Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

[Finster]

Today Bloomberg published the following report.

Pimco's Gross Urges Bush to Bail Out U.S. Homeowners

By Patricia Kuo

Aug. 23 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co., urged the Bush administration, rather than the Federal Reserve, to bail out U.S. homeowners to avoid ``destructive housing deflation.''

Let’s dig into this a little bit.

Pimco's Gross Urges Bush to Bail Out U.S. Homeowners

No, Bill. Bush doesn’t have that kind of money.

Gross advised President George W. Bush to set up a ``Reconstruction Mortgage Corporation'' and ``write some checks'' to bail out homeowners

Oh … I see. You want Bush to use MY money. How generous of you.

``Fiscal, not monetary policy should be the preferred remedy,'' said Gross, who manages the $103 billion Pimco Total Return Fund.

You skipped a crucial question. Why does there need to be a "remedy"?

Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co., urged the Bush administration, rather than the Federal Reserve, to bail out U.S. homeowners to avoid ``destructive housing deflation.'

Destructive to whom? Sellers? What about buyers? How can we bemoan the "unaffordability of housing" for buyers out of one side of our mouths and then take the side of sellers out of the other?

Only deflation is destructive? Inflation is not?

``This rescue, which admittedly might bail out speculators who deserve much worse…''

Glad you were able to admit that.

There are precedents from previous crises in the 1990s, Gross said. The U.S. government created the Resolution Trust Corp. to rescue the insolvent savings and loan industry and the Fed organized a bailout to prevent billions in losses from rippling through Wall Street after the collapse of Long-Term Capital Management LP hedge fund in 1998.

You don’t see the connection? It’s called "moral hazard," Bill.

So now you want to sow the seeds of the next crisis. We do this by taking money away from people who did NOT speculate, leverage up, and try to get rich quick, and give it to the ones who did.

``Even cuts of 200-300 basis points by the Fed would not avert a built-in upward adjustment of adjustable-rate-mortgage interest rates,'' Gross said. ``Nor would it guarantee that the private mortgage market, flush with fears of depreciating collateral, would follow the Fed down in terms of 15-30 year mortgage yields and relaxed lending standards.''

Now you’re talking. The way to "avert a built-in upward adjustment" would have been to not issue credit at artificially low rates to begin with.

Not that there isn’t anything that should be done. Maybe some kind of bail-out is in order. How about handing the tab to the lenders who extended credit to people they knew wouldn’t be able to pay it back? Allow no foreclosures on loans made under circumstances of fraudulent lending? Given the creativity of the American tort industry, heck, probably no legislation would be needed. Sure, probably see quite a few more hedge funds would go belly-up, but betcha a truckload of bonds that it would be a long time before we had another crisis like this one!

[bart]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners

Not that there isn’t anything that should be done. Maybe some kind of bail-out is in order. How about handing the tab to lenders who extended credit to people they knew wouldn’t be able to pay it back? Allow no foreclosures on loans made under such circumstances? Given the creativity of the American tort industry, heck, probably no legislation would be needed. Sure, probably quite a few more hedge funds would go belly-up, but betcha a truckload of bonds that it would be a long time before we had another crisis like this!

I like the idea of converting the hedge hogs into road kill...

[WDCRob]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners

Wasn't his point that if someone was going to be bailed out it ought to be Main Street instead of Wall Street?

"Why is it possible to rescue corrupt S&L buccaneers in the early 1990s and provide guidance to levered Wall Street investment bankers during the 1998 LTCM crisis, yet throw 2 million homeowners to the wolves in 2007"

Because I think that's a damn fine question. I'll agree that in a vacuum the right response would be to take the pain and suffering today. But if someone is going to get bailed out (and you know they are), why shouldn't it be the little guy?

Or should 'no moral hazard!' only apply to people who didn't read the fine print on their mortgage (and wouldn't understand it if they had), and those who have employer-provided health insurance?

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners

Wasn't his point that if someone was going to be bailed out it ought to be Main Street instead of Wall Street?

"Why is it possible to rescue corrupt S&L buccaneers in the early 1990s and provide guidance to levered Wall Street investment bankers during the 1998 LTCM crisis, yet throw 2 million homeowners to the wolves in 2007"

Because I think that's a damn fine question. I'll agree that in a vacuum the right response would be to take the pain and suffering today. But if someone is going to get bailed out (and you know they are), why shouldn't it be the little guy?

Or should 'no moral hazard!' only apply to people who didn't read the fine print on their mortgage (and wouldn't understand it if they had), and those who have employer-provided health insurance?

This wouldn't just be a bail-out for homeowners, as Gross himself admits. It would be a bailout for hedge funds and other high-finance speculators. Going the tort route would save the homeowners at the expense of the latter. Not yours and mine and other folks that had nothing to do with it. If we simply continue to reward the irresponsible and penalize the responsible, we'll continue to get more of the former and less of the latter.

[WDCRob]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners

Sorry Finster, I didn't actually get to the end of your post.

Or maybe the lack of oxygen way up there atop the Moral High Ground affected my reading comprehension?

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners

Sorry Finster, I didn't actually get to the end of your post.

Or maybe the lack of oxygen way up there atop the Moral High Ground affected my reading comprehension?

You're missing the point. It's about who pays.

Take a closer look at what's at stake:

http://www.bloomberg.com/apps/news?p...d=a2kyW8bmxMd8

Bonuses on Wall Street Threatened by Credit Crunch

(Update2)

By Jenny Strasburg and Christine Harper

Aug. 22 (Bloomberg) -- The credit-market freeze that's paralyzing leveraged buyouts, mergers and myriad computer-driven trading strategies may cut Wall Street bonuses for the first time in five years...

[jimmygu3]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

Thanks, Finster. It seems to me that whenever some finance bigwig (like our pal Cramer) starts pleading for government to bail out the little guy, he has an ulterior motive. The hot potato is overvalued housing, and the banks and Wall St. would rather leave the little guy holding it. Problem is, the potato's so hot that the little guy can't hold it, so Gross is asking Uncle Sam for oven mitts. He recognizes that government subsidies could keep the mortgage payment cash flowing in, avoiding millions of bank-owned houses that nobody wants or can afford without the bank taking a big write-down on the price.

I suppose one thing the little guy could use would be the right to declare bankruptcy and walk away from a predatory subprime mortgage without the bank seeking deficiency judgement. I assume our bank-authored bankruptcy bill doesn't allow for that, though.

[Ant]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

Not that there isn’t anything that should be done. Maybe some kind of bail-out is in order. How about handing the tab to the lenders who extended credit to people they knew wouldn’t be able to pay it back? Allow no foreclosures on loans made under circumstances of fraudulent lending? Given the creativity of the American tort industry, heck, probably no legislation would be needed.

You are correct. Just one venue open to any borrowers who were legitimately defrauded detailed in story "Mtge Lawsuits Could Bail Out Some Borrowers" and discussed on Barry Ritholtz' blog:

...For those few people familiar with the Federal Truth-in-Lending Act (TILA), this won't be much of a surprise. To everyone else, read on.

What happens if a lender fails to comply with the TILA rules? The borrowers are allowed to RESCIND THE LOANS AND VOID THE MORTGAGES ON THEIR HOMES. The mortgage lender is then just another unsecured creditor, who must get in line behind everyone else who may have filed a lien on the property. Who ever files first (Credit card, auto finance, doctors, etc.) has first priority.

http://bigpicture.typepad.com/

[GRG55]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

Maybe there's another way of looking at this situation. Perhaps the Main St. vs Wall St. bail out may be a moot point. Wall St. appears to have executed a remarkably effective marketing job to foreigners, and stuffed every corner of the globe with garbage paper backed by US housing. Every day there's a new revelation by someone holding this junk - hedge funds from Australia to Zurich, German state banks, BNP Paribas, and today even the Chinese fessed up. Isn't a bail out of anybody really ultimately a bail out of these foreign CDO holders?

I am not an economist, but on a macro level seems to me that over the last 5 years the USA has built about 20 years of housing stock, complete with new roads/utilities/malls/schools, etc. without using any of its own national savings (hell, there aren't any savings...). All of this funded by foreigners who are now taking a major balance sheet hit. They can't very well jet over to the USA and take the assets back with them now can they.

Bail out or no bail out, the end result is the USA has an enormous inventory of modern housing stock and the foreign investors have...well...a fresh hair cut. Over the years to come this probably means that a disproportionate share of USA national income and savings can be devoted to productive, export related investment as it works off the oversupply in the fundamentally unproductive housing sector. That should make the Chinese lose a bit of sleep.

[Rajiv]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners

An article by Alan Maas - "Paying For The Mortgage Mess"

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These two stories show that the real victims of the U.S. economy’s spreading mortgage crisis aren’t panicked investors or Wall Street banks–and especially not the loan sharks at Countrywide or New Century or the other mortgage companies that got rich off the housing boom.

The real victims–whether they lose their homes, or if they’re “only” forced to pay for the crisis through a variety of economic consequences, including a looming recession–are working people.
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Only a few weeks ago, the International Monetary Fund announced it was raising its outlook for the global economy, predicting that any slowdown in the U.S. would be offset by rapid expansion in China and India, and an upswing in Japan and Europe.

But this month’s panic on the financial markets indicates that the opposite could be taking place–the crisis set off by the U.S. mortgage mess causing a generalized credit crunch that chokes off economic growth worldwide.

Whatever happens next, this much is certain–the threat of recession comes after a period of economic expansion in which U.S. workers’ living standards nevertheless stagnated or declined.

Even after the last recession officially ended in 2001, median household income (adjusted for inflation) continued dropping, ending almost 4 percent lower in 2004 than five years before. Individual states in the industrial Midwest suffered depression-like declines amid the “boom.” In Michigan, real household income dropped by 18 percent between 1999 and 2004.

Now, without even having made up lost ground from the last recession, U.S. workers face the possibility that the bottom will fall out again. The first signs this time won’t be job losses–but home foreclosures. And they will happen this time after Congress did Corporate America’s bidding and passed a bankruptcy bill that makes overwhelming debt a life sentence.
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A real solution to this crisis would require major government action. For one thing, the bankruptcy bill should be repealed immediately. The Feds could take over the mortgage companies and expropriate the assets of any of the crooks associated with them. Mortgages that were packaged together in bonds for the speculators to gamble on could be taken over, too, and the loans renegotiated on generous terms.

But in America today, the profits of a hedge fund come before the homes of working people.

What kind of society sets such immense financial obstacles in the way of people guaranteeing one of the most basic necessities of life–a roof over their head? As this crisis plays out, millions more people–in the U.S. and around the world–will be asking that question.

[Finster]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

...The hot potato is overvalued housing, and the banks and Wall St. would rather leave the little guy holding it. Problem is, the potato's so hot that the little guy can't hold it, so Gross is asking Uncle Sam for oven mitts...

Great quip, Jimmy! This issue is a gem. It has a lot of different facets, but they're all part of the same stone.

Despite my pointed rhetoric, I think Gross is a pretty good guy. But his reco here is a disaster. If it's just homeowners he wants to help (with other people's money), there are lots of other ways to do that.

What happens if Uncle Sam (meaning you and me and lots of other innocent folks) cuts a bunch of checks? The homeowners get to keep their homes, all right, but by making payments to the lenders. Thus the lenders get bailed out. The lenders to the lenders in turn get bailed out. We prevent a recession in the Hamptons and Cayman Islands. Is that a good use of US middle class tax money?

It would also subsidize profits at places like BNP Paribas and Bank of China. Bank of China Shares Fall in Hong Kong on Subprime. GRG55, you correctly pointed this out. So net-net these lenders and lenders to lenders and lenders to lenders to lenders effectively get their subprime paper upgraded to gilt-edged Treasuries at US taxpayer expense.

No, what needs to happen is for the insolvency of the subprime borrower to flow right back up the chain to the lenders.

Of course, homeowners in default run a legitimate risk of loss themselves, specifically, foreclosure. The papers they signed gives the lenders that right. But that's not quite so simple either. As WDC noted, there's a lot of stuff in fine print. Worse yet, the borrower doesn't actually even see most of that fine print until he gets to the closing table. By then, the movers are on the way, his previous house sold, or maybe his credit card collection agency is hounding him. Either way, he's under immense pressure to complete the transaction. Now if it was perfectly clear to the borrower when he applied for the loan that the payment could to go up to 3X dollars in three years and if he couldn't pay he'd likely lose his house, then that's a risk he knowingly took and foreclosure is the just outcome if he doesn't pay. But that represents probably the minority of transactions. Lenders got very aggressive and highly relevant information was presented late in the process when the borrower was under duress. In such circumstances, a good argument can be made that the borrower ought to get to keep his house merely by making the same payments he was quoted at the teaser rate. The lender absorbs the loss.

[jimmygu3]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

Bail out or no bail out, the end result is the USA has an enormous inventory of modern housing stock and the foreign investors have...well...a fresh hair cut.

Good point. But if there's a bail out, as Finster said:

lenders effectively get their subprime paper upgraded to gilt-edged Treasuries as US taxpayer expense.

However, with no bail out, investors have to realize REAL losses. Banks have to foreclose, reprice and resell huge inventories of homes. The people and companies that encouraged this mess will be held accountable (maybe). And perhaps investors will be a bit more careful who's advice they trust in the future.

Meanwhile, drowning subprime borrowers can just leave the keys with the bank and go rent an apartment. Big corporate landlords can buy up the distressed houses for 50 cents on the dollar and rent them out to the same people. The Chinese may even want in on that deal. Owners of capital will own the houses and people living check-to-check will pay rent like they used to. Rents and housing values will fall back into historical norms. Balance is restored. I know it's not that simple, but it makes sense to me.

Jimmy

[jk]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

a bailout of borrowers can be arranged without bailing out the lenders. just have gambler mae buy the mortgages or mortgage based securities AT THE MARKET PRICE, giving the lenders a severe haircut. then gambler mae can renegotiate new mortgages on reasonable, or possibly concessionary, terms.

[bill]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

http://www.washingtonpost.com/wp-dyn...l?hpid=topnews

Now, as the era of easy money yields to a credit crunch, the Bush administration is considering broadening the FHA's mandate to help borrowers avoid foreclosure. The administration is studying the possibility of allowing the FHA to take on mortgage refinancings for borrowers in default, something the agency is not currently permitted to do, a senior official at the Department of Housing and Urban Development said.

The government could make the change without action by Congress, the official said, adding that no decisions have been made. One question to be resolved is whether the FHA should be given flexibility to insure loans without a down payment.

[metalman]

Re: Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money

http://www.washingtonpost.com/wp-dyn...l?hpid=topnews

bill you are peerless in ferreting out this info on what the gummit is up to.

moral hazard in every direction. why i'm gonna go out and put a punch of gold on my credit cards and then borrow against the sure thing appreciation in gold. if it falls in value half and i default on my loan, they'll bail me out, right?

oh, i forgot. gold ain't part of the fire econ. houses are. darn.