Bill Gross goes to Washington

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Bill Gross, co-founder and co-CIO of PIMCO, is to my mind one of the shrewdest money men around. His monthly newsletter therefore always makes for thought-provoking reading.

The following are a few excerpts from the September report:

“I proposed a solution that recognized the necessity, not the desirability, of using government involvement, which would take the form of rolling Fannie Mae (FNMA), Freddie Mac (FHLMC), and other housing agencies into one giant agency – call it GNMA or the Government National Mortgage Association for lack of a more perfect acronym – and guaranteeing a majority of existing and future originations. Taxpayers would be protected through tight regulation, adequate down payments, and an insurance fund bolstered by a 50–75 basis point fee attached to each and every mortgage. Seemed commonsensical to me. After all, Fannie and Freddie had really blown up because of the private/public nature of their charter, which incentivized executives and stockholders to go for broke with the implicit understanding that Uncle Sam would be there as a backstop should anything go wrong.

“If you eliminated the private incentive and provided a tighter regulatory watchdog, we would have no more “liar loans” or “no docs” and a much sounder foundation for future homeowners and investors. The private market, to my mind, had really lost its claim as the most efficient and judicious arbiter in this particular case. Markets and private incentives without proper guardrails were as threatening to a sound economy in the 21st century as too much regulation and government ownership proved to be in the 1970s.

“My argument for the necessity of government backing was substantially based on this commonsensical, psychological, indeed sociological observation that the great housing debacle of 2007–2010+ would have a profound influence on homebuyers and mortgage lenders for decades to come. What did we learn from the Great Depression, for instance: Americans, for at least a generation or more, became savers – dominated by the insecurity of 20%+ unemployment rates and importance of a return of their money as opposed to a return on their money. It should be no different this time, even though the Great R. is a tempered version of the Great D. Americans now know that housing prices don’t always go up, and that they can in fact go down by 30–50% in a few short years. Because of this experience, private mortgage lenders will demand extraordinary down payments, impeccable credit histories, and significantly higher yields than what markets grew used to over the past several decades. Could an unbiased observer truly believe that housing starts of two million or even one million per year could be generated under the wing of the private market? In front of Treasury Secretary Geithner and the assembled audience, I said that was impractical. Let me amend that to “ludicrous.”

“Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending. The cost would be enormous in terms of yields – 300–400 basis points higher than currently offered, crippling any hopes of a housing-led revival to the economy.”

Click here for the full article.

Gross also shared this message in the following CNBC interview:

Sources: Bill Gross, PIMCO – Investment Outlook, September 2010 and CNBC, August 17, 2010.

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4 comments to Bill Gross goes to Washington

  • larose Marc

    This is like the system in Canada. Which has its problem . Take note 770 billion of dollars in morgages and only 9 billions in reserve. Well the tax payers are on the hook if anything happens. The conservative government put in 45 billion into the program in 2008-2009. There is a problem to have the control over this mess. It is a crown corporations but it must be able to follow strict rules of lending / reserve so that it can operate without taxpayers money

  • Talking his book as usual.

    So what if mortgage rates rise 300-400 basis points? This won’t necessarily make housing unaffordable. However, it will cause the price of housing to fall to the level that it should have been at in the first place.

    Of course, this would put a hurtin’ on existing MBS holders of which Gross is probably the largest.

    Smart guy – yes. Does his proposal put the needs of our society ahead of his own – no f-ing way.

  • The large supply of housing inventory is a market signal that the price is generally still too high. It doesn’t matter why it is too high or how each of us arrives at that conclusion. The market is the “polling device” that gives us the answer.

    No government mortgage scheme, no matter how clever the author, is going to “solve” the problem.

    If prices are allowed to fall and mortgage rates to rise, the market would start to clear and eventually correct. Property is still a good investment but only if you start at a reasonable entry price.

    The question as a society is whether we are willing to let market forces take their natural course or to transfer wealth to prop up the rotting remains of a popped bubble.

  • Debitores Caveatis

    With the expectations of greater national wealth came the need for home loans when oil was discovered in Pennsylvania. With the passing of USA peak oil in 1973 we should have shut down our home loan programs with the expectations of looming disintegration of national wealth. We are now living within an epoch of de-leveraging with less need for new loans to debtors but more need for repaying creditors for old loans.

    There is a time for all crunch under the sun.


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