Posted by: Ben Steverman on September 4, 2008
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.”
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.