Bond fund guru Bill Gross, investment head of Pimco, says waiting for Wall Street to step up and fix the ballooning credit crisis simply won't do the job.
The Feds need to put taxpayer money into directly bailing out homeowners at risk of foreclosure or risk much bigger pain down the road.
"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," Gross says in his current note to investors.
Gross says that the current wave of delevering by the banks has pushed up risk spreads and volatility, among other negative indicators. That will continue until enough capital has been raised to reach "equilibrium."
Banks have raised nearly $400 billion so far, but most estimates of the total cost of the credit crunch top $1 trillion.
As long as that balance is out of reach, "prices of almost all assets go down," he writes.
Gross suggests a new Resolution Trust Corp. (RTC), the government agency that unwound the savings and loan crisis by closing down failed hundreds of thrifts in the late 1980s and early 1990s.
"A 21st century housing-related version of the RTC 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," Gross writes, referring to the former Clinton Treasury secretary.
Delevering is simple enough to understand, Gross writes. When government-sponsored entities like Fannie Mae and Freddie Mac, banks, hedge funds, and even individual households "delever," they do so by selling assets. That lowers the prices of not just what they are selling but on other, similar securities in the marketplace.
"The past 12 months, for instance, have focused on subprime and alt-A mortgages and their drastically lowered prices. Stocks of companies that own them are of course marked down, but so are other assets of impeccable quality," Gross contends.
Pimco figures this process has lowered the price on Fannie and Freddie mortgages by as much as 4 percent and pushed up the yield on their 30-year fixed paper by as much as 75 basis points, Gross says.
The "rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time," Gross warns.
"Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami."
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