PIMCO fund manager Bill Gross warned a week ago in Bloomberg, U.S. Must Buy Assets to Prevent `Tsunami’
The U.S. government needs to start using more of its money to support markets to stem a burgeoning “financial tsunami,” according to Bill Gross, manager of the world’s biggest bond fund.
Banks, securities firms and hedge funds are dumping assets, driving down prices of bonds, real estate, stocks and commodities, Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., said in commentary posted on the firm’s Web site today.
“Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,” Gross said. “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.”
The government needs to replace private investors who either don’t have the money to buy new assets or have been burned by losses, Gross said. Pimco, sovereign wealth funds and central banks are reluctant to fund financial firms after losses on investments they made to support the companies, Gross said. The world’s biggest banks and brokers have raised $364.4 billion in new capital after more than $500 billion in writedowns and credit losses since the beginning of last year.
This and with Gross’s previous call to blow up homes are a belief that something around the current level of asset prices is necessary to avoid a collapse of the economy.
Why should asset prices not fall? Of course this is worse for the owners of assets, but it is good for people with cash who wish to purchase assets. There is no particular level of asset prices that is necessary for the economy to function. Assets derive their value, ultimately, from consumer demand for the products that are produced by business firms. Asset prices do (or should) represent the best estimate of the value of the firm’s capital toward meeting consumer demand some time in the future.
The Austrian theory of the business cycle shows how asset prices can rise above the level consistent with the organization of investment to meet consumer demand, through an expansion of credit. Another factor that can distort asset prices is the moral hazard created by central bank bailouts of failing financial institutions.
Falling asset prices, then, are part of the process of reorganizing productive activity to meet consumer demand. What I suspect that this is about is bailing out Gross and his buddies who were large shareholders of paper that would lose most of its value if a rational re-pricing were allowed to occur.
This week, Gross got his wish. The Financial Times reports , “Mr Gross had made a big shift out of US Treasuries and corporate bonds over the past year and into agency bonds, betting that the government would support Fannie and Freddie Mac. By May this year, more than 60 per cent of his $132bn fund was in mortgage debt.”. The value of the bailout to PIMCO was estimated by the FT at $1.7Bn.