Pimco's Gross calls for US govt to bail out bonds, housing
5th Sep 08, 10:27am
Most New Zealanders don't know about the investment gurus that the rest of the world listens to. Our 'gurus' are the likes of Ron Brierley or Graeme Hart, although we rarely hear their pearls of widom. We simply watch what they do and applaud from the sidelines. However, in America, there are at least two 'investment gurus' that people follow closely. Warren Buffett is a legend who now attracts tens of thousands of acolytes to his annual meeting in Omaha Nebraska. The other 'guru' is Bill Gross, who runs PIMCO, the world's biggest bond fund manager. When he talks about interest rates and bond markets the whole of the world's professional investors and many of the world's amateur bond investors sit up and listen.
He has made the extraordinary plea for the US Government to essentially step up and bail out Fannie Mae and Freddie Mac to rescue the bond market. He says the government should also subsidise house purchases to ensure a collapse in the housing market doesn't worsen the situation.
Here's the core of his argument.
|He has just issued his latest newsletter that says some extraordinary things. Gross has basically said the US bond markets are about to go into a death spiral of debt reduction, asset sales, asset revaluations and liquidations that would make the Depression look like a picnic.|
As the chart (above) demonstrates, there have been prior periods when this trio (stocks, bonds, houses) has not done well and the U.S. economy has hardly blinked. However, the current year-over-year decline of over 10% has never really been witnessed since the Great Depression. That, in and of itself, is a potential red flag. Yet a 10% aggregate asset price decline does more than make us all 10% less wealthy. 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. In the housing market for instance, it is one thing to observe a 15% national decline in home prices. It is much more serious however, when margin calls in the form of monthly mortgage payments (many of which are in-creasing due to adjustable or option-related contractual provisions) lead to foreclosures, which in turn cause a debt liquidation. The bank in this case, takes possession of the home and dumps it back on the market, lowering the price even further, which leads to more foreclosures, which leads to"¦. This rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time. Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami. Central bankers, of course, adopting the cloak and demeanor of firefighters or perhaps lifeguards, have been hard at work over the past 12 months to contain the damage. And the private market, in its attempt to anticipate a bear market bottom and snap up "bargains," has been constructive as well. Over $400 billion in bank- and finance-related capital has been raised during the past year, a decent amount of it, by the way, having been bought by yours truly and my associates at PIMCO. Too bad for us and for everyone else who bought too soon. There are few of these deals now priced at par or above, which is bondspeak for "they are all underwater." We, as well as our SWF (Sovereign Wealth Fund) and central bank counterparts, are reluctant to make additional commitments. Assets are still being liquidated but there is an increasing reluctance on the part of the private market to risk any more of its own capital. Liquidity is drying up; risk appetites are anorexic; asset prices, despite a temporarily resurgent stock market, are mainly going down; now even oil and commodity prices are drowning. There may be a Jim Cramer bull market somewhere, but it's primarily a mirage unless and until we get the entrance of new balance sheets, and a new source of liquidity willing to support asset prices. New balance sheets? Is this now some Deloitte & Touche metaphor? Hardly. What I mean, what our blackboard and our Investment Committee point out is that to ultimately stop this asset/debt deflation, a fresh and substantial new source of buying power is required. This became all too obvious as the Treasury's attempt to entice additional capital into Freddie and Fannie came up empty. Yet this same dilemma is and will continue to confront all highly levered institutions in the throes of asset liquidation. Without a new balance sheet, their only resort is to sell assets, which in many cases leads to further price declines, or ultimately debt liquidation/default. A Depression-era bank robber named Willie Sutton once said that the reason he robbed banks was because "that's where the money is." Illegal for sure, but close to an 800 SAT score for logic if you were in the business of stealing other people's money. And now, while some will compare current government bailouts to Slick Willie, citing moral hazard, near criminal regulatory neglect, and further bailouts for Wall Street and the rich, 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 (Federal Housing Authority) and other government institutions. A 21st century housing-related version of the RTC (the Resolution Trust Corportion was set up after the US Savings and Loan crisis of the 1980s to buy the assets of failed financial institutions) such as advocated by Larry Summers amongst others could be another example of the government wallet or balance sheet that is required during rare periods when the private sector is unable or unwilling to step forward. The bill for our collective speculative profligacy, obvious in the deflating asset markets, can be paid now or it can be paid later. Those aspiring for a perfect 800 on the Wall Street policy exam would conclude that the tab will be less if paid up front, than if swept under a rug of moral umbrage intent on seeking retribution for any and all of those responsible. Now that the Fed has spent 12 months proving that it "knows something"¦knows something," it is time for the Treasury to do likewise.This is seriously worrying from someone who is very careful with what he says. Remember New Zealand has borrowed at least an extra NZ$85 billion from foreign (debt) investors in the last 7 years to pay for a frenzy of home buying, property investing and general consumption. At least NZ$83 billion of our total foreign debt of NZ$219.4 billion is on terms of 90 days or less. We receive payments of about NZ$13-15 billion for exports of goods and services every 90 day. If a global debt death spiral start that forces liquidation of assets to repay debt, that will wash onto our shores. Gross' piece will spark a massive debate in the United States. We will watch with interest. In the meantime we should be paying back our debt as fast as we can and keeping interest rates high to ensure we continue saving rather than spending.