Subprime Crisis is Not an Isolated Event says Bill Gross
PIMCO’s Bill Gross covers the Bear Stearns/subprime crisis in his July 2007 investment outlook, which is entitled “Looking for Contagion in All the Wrong Places”. Here are some snippets:
Many of these good looking girls are not high-class assets worth 100 cents on the dollar. And sorry Ben, but derivatives are a two-edged sword. Yes, they diversify risk and direct it away from the banking system into the eventual hands of unknown buyers, but they multiply leverage like the Andromeda strain. When interest rates go up, the Petri dish turns from a benign experiment in financial engineering to a destructive virus because the cost of that leverage ultimately reduces the price of assets. Houses anyone?
[SNIP]
Those that point to a crisis averted and a return to normalcy are really looking for contagion in all the wrong places. Because the problem lies not in a Bear Stearns hedge fund that can be papered over with 100 cents on the dollar marks. The flaw resides in the Summerlin suburbs of Las Vegas, Nevada, in the extended city limits of Chicago headed west towards Rockford, and yes, the naked (and empty) rows of multistoried condos in Miami, Florida. The flaw, dear readers, lies in the homes that were financed with cheap and in some cases gratuitous money in 2004, 2005, and 2006. Because while the Bear hedge funds are now primarily history, those millions and millions of homes are not. They’re not going anywhere…except for their mortgages that is. Mortgage payments are going up, up, and up…and so are delinquencies and defaults.
[SNIP]
The right places to look for contagion are therefore not in the white-washed Bear Stearns hedge funds, but in the subprime resets to come and the ultimate effect they will have on the prices of homes – the collateral that’s so critical in this asset-backed, and therefore interest-sensitive financed-based economy of 2007 and beyond. If delinquencies lead to defaults and then to lower home prices, then we have problems and the potential for an extended – not a 27-day Paris Hilton sentence.
[SNIP]
If subprime total losses hit 10% then even some single-A tranches face the grim reaper. AAA’s? Folks the point is that there are hundreds of billions of dollars of this toxic waste and whether or not they’re in CDOs or Bear Stearns hedge funds matters only to the extent of the timing of the unwind. To death and taxes you can add this to your list of inevitabilities: the subprime crisis is not an isolated event and it won’t be contained by a few days of headlines in The New York Times. And it will not remain confined to a neat little Petri dish in some mad financial derivative scientist’s laboratory. Ultimately through capital market arbitrage it will affect risk spreads in markets completely divorced from U.S. housing.
[SNIP]
Importantly, as well, and this point is neglected by most pundits, the willingness to extend credit in other areas – high yield, bank loans, and even certain segments of the AAA asset-backed commercial paper market should feel the cooling Arctic winds of a liquidity constriction.
If not taken too far – and there is no hint yet of a true “crisis†– these developments may be just what the Fed has been looking for: easy credit becoming less easy; excessive liquidity returning to more rational levels. Still, PIMCO looks for the Fed to issue an insurance policy in the form of lower Fed Funds at some point over the next 6 months…
This post has 4 comments
June 26th, 2007
Bondo Gross?
The Bondo Gross who’s been talking about Grapes of Wrath, soup kitchens, tobacco road, brother can you spare a dime, zimbabwe style inflation, 1929, and dot bomb…all while eating the market’s dust the past 3 years?
That’s the Gross you’re talking about?
June 26th, 2007
Bondo Billy does have a flair for hyperbole, doesn’t he? Too bad the actual numbers are not working in his favor.
If you look over the last two years—2005, 2006—over that two year period there were 16 million mortgages issued for both new and existing homes. Of that amount, only 20 percent of those were subprime, which means 3.2 million subprime mortgages in its peak. There’s 114 million mortgages outstanding. Even if every single one went into default, which we know that isn’t going to happen, that’s 2 percent of the overall outstanding mortgages.
Contagion or scared permabear hype?
June 26th, 2007
Call me old fashioned— call me old, for short— but I find it highly inappropriate for the Managing Director of trillions of dollars of other peoples’ money to refer to the Chairman of the US Federal Reserve System as “Ben”, rather than as “Mr. Bernanke”.
And I would not place a dime of my own moola with any clown in such a position who thought it appropriate to so much as mention Paris Hilton in a sentence.
June 27th, 2007
C’mon O’Connor, Bondo Billy is simply executing a time tested and tired old tactic of being snide, glib - and wrong. When thet’re getting the snot beat out of them, certain character-types always take the low road and show their true colors.
Being right is far less important than simply sounding convincing to those guys - that’s where the money is.