Saturday, February 9, 2008

Bond Guru Bill Gross on the Housing Crisis

From U.S. News & World Report:

Bill Gross, founder and chief investment officer of PIMCO, the world's largest family of bond funds with $746 billion in assets under management, believes that without government intervention, home prices could drop as much as 20 percent over the next two years. U.S. News spoke with Gross about what he thinks the government should do to prevent such losses. Excerpts:

Why do you think housing prices are declining?
The simplest explanation is because they went up too much.... It's hard for a home to go down in price significantly unless there's been a bubble. The reason for a significant bubble is not only low interest rates back in the 2003-2004 time period but a significant amount of near-fraudulent behavior in the mortgage market with no-documentation loans and—[as] I call them—"funny money" mortgages. Not all of them are fraudulent, but there certainly was an egregious overreach in terms of the private marketplace that made it possible for anyone and everyone to buy a home.

So now, as the easy lending is not only being pulled back but eliminated, then [the climbing prices], almost by necessity, come to an end. Those are some of the primary reasons, but down the list would also be slow employment. People are getting laid off, and the American wage earner who is the homeowner basically can't afford a home as easily as they could before.

What would stop those declines?
Two things would stop it: One is monetary policy in terms of lower interest rates. Obviously the Fed has lowered interest rates and will probably do more, and that helps out existing homeowners to some extent. For those with [adjustable-rate mortgages] it does, if they don't have to adjust upwards and can begin to adjust downwards.

But the housing decline is really a function of people not buying homes as well as people trying to get out. The old ARM is basically being shunned, so affordability rests on the 30-year mortgage. So what [Fed Chairman Ben] Bernanke is doing is helping, but the fact is, the 30-year mortgage hasn't come down like the fed funds rate. So the Fed has a problem. They can lower short-term rates, but they don't have any control over the 30-year mortgage. That's controlled by us, the Chinese, and anybody else that wants to buy them.

That's a problem and will continue to be a problem. Then it's up to the fiscal side, to Congress, to make changes in terms of regulations and additional programs. They need to use a government agency that's been around since the 1930s, the Federal Housing Administration. We need the FHA to provide mortgages with, at least in my opinion, a subsidized interest rate. Instead of 5.5 or 6 percent, they could put 4 or 5 percent and minimize, if not eliminate, the down payments, so people can afford to buy not only a new home but an existing home....MORE