Thursday, September 4, 2008 1 comments ++[ CLICK TO COMMENT ]++

Bill Gross Calls for US Treasury to Buy Assets

Bill Gross is considered to be one of the top bond managers in the world. It has never been clear to me whether he was just riding the huge bond bull market in the 80's and 90's or if he actually has some skills. I used to read his monthly commentaries a few years ago and came to understand how he was just as wrong as I was. Meaning, there was little insight for me. One of the memorable ones for me was his bearish call on stocks around 2003 while being bullish on bonds and that turned out to be wrong. His commentary is also hard to read and purposely opaque (similar to Alan Greenspan) so selfish comments versus general market comments are hard to separate. Bill Gross is a Republican so I don't generally agree with him on many things, especially anything to do with supply-side economics, trickle-down theories, and so on (although both him and I have been against the bogus Iraqi war from day one.)

In any case, in his latest commentary he calls for massive government intervention. He basically wants the US Treasury to buy assets or facilitate real estate lending while weakening its balance sheet. Bloomberg has a summary of his letter:

Treasury should support not only mortgage finance providers Fannie Mae and Freddie Mac, but also ``Mom and Pop on Main Street U.S.A.,'' by subsidizing rates on home loans guaranteed by the Federal Housing Administration and other government institutions, Gross said. A new version of the Resolution Trust Corp., which bought assets from failing institutions during the savings-and-loan crisis of the 1980s, may also work, he said.

Gross has been calling for the government to drop money from helicopters onto the real estate rubble for a while now. His latest words are a much stronger call for help, with a proposal for the US Treasury to start subsidizing mortgages on a grand scale.

It's not clear to me if Bill Gross is simply calling for help out of genuine interest for the world. Or if he is doing it to enrich himself or possibly extricate himself from some bad investments. Gross seems to have been shifting heavily into mortgage bonds issued by Fannie and Freddie and I'm wondering if he is taking some losses on those (recall that Fannie and Freddie debt costs have actually gone up even though the US government confirmed that they will back them.) Even if he isn't showing mark-to-market losses, his plan would result in better performance by those bonds.

I think the government should back Fannie and Freddie but I don't really think they should be subsidizing homes. The whole mess started with people who couldn't afford to buy homes ending up with one--and then losing it. So subsidizing homes simply takes us back to square one, except with the government bearing all the costs rather than the private investors, banks, and the like. Some of my investments, like Ambac, would likely benefit if the government started subsidizing mortgages but I think it places a huge burden on American taxpayers.

Yves Smith of Naked Capitalism also wonders whether this will have any impact given the size of the market. The US Treasury would have to significantly weaken its balance sheet in order to undertake Gross' suggestions. Given that the "fiscally conservative" Bush administration has decided to run huge deficits, it's not as if the Treasury is in a good spot. It would be very costly to borrow such a large sum.

If enough money cannot be borrowed at reasonable rates, then the government has to print money. This is called monetizing the debt and involves the Federal Reserve printing money and swapping it for US government debt (in contrast, if the US govt issues debt and sells it to a foreign central bank or a private investor, no money is created.) The Federal Reserve has tried judiciously to avoid printing money throughout this credit crisis so you may end up undoing all the hard work of the last year. If you goal is inflation then it's worth pursuing that. But I doubt Gross would be in favour of inflation.

If you are suggesting giving money to people why real estate? Yes that is what is causing problems, but why not give free money to all the people out there? It was already done to a minor degree earlier this year but simply extend it to the amount that Gross suggests. That would help with consumption, which is something like 70% of the US economy. Of course, this isn't going to help anyone that owns mortgage bonds.

So, to put it simply, Gross' plan would require massive debt issuance by an already fiscally-weak government, or it would require printing money. One of the reasons many non-investors are skeptical of Wall Street or have negative view of investors is because of situations like this. Is Bill Gross suggesting the plan to help the economy or is it to save real estate investors?

One of the unfortunate things I notice is that people don't seem to be distinguishing normal or "good" deflation versus a bad, crippling, one. Admittedly the categorization is subjective but I think we can see it in practice. For instance, the technology bust in the early 2000's is a normal/good deflation in my eyes. By normal, what I mean is that an unsustainable bubble burst and it was contained largely to a select few areas of the economy. It was a disaster for anyone in the industry but it only created a mild recession. It cleaned out the excesses and unsustainable elements in the economy and the economy as a whole was fine. A bad or cripping deflation would be Japan in the 1990's (or the Great Depression.) These are the ones that need to be avoided.

Although the housing mess is pretty bad, the US economy is fine. My opinion is that housing was totally unsustainable (eg. part-time strawberry picker in California owning a house I never could) so the excesses are going to have to be worked through. Subsidizing houses will improve the real estate situation but won't we be back to the original situation? I mean, who is really going to buy that $600,000 home of the strawberry picker? The answer is obvious: the same people who couldn't afford it originally will end up buying with the government subsidy. But just like before, if mortgage rates go up, or if their incomes decline, or whatever, we will have all these non-performing mortgage loans. Only this time, no CDOs consisting of subprime mortgages :)

Tags: ,

1 Response to Bill Gross Calls for US Treasury to Buy Assets

September 6, 2008 at 12:52 AM

"Although the housing mess is pretty bad, the US economy is fine."

I think at least 6.1% of the US population would disagree w/ that assessment.

I, of course, disagree w/ your assessment as well (what's new?).

As far as Bill Gross goes, all I would say is be careful what you ask for. His whole premise is that the treasury bond market would be dumb enough or oblivous enough to ignore the multi-trillions of additonal liabilities that the US government would assume.

Maybe the treasury bond market is comatose, I don't know. But at some pt the treasury bond investors would wake up and start pushing yields up to compensate for the fiscal recklessness. The gazillion-dollar question is, of course, when that may happen.

I don't have the answer.

But it sure is FUN watching the chaos as a financial anarchist!

Post a Comment