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October 1, 2007
Bill Gross Hearts Jim Cramer
Some interesting stuff on changing debt markets in Bill Gross's latest column on the Pimco site, including a back-handed love note Jim Cramer:Yet the validity of Cramer’s [Fed knows nothing rant on CNBC] rant remains to be disproved. The modern financial complex has morphed into something unrecognizable to many astute market veterans and academics. Bernanke’s fellow governors and Hank Paulson’s staff at the Treasury spread their roots during an era in which traditional banking activity – lending out deposits backed by a certain level of reserves – was the accepted vehicle for liquidity creation. Remember those old economics textbooks that told you how a $1 deposit at your neighborhood bank could be multiplied by five or six times in a magical act of reserve banking? It still can, but financial innovation has done an end run around the banks. Derivatives and structures with three- and four-letter abbreviations – CDOs, CLOs, ABCP, CPDOs, SIVs (the world awaits investment banking’s next creation; perhaps IOU?) – can now take a “depositor’s” dollar and multiply it ten or 20 times. Reserve banking, and the Federal Reserve that regulates the system, appear anemic in comparison.
I’m sure that Bernanke, Paulson, and their cohorts understand this, but it isn’t yet clear how much they appreciate it. Alan Greenspan admits in his newly published book that he didn’t appreciate until recently the impact adjustable-rate mortgages and their subprime character, accompanied in some cases by outright fraud, would have on the housing market. If the Fed was so slow to grasp the role that subprime mortgages played in the housing boom and bust, do the Fed and the Treasury of today totally comprehend what happens when the nonbanking private system suddenly stops flooding the market with credit? Do they recognize that such a shutdown puts spending for housing and business investment at risk, and job growth as well? The Fed will have to adapt its monetary policy, and the Bush Treasury will have to adjust its fiscal policy to this brazen new world dominated more and more by private rather than public policies and proclivities. To overcome private-market caution, the Fed may need to put on a bold face marked by even more decisive cuts in short-term rates. To prevent a housing-market slump from metastasizing into a cancerous self-feeding tumor, Treasury Secretary Paulson will have to coordinate policies that lend a helping hand to homeowners in distress.
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How true. As Churchill said many years ago, "America always does the right thing -- after trying every other option."
Hopefully, we will not see a new bout of regulation by Congress. I suspect most market participants in the subprime lending mess are pretty chastened right about now, so regulation may be unnecessary.
Bill Gross loses all credibility with me when he repeatedly calls for a bailout for homeowners. Also, it is clear that he's a Democrat with his repeated digs at "Republican orthodoxy." It is good to see that he finally takes a moderate stance with regard to rates, as he recognizes the dollar-weakening and market-inflating effects, but I have to wonder if anyone takes him seriously.
Could a meltdown caused by non-traditional credit sources result in regulation of those markets?
There's no time like after the damage has been done to fix the problem - it's what the federal government is great at. In the military, it's referred to "Always fighting the last war."