Bond fund manager Bill Gross of the giant fund family PIMCO writes in his recent commentary
Make no mistake, the current conundrum that must be solved is: how to make the price of 120 million U.S. barns stop going down in price and then to make them go up again. That, however, is easier said than done. One of the wisest men I know has this serious but admittedly impractical solution: have the government buy one million new/unoccupied homes, blow them up, and then start all over again. Absent that, he’s not quite sure what to do, nor am I, with the exception of the next paragraph’s proposal.
It’s not entirely clear how serious Gross is but, taking him seriously for the moment, this is rather similar to programs actually carried out during the Great Depression to buy up agricultural products (such as pigs) and destroy them. The thinking at that time was that low prices caused the depression by lowering the purchasing power of sellers; so that, if prices of agricultural products could be raised, then the purchasing power of farmers would increase, they could buy more of other goods, and that would lift the economy out of its slump.
The flaw in this thinking is shown Say’s law: supply of one kind of thing constitutes demand for other kinds of things. Reducing the supply of some goods, i.e. pigs, or homes, reduces the demand for other goods. For this reason, there can never be a general oversupply problem.
However, there can be insufficient demand for existing supply of a particular good to support a selling price above the cost of production because the good was produced out of proportion to demand for that thing in particular. This is the case we are facing right now with housing. Contrary to Gross, falling home prices are part of the solution, not part of the problem. The problem is not low home prices as such. The problem is that home prices were inflated out of proportion to real (i.e. funded) consumer demand by a combination of credit expansion, the activity of the GSE in purchasing home mortages, lower lending standards, and bogus ratings on securitized loans.
These factors resulted in more homes being produced than were really demanded by consumers, at the cost of fewer of other types of goods being produced. While it’s true that the these homes were built because of artificial demand, now that they exist, they are certainly worth something to someone, and destroying them would only us even poorer than we would otherwise be when we get done paying for this mess.
{ 19 comments }
Yes, how wonderfully compassionate…to decide that people shouldn’t be allowed to pay lower prices for homes.
The irony would be hysterical were it not so sad. After decades of failed attempts by government to provide “affordable housing” they’ve finally succeeded, only now they want to blow up all the affordable housing!
In addition to Robert’s excellent analysis, I would add that fundamental changes need to be made in this country’s monetary and banking policy so that artificially induced asset bubbles do not reoccur.
I am assuming that monetary/financial stability is considered a positive. Some finance practitioners view volatility (and the boom phase) as a chance to make money, and have little concern for the economic and ethical consequences, including the eventual resulting economic contraction, of the Fed’s manipulation of money and credit.
After decades of failed attempts by government to provide “affordable housing” they’ve finally succeeded, only now they want to blow up all the affordable housing!
It’s almost enough to make a fellow wonder if affordable housing was their true goal.
If not, then it’s not a case of “irony” so much as “fraud.”
One can only hope our financial leaders and their wise friends can safely and sanely lead us out of this mess……..
Oh, nevermind.
On second thought, I think they might be onto something, we’ll give them away to Bond Managers and their wise friends first. Then by all means carry on……
What gets me most is that he seems to understand that our money system since WWII has led to the “rancid” side effect of inflation, and ultimately is responsible for our hellacious bind we are now in, but that it was STILL necessary for capitalism to work. Socialist money management necessary for capitalism to work. Where did I leave my copy of 1984…..?
Who says real estate never goes down?? It’s subject to the same market forces as everything else.
I’ve read Bill Gross’ commentary on a few other topics already, so it comes as no surprise to read another ridiculous proposal like this one. The previous thing I read by him was placing the blame on the finance industry for the subprime crisis and called for regulation of financial instruments, completely ignoring any role government might have had in the process.
If destroying unwanted houses is the preferred method of keeping the prices of (surviving) houses high, what do you think they would do to keep wages high?
Hmmm… Americans can all be more prosperous by destroying valuable American homes… I don’t think this lunacy needs any further comment
Yet another confirmation that investment and/or business skills do not corelate with economic comprehension. Perot, Iacocca, Soros, Buffett and now Gross are the evidence.
Gross owns a metric tonne of mortgage debt in his various funds, and he is, to be charitable, an attention whore. Even though I work in his field, I no longer can even force myself to read his stuff.
I’m not sure that Bill Gross is serious. In the past, cars, college tuition, and maxed-out credit cards were financed by taking out home equity loans based on inflated equity. The fact that this can no longer take place is bound to have a “negative” effect. This is where the Austrian School would disagree and call this a positive effect.
Reading through Bill Gross’s article, he makes many good points. However, the idea that poor credit or credit fraud was the source of the problem is just not true. Even if an application had no income/no assets, it at least had a FICO score, and this was known to Moody’s and S&P when they rated the securities. (There were only a handful of cases where people figured out how to game the FICO score to get a better rate.)
Bill Gross also calls for regulation of financial instruments. Isn’t that what the SEC did? You can’t securitize anything without filing with the SEC.
@magnus – Heh, that’s great
@Brian – yup, and that’s why you get convoluted theories like reflexivity or whatever Soros believes in instead of pure economics.
I’ve wondered many times how otherwise extremely intelligent people who understand business quite well (especially Buffett) don’t understand the causes of business cycles or bubbles.
At least Buffett is smart enough to mostly stay out of dangerous investments and not make recommendations like razing a million homes to the ground.
If markets were allowed to adjust (that’s a big if with the coming socialization of Fannie & Freddie), housing should become cheaper than it has been in a long, long time.
Another guy of PIMCO is supporting governement backing of wall street assets on the ground of keynesian “paradox of thrift”.
http://www.pimco.com/LeftNav/Featured+Market+Commentary/FF/2008/GCBF+July+2008.htm
“For me, a simple concept brought this realization: the paradox of thrift. For those of you who might not recall, the paradox of thrift posits that if we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person’s spending is another’s income – the fountain from which savings flow.
This principle is part of a whole range of macroeconomic concepts under the label of the paradox of aggregation: what holds for the individual doesn’t necessarily hold for the community of individuals. Understanding this paradox is absolutely vital to understanding macroeconomics and even more so to understanding what is presently unfolding in global financial markets. ”
As we could expect, PIMCO bought a lot of Fannie Mae / Freddie Mac bonds thanks to government backing.
http://www.smartmoney.com/email/index.cfm?emailcontent=/news/ON/index.cfm?story=ON-20080717-000760-1235
“Pimco: Enthusiastically Buying Agency Mortgage Bonds July 18, 2008
By Prabha Natarajan
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)–Pacific Investment Management Co., or Pimco, which manages the world’s largest bond fund, said it is bullish on mortgage bonds guaranteed by Fannie Mae (FNM) and Freddie Mac (FRE).
The fund manager in a conference call with nearly 800 clients Thursday said it is overweight on these bonds in its portfolios, without divulging specific percentages.
“We have incorporated them within our core portfolios, and are adding them enthusiastically on weakness,” said Jennifer Bridwell, a mortgage strategist and senior vice president at Pimco.
She added that Pimco is buying fixed-rate pass-through notes issued by Fannie, Freddie and Ginnie Mae.
Pimco’s mortgage strategists say their position is in line with their thinking that these so-called agency bonds remain fundamentally sound investments and at today’s prices, considerably attractive to buyers.
Further, U.S. Treasury Secretary Henry Paulson’s proposal on Sunday in addition to statements from President George W. Bush and Fed Chairman Ben Bernanke indicate unprecedented levels of support to the two government-sponsored enterprises, Pimco’s strategists said. ”
“By definition, levering Uncle Sam’s balance sheet to buy or guarantee assets to temper asset deflation will put the taxpayer at risk – but will do so for their own collective good! ”
I just sold all my stock funds for dollars, and sold all my dollars for gold. I also sold all my saved dollars for gold. thats my way of “dynamiting.” but rather than burning the dollars, I put them back in circulation.
If only those million homes could be dismanteled, and we could infuse the capitol and material of which they were made back into the economic system, employing people to rebuild something new and of better value
Destory NEW homes? It is the old homes that need to be destroyed. I know many people who have found out the hard way that a tiny 100 year old home for $120,000 is more expensive than a large new home for $200,000 after you count how much it costs to heat.
I wonder if Bill Gross is also one of those people who think CO2 is a big problem. Would really make his position ironic because heat is a byproduct of CO2 production.
Ron: “After decades of failed attempts by government to provide “affordable housing” they’ve finally succeeded, only now they want to blow up all the affordable housing!”
I was thinking the same thing. It worries me what they might do should healthcare costs start falling one day. The horror…
Why not?
I seem to remember the DOA burning surplus crops, paying farmers not to grow etc.
During the S&L crisis, when S&L’s had used their subsidy to produce a glut of unoccupied commercial real estate, there were calls to bulldoze it!
It seems, for the government, that this is par for the course.
Has anyone come up with a plan to pay home builders not to build?
Bill Gross is a smart private sector bond trader who watches the markets, like a hawk flys over and watches a farm field for its next meal, and he tries to turn a profit for Pimco. Don’t blame him for government policy. Give him stupid government decisions and he’ll figure out a way to profit from it. He is a player, not a rule maker….. And he doesn’t depend on policy mistakes to turn a profit, mistakes just provide additional volitility to create speculative opportunities.
Take his comment about blowing up houses with a grain of salt. He was speaking rhetorically…about supply and demand of housing…and simply turning a phrase to explain that there is currently a glut in the housing market and further that this is sufficiently important to spill over to into a macroeconomic conundrum that is throwing off Wealth, Consumption, Investment, Employment etc. These fundamental metrics of the economy are sufficiently out of whack to be having serious secondary and tertiary ripple effects through the domestic and international economies. Simultaneously every other thing is effecting every other thing.
Hence Gross calls it all a conundrum, for everyone, but especially the policy makers who have many simultaneous goals mandated by their complex plural constituency…thus they have many plates in the air…like the entertainers on the old Ed Sullivan TV show. If it’s hard to keep a dozen plates spinning on a dozen sticks, then imagine how difficult it is for the Federal Reserve, Treasury, Congress, and the President and the 50 state governments to influence and set rules for money supply, banks, housing, employment, etc. etc etc.
They try while at the same time you and I and Bill Gross and nearly everyone else are gaming the system for our private interests.
And for entertainment, we would throw to the lions any government or corporate officer who gets caught ruling without integrity, failing to put the economy and the collective common good ahead of their narrow private interest.
Remember, like us, the rulers are tempted too, but we demand they keep themselves in check.
Some feel that all would be well, if only, we who are ruled would reflexly demand of ourselves that we keep in check too. But then we don’t all play by the same rules ourselves, not consistently being sure what rules even apply and whether we would choose to abide by them if we did know them.
Do you still follow what I’m trying to say or are you lost? If you are lost, then you may be part of the problem causing the conundrum that surrounds this enigma that we hope the Fed, Congress, and President etc will soon fix.
Excellent post ^^
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