 8PM

Posted by Larry Doyle on September 12th, 2009 3:07 PM |

UPDATE: This episode of NQR’s Sense on Cents with Larry Doyle has concluded. You can listen to a recording of the episode in its entirety by clicking the play button on the audio player provided below. Once the audio begins, you can advance or rewind to any portion of the episode by clicking at any point along the play bar.

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Please join me this Sunday evening for NQR’s Sense on Cents with Larry Doyle as we dig deeper and work harder in navigating the economic landscape.

Bruce Carton will be joining me to discuss a wide range of securities litigation and enforcement issues which currently occupy center stage on our economic landscape. Bruce is uniquely qualified to discuss these topics. He is the editor of Securities Docket and the author of the SD Insider Column. Bruce is a former Senior Counsel with the SEC’s Division of Enforcement, as well as a former securities litigation partner with one of the world’s largest law firms. He is a featured columnist for Compliance Week on securities enforcement and litigation issues, and the author of Compliance Week’s Enforcement Action blog.

What is on your mind? What would you like to address? Please share your questions and thoughts by calling in to (347) 677-0792, and also join our live chat room, which I’ll start up about 10 minutes before the show begins.

As a reminder, all of my radio shows are archived and can be listened to right here at Sense on Cents by clicking on the NoQuarter Radio tab located under the page header. (FYI, I keep an audio player of my most recent episode in the right sidebar). In addition, all NoQuarter Radio programming is available as a free podcast on iTunes. From the iTunes Store, type “NQR podcasts” in the search window.

Many thanks to Larry Johnson and the rest of the team at NoQuarterUSA blog for providing such a vibrant media vehicle as NoQuarter Radio. I look forward to having you join me Sunday evening as we collectively navigate the economic landscape!!

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September 12, 2009: Month to Date Review of Markets

Posted by Larry Doyle on September 12th, 2009 8:17 AM |

Investors continue to race to put cash to work. Across virtually every market segment, asset values continued to increase. This is great. Or is it? Do the markets reflect a recovering economy or merely excess liquidity? Do the markets foresee a recovery in employment, housing, and personal consumption? The wizards in Washington, in true political fashion, are declaring victory in terms of rescuing the economy. Is that premature? Let’s read the market’s tea leaves for September’s month-to-date returns…

Equities

DJIA: 9605, +1.1%
Nasdaq: 2081, +3.6%
S&P 500: 1043, +2.2%
MSCI Emerging Mkt Index: 894, 4.9% !!!
DJ Global ex U.S.: 193.8, +4.4% !!!

Commentary: Clearly, the real action is overseas. The U.S. markets are merely riding the coattails of the emerging markets and other developed international markets. Is the rally overseas sustainable? Are these markets forecasting a global economic recovery? Why hasn’t the Baltic Dry Index rebounded?

Bonds/Interest Rates

2yr Treasury: .91%, a decline of 7 basis points (1 basis point is .01%) Remember, lower rates implies higher bond prices.
10yr Treasury: 3.35%, a decline of 6 basis points

COY (High Yield ETF): 6.35, +4.9% !!!
FMY (Mortgage ETF): 17.52, .69%
ITE (Government ETF): 57.85, .12%
NXR (Municipal ETF): 14.07, 0.0%

Commentary: The fact that U.S. Treasury rates continued to decline this week even in the face of $70 billion of 3yr, 10yr, and 30yr issuance indicates to me:

>> investors view the U.S. economy as weak

>> investors do not see inflation on the horizon. In fact, could the market be fearful of disinflation if not outright deflation? I am starting to think so. If that is the case, can we have disinflation domestically in the context of a global economic rebound? The cross currents and price action between the bond markets and equity markets presents a real conundrum.

The eye popping returns within the high yield space are highly correlated with those in the emerging market space. I would caution people before adding exposure in those segments.

U.S. Dollar

$/Yen: 90.65 vs 93.11 at August month end
Euro/Dollar: 1.4582 vs 1.4338 at August month end
U.S. Dollar Index: 76.72 vs 78.14

Commentary: The decline in the value of the U.S. greenback by approximately 2% reminds me of the overused Wall Street phrase, ‘squeal like a pig…’

The fact is Big Ben Bernanke is not only funding the domestic economy with the Fed Funds rate at 0-.25%, he is also funding the spike in a number of markets around the world. How so? Investors around the world have entered and, given this week’s price action, continue to enter into the ‘positive carry‘ trade in which they borrow U.S. dollars to purchase higher risk assets.

This ‘positive carry’ trade was fed by the Japanese yen throughout the ’90s given the exceptionally low rates in that country.

Make no mistake, though, this ‘positive carry’ trade is nothing more than implementing leverage. Do not confuse leverage with brains when a market is rising because as I said the other day, leverage is death when that bull becomes a bear. As I think of market developments, I am convinced that this ultimate unwind of leverage trades currently being implemented is Jeff Gundlach’s reasoning for being bullish on the dollar. How will this work? Investors will look to exit their risk based investments (emerging market stocks and the like) and buy back the dollars which they have borrowed. In the process, the dollar may rally significantly. The timing of this unwind is the critical question.

Commodities

Oil: $69.12/barrel vs $69.93 at August month end
Gold: $1007.6/oz. vs $952.4 at August month end
DJ-UBS Commodity Index: 123.792 vs 125.73 at month end

Commentary: How can we experience a global economic recovery without further improvement in commodity prices? The move in gold is a safe harbor trade against the weak dollar. Please see my comments above regarding the Baltic Dry Index.

Summary/Conclusion

While there are a few indications of economic improvement, overall I view the disconnect between the markets and the economy to remain significant. I am more in the camp that market returns are more reflective of ‘fast’ or ‘hot’ money chasing further price appreciation with an eye to exit. This price action can and will force participants into the casino, but please be aware ‘the road to hell is paved with positive carry.’

Thoughts, comments, questions always appreciated.

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The Meltup Continues; What Does It All Mean?

Posted by Larry Doyle on September 11th, 2009 2:44 PM |

What does it mean when virtually every asset class is increasing in value? Is this an indication of a ‘Goldilocks’ market in the context of an economy with widely disparate winners and losers? Can virtually all the different sectors of the market be trading off underlying factors and fundamentals which benefit that asset class? Let’s navigate the different sectors of the market and ask the difficult questions.

Equities

Have companies so improved their balance sheets so as to thrive in the midst of mediocre sales volumes?

Will exports increase so dramatically as to replace weak domestic consumption?

Are valuations sufficiently cheap as to warrant aggressively adding to positions currently?

Is the rally an Uncle Sam induced rebound in the midst of adapting to an entirely new economic dynamic?

Bonds

Why do government interest rates continue to decline in the face of overwhelming supply and a greenback under pressure?

Is the bond market sending warning signals of growing deflationary pressures? If so, can that possibly be good for equities?

How does a bond market continue to rally even as Uncle Sam’s quantitative easing initiative is starting to wind down?

Is the rally in U.S. government debt a warning signal of an economic relapse or proverbial double dip? How do investors reconcile the price action in both bonds and stocks?

The Dollar

The one segment of the market not finding much favor.

How can the dollar decline and the other sectors of the market rally? Isn’t that counterintuitive? A declining dollar is ultimately inflationary. Is that expectation of inflation overwhelmed by the growing deflationary pressures elsewhere within the economy?

Commodities

Has the improvement in oil specifically been a reflection of global economic demand or more a function of a weak dollar?

Is the recent retreat in the Baltic Dry Index forecasting a further pullback in the prices of commodities?

Do emerging market stocks accurately reflect this retracement within the BDI?

Will we have inflationary trends overseas while we experience disinflation or deflation domestically?

Conclusion

The markets do present opportunities for short term traders. As a former trader and currently a long term investor, whenever I have more questions and uncertainties than answers and revelations, I am inclined to reduce risk rather than add to it. Some may say I am going to miss out on further price appreciation for selected assets. I would respond that I am playing a different game.

Thoughts, comments, questions always appreciated.

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A Wall Street Veteran’s Recollections of September 11, 2001

Posted by Larry Doyle on September 11th, 2009 6:49 AM |

On Tuesday September 11, 2001 I was employed as the National Sales Manager for Securitized Products at JP Morgan Chase located at 270 Park Avenue in the heart of midtown Manahattan. As I recall, it was a beautiful Indian Summer day.

At 8:30am, I entered a meeting with a salesman to discuss the fact that our Credit Department was not willing to do business with a particularly high profile client. This meeting took place in a small meeting room situated on the trading floor.

I exited the meeting at 8:50am to witness a woman literally collapsing on the floor. I then heard somebody say that a plane had crashed into the World Trade Center. Looking across the trading floor to a TV monitor, I saw what appeared to be a hole in one of the towers. I dismissed it as either my looking from a distance or a problem in the transmission. I distinctly recall thinking that a small prop plane had likely lost control and crashed. That said, I quickly hustled back to the sales desk only to be apprised by a young salesman that a jumbo jet had crashed into the WTC. I sensed real concern amongst my surrounding colleagues.

The young salesman asked me what I thought of the chances that this crash was no mere accident, but an act of terrorism. Thinking it over, we agreed the crash very well could be terrorism. It was now approximately 9:00am.

We had a number of clients located in both towers. A senior salesman situated to my right called a client in the tower not yet hit and asked him what was going on inside the building. The client responded that building management was putting out the message to remain in the building as management monitored the situation. Our salesman apprised him of the mayhem surrounding the first tower. Little did our client know that he and his colleagues at Sandler O’Neil only had a few minutes to exit the building. In hindsight, those few minutes had already passed. Within a few minutes, we witnessed the horrific scene of the second jumbo jet slicing into the second WTC tower.

Panic set in on our desk as we all felt that the city of New York was under attack. I thought we would likely witness a string of attacks at other high profile locations, including Grand Central Station, Penn Station, the PATH Train, and the Empire State Building. Thinking we would literally be trapped in Manahattan, I gave my corporate credit card to the aforementioned young salesman and asked him to go reserve a slew of hotel rooms.

I then called my brother who worked one block away from the WTC and encouraged him to get out of his building. He agreed that he would do just that. In turn, I called my folks to apprise them that I had touched base with my brother and that he was leaving his building. When I called him 30 minutes later, at approximately 9:45am, he still had not left the building. He informed me that it was a sea of humanity surrounding his building and he and his colleagues were trying to determine if they were safer inside or outside. I encouraged him to leave and get uptown. Shortly thereafter he did.

At this point, an eery silence had set in as people were trying to determine the circumstances surrounding these crashes. We were thinking of the people trapped in both towers. We then learned of the plane which crashed into the Pentagon and the other that was downed in the fields of Pennsylvania. Not only was New York under attack, but our country as a whole was under siege.

The young salesman whom I had asked to reserve the hotel rooms returned and apprised me that no hotel rooms were to be had.

After witnessing the collapse of both towers, we knew the world was a changed place. How many friends and colleagues perished literally right before our eyes. I remember thinking that given the points of entry of both jets, a likely death count could be upwards of 8-10 thousand people. Fortunately I was quite high in my estimate as many people had been able to exit. That said, for the thousands who perished and the loved ones they left behind, this was a nightmare beyond description.

I encouraged my colleagues who lived in NYC to head home, and those who lived outside the city to make plans to leave. I heard that train service from both Grand Central (my means of transportation) and Penn Station resumed shortly after noon or thereabouts.

I was in constant contact with my wife throughout this ordeal. Knowing that I had no other way of getting home, I was going to have to go into Grand Central. I was very nervous thinking about that prospect. Ultimately after everybody on our sales desk had departed, I left to catch a train around 2:30pm. The train was jammed, but it was silent. People admittedly were in a state of shock.

For the better part of the next 4 months, I drove into Manhattan every day to avoid Grand Central Station. I would leave my home around 4:30am in order to avoid traffic at bridges and tunnels.

Like many people, I had problems sleeping. I lost a dozen friends and colleagues that day.

May they rest in peace . . . and may we never forget.

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Did Morgan Stanley’s John Mack Just Get ‘Shot?’

Posted by Larry Doyle on September 10th, 2009 7:42 PM |

Why would John Mack step down from his role as CEO at Morgan Stanley? Mack is widely regarded as one of the most competitive, if not cutthroat, individuals on Wall Street. I find it very hard to believe that he is stepping down because he just turned 65. Morgan Stanley is not the U.S Post Office.

Morgan Stanley has been ridiculed for not taking greater risk within its trading division over the last 6 months. In the process, Morgan Stanley has lagged its main rival, Goldman Sachs. What did Mack do to address this problem? He recently hired Jack Demaio, a highly regarded markets pro with whom Mack worked during his short tenure at Credit Suisse. So what happened? Why is Mack stepping aside? I think in true Wall Street fashion, he may have been pushed out, or — in Wall Street parlance — he just ‘got shot.’ Why? What have we learned and what do we know?

After Mack left Morgan Stanley in 2001, he was headed to work at Pequot Capital, a large hedge fund run by the legendary Art Samberg. In the midst of his transition to Pequot, Mack was thought to have been involved in providing inside information about Microsoft to Samberg.

Bloomberg addressed this story on May 28th in writing, Pequot Capital to Shut Amid SEC-Insider Trading Probe:

Arthur Samberg, once the world’s biggest hedge-fund manager, said a federal insider-trading investigation is forcing him to shut Pequot Capital Management Inc. more than two decades after starting its first fund.

“With the situation increasingly untenable for the firm and for me, I have concluded that Pequot can no longer stay in business,” Samberg wrote in a letter to clients yesterday. Pequot oversees $3.47 billion, according to a May 15 regulatory filing, down from $4.3 billion in November and $15 billion in 2001, when it was the top-ranked hedge-fund firm by assets.

The U.S. Securities and Exchange Commission in January resumed a probe into whether Samberg’s funds illegally profited in 2001 by trading on inside information about Microsoft Corp., people familiar with the matter said at the time. That was about a year after the agency told Samberg and Morgan Stanley Chief Executive Officer John Mack they wouldn’t be accused of wrongdoing related to insider trading.

So John Mack stepped down because he is soon turning 65? Yeah, right!! If you believe that, can I interest you in some toxic mortgage assets priced at 90 cents on the dollar? I think there is real value there!!

In my opinion, ‘Mack the Knife’ getting shot is an indication of the SEC flexing its muscle.

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Bernie Madoff: “This Conversation Never Took Place…”

Posted by Larry Doyle on September 10th, 2009 2:40 PM |

If there was ever a doubt as to whether Bernie Madoff was aided and abetted in his Ponzi scheme, that doubt should now be extinguished. How so? An hour-long discussion between Madoff and executives from Fairfield Greenwich reveals Madoff giving these ‘co-conspirators’ instructions on how to deal with regulators from the SEC.

The conversation is riveting and exposes the calculating mindset of both Madoff and the executives from Fairfield Greenwich. The conversation encompasses a wide array of topics, including:

1. Madoff’s model and strategy

2. Fairfield Greenwich’s model and strategy, in which Madoff was supposedly merely an executing broker.

3. Madoff recommends to Fairfield Greenwich to never reference writing things down “because any time you say you have something in writing, they ask for it.”

4. Fairfield Greenwich should not acknowledge that they knew when Madoff entered and exited the market.

5. Fairfield Greenwich requests info on Chinese walls and controls at Madoff. Bernie acknowledges that the SEC already knows of Chinese walls at Madoff.

6. Bernie talks about funds which promote transparency. Bernie views the flow of information as problematic for managers in regard to accusations of front-running.

7. Bernie acknowledges he knows how to handle regulators based upon his relationship with them.

8. Bernie says, ” . . . the hedge funds operate in totally different ways than they used to . . . it’s changed the landscape and the commission (SEC) has no idea what the hell is going on.”

9. Bernie indicates that he is the only one who pulls the trigger at Madoff. Bernie says the execs at Fairfield Greenwich do not need to know that. The SEC will try to draw information out, but the less the Fairfield Greenwich execs know of Madoff, the better.

In listening to this conversation, there is truly only one conclusion which one can draw:

The Fairfield Greenwich executives on this call were not only stooges for Madoff, but also co-conspirators. Any entity who invested the amount of money Fairfield Greenwich did without fully understanding the trading strategy and model should be exposed. The senior exec at Fairfield, Walter Noel, must have fully known of the Madoff fraud.

Having worked in the industry for 23 years, I have never heard of a conversation in which strict instructions and guidance of this sort was ever provided when it came to regulatory oversight.

If I were an investor in Madoff through the Fairfield Greenwich feeder fund and listened to this audiotape, I would instruct my lawyers to get even more aggressive in seeking damages.

The audiotape embedded in this CNBC story, Madoff, Caught on Tape, Reveals Ways to Dodge SEC, runs 69 minutes. It is well worth a listen.

Shame on every regulator who did not perform in unearthing this greatest of scams.

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American Business Needs More Leaders with Unquestioned Integrity

Posted by Larry Doyle on September 10th, 2009 11:38 AM |

Volumes can and will be written about the pitfalls and problems our economy has encountered leading up to our current economic crisis. Regrettably, there are never enough volumes written about those individuals who swim ‘against the tide’ and promote the principles of truth and integrity which are sorely lacking in our country today.

Against this backdrop, I always enjoy reading the commentary of Bloomberg’s Jonathan Weil who digs through the books and records of a wide array of corporations to expose accounting smoke and mirrors. This morning, Mr. Weil profiles 5 individuals who deserve real praise. I reference Weil’s work not only to bring greater adulation to these individuals but also to bring greater attention to the corporations and industries with which they are connected. Weil writes Five People Who Stayed Clean in Banking’s Bilge:

In the year that has passed since Lehman Brothers Holdings Inc. collapsed, there haven’t been many good guys to emerge from the wreckage of the financial crisis. Look hard enough, though, and you will find a few.

It’s a challenge, no doubt. So many people at the highest levels of government and industry blew it, including almost every top banking and securities regulator in Washington. Yet those failings are not what this column is about.

Rather, it’s to introduce you to some of the people I’ve come across over the past year who stuck to their core values in the face of enormous pressure to abandon them.

1. Dick Evans, chief executive officer, Cullen/Frost Bankers Inc. He said no to the government’s bailout money.

Cullen/Frost was profitable and had plenty of capital. Evans and his team concluded that the true cost of the government’s funds was higher than advertised. They thought taking the money would dilute their shareholders’ stake. Throughout the whole mess, the company has reported profits every quarter.

2. Joseph St. Denis, former vice president of accounting policy, AIG Financial Products.

American International Group Inc. hired this former Securities and Exchange Commission accountant in June 2006 to help clean up its financial-reporting systems. Within a year, St. Denis said he had found serious errors. Soon after, the head of AIG Financial Products, Joseph Cassano, began excluding him from discussions about the “super senior” credit-default swaps that ultimately sank the company. Cassano also demoted him. St. Denis did the right thing: He quit, at great personal cost.

3. Charles Bowsher, former chairman of the Federal Home Loan Bank System’s Office of Finance.

Bowsher resigned in March, less than two years into the job and just one week before the government-chartered system’s 12 regional banks were due to file their combined annual report. The reason: As an audit-committee member, he wasn’t comfortable signing off on their financial statements.

Specifically, he was bothered by the accounting standards and processes the banks were using to value their mortgage- backed securities. He also wasn’t about to risk his reputation. Bowsher, 78, was comptroller general of the U.S. from 1981 to 1996, during which time he was among the first to warn the public about the brewing S&L crisis and the need for regulation of derivatives dealers. The shame is that more corporate directors don’t have the guts to do what he did.

4. & 5. Tom Linsmeier and Marc Siegel, members of the Financial Accounting Standards Board.

Last April, the FASB caved to pressure by Congress and changed its rules so that banks and insurance companies could exclude huge unrealized losses on mortgage-backed securities from their earnings and regulatory capital. The decision promises to stain the board’s reputation as an independent standard-setting body for years to come.

The ruling wasn’t unanimous, however. Linsmeier, a former accounting professor at Michigan State University, and Siegel, a longtime forensic accountant, voted against the change. (The measure passed by a 3-2 vote.)

In a joint dissent, they wrote that “investors generally have opined that their preference is for the fair value of financial instruments to be reflected in net income.” Delaying recognition of losses, they said, may result in “a negative effect on investor confidence.” Linsmeier and Siegel emerged with their reputations enhanced.

While government pundits, market analysts, and high profile economists will posture and rationalize about a wide array of programs and policies implemented throughout this crisis, there is no substitute for prioritizing reputation and integrity. In fact, I would maintain that those individuals and corporations that prioritize these intangibles will be the real long term winners. America needs more men like the 5 referenced above . . . it also needs more journalists like Jonathan Weil willing to embrace similar characteristics.

Related Sense on Cents Commentary:
Freddie Mac, Fannie Mae Deja Vu? (May 28, 2009)
The Greatest Risk (December 21, 2008)

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Jeff Gundlach of TCW Calling for Deflation and Dollar Rally

Posted by Larry Doyle on September 10th, 2009 8:39 AM |

Jeff Gundlach did not become one of the most highly regarded and respected money managers in the business by accident. His long term track record managing TCW’s Total Return Bond Fund (TGLMX) is nothing short of spectacular. Gundlach presented at a conference yesterday. Inside sources shared with me that he received a standing ovation for his thorough yet sobering commentary. MarketWatch provides a review of this Sense on Cents Economic All-Star’s outlook in which he is calling for a serious bout of deflation and a resulting rally in the dollar.

Alistair Barr of MarketWatch writes:

The stock market’s recent rally is likely to run out of steam soon and equity prices may collapse again, Jeffrey Gundlach, chief investment officer at Los Angeles-based mutual-fund giant TCW Group Inc., said Wednesday.

The benchmark Standard & Poor’s 500 index is “extremely unlikely” to climb above 1,100, before collapsing again, he said during a conference call.

“You’ve made 90% of the money you’re gonna make in this rally,” Gundlach said, advising investors to sell on strength when the S&P 500 is above 1,000.

The S&P 500 closed at 1,033 Wednesday, leaving it up more than 50% since early March.

Gundlach, who also runs TCW’s flagship Total Return Bond Fund (TGLMX 9.98, -0.01, -0.10%), had spotted cracks that subprime mortgages were forming in the financial system by June 2007 and was among the first to warn that an era of easy money would come to a bad end. See full story on Gundlach’s warning.

His new concern is the massive debt being accumulated by the U.S. government as it tries to stimulate an economy that’s been mired in the worst recession since the World War II.

“We’re basically borrowing money and calling it economic growth,” he said on Wednesday. “It’s not real economic activity.”

Debt-fueled government stimulus, such as the “cash for clunkers” program, may keep the U.S. economy growing for one or two years, but then growth will probably “just die,” Gundlach said.

Cash for clunkers, in which the government gave up to $4,500 to new car buyers if they handed in old gas-guzzling vehicles, illustrates another of Gundlach’s concerns, that of deflation.

“Deflation is so strong that you can’t even sell cars unless you slash prices 20% through government subsidies,” he said.

Gundlach is similarly bearish on credit markets and commodity prices, arguing that “a turning point is close at hand in these markets.”

One of the few areas he’s bullish on is the U.S. dollar — but not for good reasons.

Gundlach sees such large debt defaults in coming years that he thinks the trend will cut the supply of dollars, pushing up the currency’s value.

“We’re standing on the edge of a major default wave,” he said. “Defaults are the elimination of dollars. You could eliminate so much actual wealth that this could be the source of a strong dollar rally.”

I wholeheartedly agree with his economic assessment and said as much yesterday in responding to a reader’s comment here at Sense on Cents. I wrote:

How do you fill the gap left by consumers who borrowed too much? Have Uncle Sam step in and borrow too much. One way or the other it’s all borrowed funds which will have to be paid back at some point in the future…

People can call it growth, the appropriate term is leverage. As I wrote above , leverage should not be confused with brains when the market is rising, but it is death when the bull becomes a bear.

In regard to the markets, I view them more as a sideshow while the real action is the race between the Fed and Treasury pumping liquidity into the system to stem the ongoing and increasing wave of defaults. Mr. Gundlach clearly believes this wave will ultimately overwhelm Uncle Sam and our economy.

I respect Mr. Gundlach too much not to give his concerns serious consideration. In fact, I believe the rally in U.S. government bonds over the last few months is sending a warning signal of deflation on the horizon. Recent downward price action in the DJ-UBS Commodity Index may also be an early warning sign. Price action in the equity market would appear to be inconsistent with these markets, but it has been for a while.

For those interested in reviewing Mr. Gundlach’s entire 47-page slideshow, please click on the image below: