FPA's outspoken CEO, Bob Rodriguez, is warning that America’s fiscal fuse is nearing its end unless the U.S. electorate stages a revolt in the upcoming midterm elections.
In an address last month to shareholders of the $30 billion fund family, newly made available on the firm’s website, Rodriguez suggested that 10 Senate seats needed to swing to the GOP to shock the U.S. political system into taking action to prevent the next crisis.
However, the former manager — the only manager ever to achieve the distinction of Morningstar Manager of the Year on both the equity and fixed-income sides — considers such a tectonic shift unlikely, foreseeing instead a time when bond vigilantes stage an open revolt against U.S. fiscal impropriety.
Before updating his current warning, however, Rodriguez, who has long been a vocal critic of excessive U.S. debt, compared his own track record in making predictions with that of the Federal Reserve.
The FPA exec noted that Fed minutes from 2005 and 2006 quote former Fed Chairman Ben Bernanke as saying there was no housing bubble; that in April and June 2007, Bernanke said there would be no contagion from subprime credit (“I argued differently,” Rodriguez recalls); that the Fed, in June 2009, expected real GDP growth of 4% to 5% in 2010 and 2011, far from the actual 2.8% and 2.1%.
Further, the Fed called for long-term unemployment to fall to 4.5% to 5.3% (saying nothing about a declining labor participation rate), and Bernanke wrote in fall 2010 that quantitative easing would create a wealth effect.
In contrast, in June 2009, Rodriguez forecast 2% real growth during the economic recovery, just shy of the 2.2% outcome since 2009. However, he notes that “it was [actually] 2%, until the Bureau of Economic Analysis revised its method of estimating GDP in July 2013 that created $500 billion of additional economic growth out of thin air.”
He also forecast high unemployment, aggravated by a declining labor participation rate; that QE and zero interest-rate policy would not bring robust growth; and that the 2009 stimulus plan would merely waste money and time on gimmicks such as “cash for clunkers” and a one-time $8,000 credit to buy a home.
Rodriguez says he was wrong in suggesting that pretax profit margins would not experience a robust recovery, but was on target in suggesting that Treasury debt measured at $10 trillion in the fall of 2008 would grow to between $14.6 and $16.6 trilion by the end of 2011.
“This comparison of the accuracy of my forecasts, versus the Fed’s, hopefully lends a degree of credibility to my comments and forecasts that follow,” Rodriguez told FPA investors.
As is his wont, Rodriguez’s predictions were stark. He compared QE to a narcotic whose effects wear off, requiring a new fix.
“Do I have confidence in a Fed exit strategy? No!" he exclaimed. "Why should I have confidence in an institution that could not recognize the greatest bubble in history, the housing bubble?”
Rodriguez was no less sanguine about fiscal policy makers for what he called “ad hoc governmental intrusion” that has occurred during the Great Recession. Instances he cited include “the differential treatment of Bear Stearns, AIG and Lehman Brothers,” the “arbitrary prioritization of the standing of creditors and pensioners in the GM and Chrysler reorganizations” and the government’s heavy-handed approach to Fannie Mae and Freddie Mac, about which he said:
“The government technically owns 79.9% of each company but says it can take 100% of the profits. Is this fair or right? I am just a bystander in this debate … I am proud of the fact that in January 2006 we concluded that both companies were insolvent and that we would not lend to them. We responded by liquidating 100% of our debenture debt holdings and placed both companies on our investment restricted list. I believe we were the only company to publically state this policy. Our prudence was not rewarded because the government eventually bailed out all creditors.”
Another current danger he cites is Dodd-Frank, which has grown from the time of its 2010 passage from 848 pages to 14,000 pages in 2013, and that with only 52% of its rulemaking requirements met.
“I recently reviewed a near two-inch thick 'summary' of the Volcker Rule. What a joy! Does anyone have an idea of how all this will unfold? I know I don’t,” he commented, adding, ominously, that FPA’s fixed-income team “has seen a dramatic withdrawal of bond market liquidity, as these rules have been clarified.”
Rodriguez’s harshest remarks, however, were reserved for the growing U.S. debt toll, and he recounted how he joined forces with former Comptroller General David Walker in what he now regards a “failed” effort to warn the nation of the risks.
“Back in early 2010, we both thought a real and substantive fiscal restructuring had to occur no later than 2013. We debated which month. When July came and went last year, nothing of substance had been achieved other than some sequester cuts, and these, too, have been modified and delayed by the December 2013 Bipartisan Budget Agreement,” he said.
This failure, he forecast in 2009, would result in a financial crisis as bad or worse than the Great Recession some time between 2014 and 2018.
Our best hope, therefore, is a sudden embrace of fiscal propriety, and Rodriquez thinks that dissatisfaction with Obamacare could fuel a political swing.
“Passage of the Affordable Care Act, in my opinion, is a fiscal and political nightmare," he said. "It has changed the political dialogue in this country for the worse. By creating another entitlement without first addressing those that have been eating away at the fiscal soundness of our country, we have in essence levered up an already highly levered system.”
Because of the highly personal nature of health care, Rodriguez thinks voters might be inspired to change course.
Nevertheless, FPA’s Washington consultants see just four to six Senate seats shifting to the GOP, and that moderate swing would ensure continued divided government after the 2016 presidential elections.
Because overhauling the U.S. fiscal condition is “too divisive,” U.S. debt would likely not be addressed before 2021, and “this would be too late,” he says.
That means the Fed would continue its bias toward QE and that its $4.5 trillion debt portfolio would rob it of the flexibility it would need to handle the next financial crisis.
The bond market, in the meantime, would revolt (a scenario he gives a greater than 50% probability), jacking up long-term interest rates. And U.S. debt, without a restructuring before 2021, would by 2024 rise to between $25 trillion and (more likely) $28 trillion vs. $17.5 trillion today.
Such a high level of debt would increase debt-service costs to between $1 and $1.2 trillion from $227 billion today.
“We’ve never seen this scale of debt and off-balance sheet liabilities, in combination with a rapidly aging population base…History has shown that, when government financial obligations become too large to service, the most likely solution is to resort to the monetary printing press. I do not believe the financial markets are factoring in this potential risk.”
FPA’s fund managers are, however, making those calculations—“holding sizable levels of liquidity” on the equity side and anchoring fixed income portfolios to a “very short duration,” Rodriguez noted.
Check out Bob Rodriguez Grades Obama, Calls Government ‘Chaos’ Top Threat on ThinkAdvisor.