The Borrower Bailout Fallacy: Why PIMCO's Bill Gross is Flat-Out Wrong
A growing chorus of regulators and consumer activists were joined this past week by PIMCO's Bill Gross in calling for a borrower bailout. It's sort of like listening to the same song in different keys: some say the Fed has to begin slashing rates, some say the GSE portfolio caps need to be lifted, and still others (like Gross) are proposing a formal government bailout a la the Resolution Trust days of the S&L crisis. They're all missing the point. And for fund managers like Gross, in particular, listening to a contrived lobby for the bail out of 'hard-working Americans' is disingenuous at best. Wall Street is about, has always been about, and will always be about one thing: making as much money as possible. It's never been about the borrowers that have essentially served as oil in the securitization machine. The Great Homeownership Experiment -- you know, the one that had the financial press drooling about historic homeownership gains at this time last year? -- had its roots on Wall Street, who securitized loan pools not out of a sense of responsibility to borrowers, but out of a desire to chase ever-greater yields. Gross at least hints at his real motivation towards the end of his most recent letter. "Stocks and risk-oriented levered investments will spring to life like the wild flowers in Death Valley after a flash flood," Gross writes in discussing the implications of a federally-funded bail out. You can have one or the other, Bill -- the securities markets or borrower's best interests -- but not both. Gross probably isn't alone in wishing for a return to the good old days, FWIW, and he's also not alone in exhorting someone -- anyone -- to step in and "do the right thing" in order to grease the wheels of the machine so it can start rolling again. Hell, I'd love to see that happen, too. HW readers know I'm a mortgage guy. But it won't, because it can't. Here's why: we have millions of borrowers who now have mortgages they simply can't afford. And the ugly truth here is that throwing money at this problem will not change this fact. In fact, it might even make things worse. Any bailout, however structured, will ultimately have the effect of establishing a significant price decline in neighborhoods that can least afford it. Imagine if Johnny Subprime sees his $500,000 2/28 ARM forgiven and replaced with a $400,000 30-year fixed mortgage -- with the difference funded by taxpayers. Now, multiply that effect by at least two million. You explain to me how the other homes in those neighborhoods continue to justify their $500,000 mortgages after that one. By bailing out those who can least afford their mortgages, we essentially reduce home prices to their lowest common denominator -- that is, to whatever price a troubled subprime borrower can bear. And that price will by its very definition be much lower than the price that the rest of the market -- that is, the majority of borrowers who can afford their mortgages -- would otherwise settle on. I haven't even begun to discuss the moral hazard issues here, for both borrowers and for Wall Street. Nor have I begun to discuss what becomes of two million or so borrowers living in homes essentially subsidized by the Federal government. Both concepts have been written about elsewhere. Bad, bad, bad -- all the way around. It isn't pretty to say, but the least painful way out of this mess is to realize that we have an entire group of borrowers who absolutely, positively must lose their home, because they never should have been allowed to purchase it in the first place. Prices are going to fall regardless of whether borrowers are bailed out or not -- and a bailout might actually exacerbate the pricing problems we need to face. The sooner this is recognized -- by regulators, by legislators, and by money managers -- the sooner we can begin working on strategies that can really help those who will be impacted, and the sooner money managers can begin adapting their risk models to something resembling reality. Federal dollars -- if there are to be any appropriated -- shouldn't be used to prolong an already bad situation, or to fund a money manager's pipe dream that says the good old days can somehow return. That money should instead be used to help those borrowers caught in this mess land on their feet. I'd hope that legislators have enough common sense to understand where Wall Street's heart really is on this -- because it isn't with the borrower. It never was.