Urgent action is needed to stave off the rise of Bushville
By Bill Gross
Published: March 5 2008 02:00 | Last updated: March 5 2008 02:00
The United States economy is far from a depression; as a matter of fact, the media and a growing percentage of economists started using the “R” word only a few months ago. I do not expect to see a depression in my lifetime.
The US is a going concern and will remain so. Still, there are developments that remind observers of the days of Hoovervilles – shantytown 1930s communities of homeless citizens nestled out of sight near the railroad tracks instead of on Main Street USA.
Most of the headlines focus on the housing market as indeed they should. While there are no visible Bushvilles as of yet, there were, according to reports from RealtyTrac, 153,000 initial foreclosure notices sent out during the month of January, which, when annualised, suggest that nearly 1½ per cent of America’s homeowners in 2008 may at some point be headed for the tracks or some other destination most of us don’t care to think about. Last year in California alone, nearly one in 52 homes had a foreclosure notice nailed on the front door. In Nevada it was 3.4 per cent.
Wherever they are and whoever was at fault in allowing them to buy a home in the first place, they are at the forefront of a recessionary saga that will cause considerable damage to many US citizens, communities and corporations alike.
Jefferson County, Alabama, for instance, announced last week that it may be unable to buy back nearly $1bn worth of floating rate debt owed to banks owing to the auction rate preferred (ARP) crisis. Standard & Poor’s swiftly cut its municipal bonds from A to junk status.
Even if default is avoided, repercussions in the ARP market apparently have led to last week’s unwinding of billions of dollars of high-quality municipal bonds encased within levered hedge fund structures, raising A and AA yields spreads to levels not seen since – well – since the Depression. Similarly, Ben Bernanke in his Congressional testimony last week spoke of the potential failure of a growing number of small banks; regulatory authorities are now preparing for the hard times by rehiring retired bank examiners who cut their teeth during America’s last banking crisis in the early 1990s.
And so it appears we may have something to fear besides fear itself. The American economy, so dependent on asset inflation of one sort or another, is now experiencing price deflation in all three major categories – real estate, stocks, and yes, bonds.
Despite the rapid decline in Treasury yields, mortgage and corporate credit markets are not co-operating, producing aggregate price declines in total. Historically high levels of consumption as a percentage of gross domestic product are not being supported any more by leverageable assets that appreciate perpetually in price. The economy is faltering.
Policymakers may have noticed this asset deflation but it appears to have had little bearing on the haste of their salvage efforts. Granted, the Federal Reserve has moved quickly with rate cuts and has established its innovative term auction facility (TAF) but with little effect. Mr Bernanke in an address to the Independent Community Bankers conference yesterday suggested a number of measures to alleviate foreclosures. Congress and the Administration, though, argue about “bail-outs” and “moral hazard” while the foreclosures mount and municipalities are forced to pay higher and higher interest rates to stay alive.
Something needs to be done quickly – not to bail out PIMCO, we’re doing fine, thank you – but to halt a destructive asset deflation which, if allowed to proceed, will move our economy in the direction of those Bushville railroad tracks – although still a far distance from them.
Whatever the decision, be it a housing fix advocated by Alan Blinder or the one by Larry Summers or a massive expansion of Federal Housing Association lending authority, it has to be studied and acted on with urgency.
And if the Fed needs to become even more vigorous by expanding the size of its TAF or the collateral it will accept, it must do it now. Policymakers must move quickly to ensure that Bushville is just a figment of some op-ed writer’s imagination and that fearing fear itself as opposed to government inaction and asset deflation becomes the order of the day.
The writer is founder and chief investment officer of PIMCO
