Thursday, August 23, 2007

Bill Gross on Adding More Liquidity

Bill Gross of PIMCO has just posted his latest investment outlook. These reports are always interesting and filled with colorful imagery (recall his comparing the new sexy credit derivatives to hookers with six-inch heels). In this latest report, Bill Gross examines the recent market turmoil and considers the implications of injecting more liquidity to the markets:

"Housing prices could probably be supported by substantial cuts in short-term interest rates, but even cuts of 200-300 basis points by the Fed would not avert a built-in upward adjustment of ARM interest rates, nor would it guarantee that the private mortgage market – flush with fears of depreciating collateral – would follow the Fed down in terms of 15-30 year mortgage yields and relaxed lending standards. Additionally, cuts of such magnitude would almost guarantee a resurgence of speculative investment via hedge funds and levered conduits which have proved to be the Achilles heel of the current crisis. Secretary Paulson might also have a bone to pick with this “Bernanke housing put” since it more than likely would weaken the dollar – even produce a run – which would threaten the long-term reserve status of greenbacks and the ongoing prosperity of the U.S. hegemon."

These points are essentially identical to the ones I made in my previous post: (1) this is an insolvency crisis not a liquidity crisis: there are real painful adjustments that have to be made in the housing sector, (2) injecting more liquidity will only led to more of the financial imbalances that got us here in the first place, and (3) there may long-term implications to monetary accommodation today, such as increased moral hazard and a weakening dollar.

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