Bill Gross Wants a Housing Bailout

Posted by: Ben Steverman on September 4, 2008

PIMCO ‘Bond King’ Bill Gross’ monthly investment outlooks are entertaining and widely read, and today’s September note might even have contributed to today’s 3% drop in the stock market.

Gross’ thesis in a nutshell: Market conditions are very bad, and the only thing that can save us is a federal government bailout of the housing sector.

In my view, it’s too early for a full-blown housing rescue. Eventually, the government may step in to end the financial crisis with some dramatic action, but at this point (and probably for the next six months at least) the financial markets are on their own.

More on my thoughts in a bit, but first a recap of the highlights of Gross’ 1,900-word, market-moving opus.

Gross mentions CNBC’s Jim Cramer (Gross watches Mad Money!?!), and Cramer’s mantra that there’s always a bull market somewhere.

However, Gross says, the problem right now is that those bull markets are very hard to find. “In a global financial marketplace in the process of delevering, assets that go up in price are rare diamonds as opposed to grains of sand,” Gross writes.

He points out that stocks, bonds and housing prices are down an aggregate 10%. He says a decline this large — essentially making us all 10% less wealthy — “has never really been witnessed since the Great Depression.”

Because many of these assets are leveraged and margined, the more they decline, the more frequent and frenzied the margin calls, and if the additional cash flow is not provided, not only an asset liquidation but a debt liquidation follows. It is the debt liquidation that potentially turns a stagnant/recessionary economy into something much worse.

He’s predicting, in other words, a runaway train of home price declines, leading to more foreclosures, leading to more home price declines. It’s similar to the scenario described in Peter Coy and Mara Der Hovanesian’s June 26 BusinessWeek cover story, “The Housing Abyss.”

Gross’ solution:

Common sense can lead to no other conclusion: if we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury – not only to Freddie and Fannie but to Mom and Pop on Main Street U.S.A., via subsidized home loans issued by the FHA and other government institutions.

The government must open its wallet at key times when the private sector is “unable or unwilling to step forward.”

Gross’ note gets a rather negative reaction from many bloggers. Yves Smith at Naked Capitalism disputes his characterization of the market environment. There are bull markets out there, with bonds and the dollar rallying, while commodities are still up substantially year over year. And Smith argues: “The US simply does not have the resources to perform a rescue operation on the scale Gross envisions. If we were to attempt it, the amount of borrowing required would push Treasury yields up, undermining (more likely, more than completely reversing) whatever benefit there was from spread reduction.”

I’ll stay out of economics to make a political point.

The end of the Republican convention this week marks the official start of a manic, seven-week general election campaign. Then, whoever wins, a lame-duck president and Congress will remain in office until January. The new president, whether Obama or McCain, will have a chance to propose bold new initiatives. But I think the markets will need to wait until Inauguration Day (at least) before it gets even a solid proposal for relief.

Thus, I think we have at least five full months — of more foreclosures, more home sales and more economic data — before politicians even propose to take action. In the meantime, we’ll also have another two earning seasons, and thus billions more in writedowns of mortgage-backed securities.

If the housing situation gets a lot worse, politicians will want to tackle the problem. They would like an achievement for their 2010 or 2012 campaign ads.

But, until next year, investors and the financial markets are on their own. In the long run, this may be for the best. There are plenty of open questions about this housing crisis. For example, how much will severe housing pain become a national phenomenon, and how much will it remain concentrated in a few hard-hit states like Nevada, California, Florida and Arizona?

Also, the last thing the economy or financial markets need is for the federal government to do something rash and reckless. A big housing bailout will have huge and long-lasting ramifications, so maybe it’s OK to take another six months to think about this first.

Reader Comments

A.Viirlaid

September 5, 2008 2:11 AM

"In the long run, this may be for the best."

As bad as it might get, I have to agree with Ben Steverman. This is not because doing nothing is better than doing something. It is because, I sadly have to conclude, there will be no meaningful difference in outcome, regardless of what is, or is not, done.

Bill Gross is an extremely smart person, especially in the investment area. His prognosis is probably right.

Sure, 'The government must open its wallet at key times when the private sector is “unable or unwilling to step forward.”'

But Uncle Sam's wallet is empty.

And in this case, to borrow even more, when borrowing is what got us into this imploding credit bubble, is to court bankruptcy, hyper-inflation, social disorder, martial law, or worse. It may come to those things anyway.

Yes, there will be cascading bad and evil effects from the coming overall debt contraction. And it is too late to learn from this event. It serves little purpose to sermonize about how we should not have gotten into this mess. At least for now. And let's not get into Moral Hazard.

Heaven forbid if we don't learn our lesson this time. It would appear that the Great Depression did little as the instructor it should have been. That period of suffering should have sufficed for 500 years.

We have over-extended ourselves. We have built "assets" that we cannot pay for, we can't even drive to some of them, and we can't pay the upkeep.
In cases like this, some municipalities will simply tear down such buildings.

How to know what to save and what to sacrifice? Because we won't be able to "save" everything.

And as cold and calculating as it sounds, there is no better way than to let the "market" (supply and demand relative to prevailing local conditions) determine which "assets" should survive.

Otherwise you can let another governement bureaucracy decide for us. Do we really think that such an agency can do better?

“Maybe it’s OK to take another six months to think about this first”? Not bloody likely. We can “think” all we want. But we’ll most likely just be bystanders watching the fires burn. This is history of epic proportions. Debasing our paper money by printing more of it will serve little purpose.

Might as well print a million dollars for each individual, give it to each person, let them pay off their debts including their mortgages — and, given that most people have debts of less than 1 million, most people will end up being debt-free.

But every financial asset, every bond, every pension, will be worthless.

ez

September 7, 2008 7:12 AM

Latest News: FALSE ACCOUNTING Caused The Urgent Bailout

Very recently discovered accounting issues brought on the immediate urgency to bailout FNM/FRE. The sham centers on overstatements of capital cushions; the assets that regulators require them to keep on hand to cover losses.

The deceitful accounting methods used by FNM to bolster their financial cushion have caused immediate, grave concerns among the companies’ regulator, outside auditors and investors.

FNM/FRE portfolios contain loans to the riskiest borrowers. FNM/FRE have not written down the value of those securities to reflect current market prices although other financial institutions HAVE been required to write down similar securities, to comply with “mark-to-market” accounting rules. Pure deceit.

Additionally and even more troubling, FNM/FRE HAVE INFLATED THEIR FINANCIAL POSITIONS by $36 Billion by claiming deferred-tax credits as capital assets.
But such credits have no value and NO other financial institutions are allowed to count such credits as assets. These credits cannot be sold and would disappear in the conservatorship. Removing those credits from assets would undoubtedly push both companies’ capital below regulatory requirements.

The final straw prompting seizure was regulatory discovery that the companies have mischaracterize their financial health by relaxing accounting policies on losses, according to independent accounting reviews. For years, FNM has effectively recognized losses whenever payments on a loan are 90 days past due. Now, in recent months, FNM have been waiting until payments were two (2) years late! As a result, tens of thousands of loans have NOT been marked down in value, which are likely worthless.

A.Viirlaid

September 11, 2008 11:06 AM

Well, looks like Mr. Gross got his Housing Bailout.

There are writers who disagree with this approach because they think this will make the recovery take even longer.

Please see http://mises.org/story/3104

Also http://mises.org/story/3103

And maybe also http://mises.org/story/3085

My take on this is that it will take a long time NO MATTER what we do.

But taking on more debt will hasten the day when the dollar really has a terminal meltdown.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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