That's the basic gist of the article. This guy usually isn't "grim". You need to go to the link to see the charts http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2007/IO+April+2007.htm ....big snip.... The problem with housing, however, is not the frequently heralded increase in subprime delinquencies or defaults. Of course write-offs, CDO price drops, and even corporate bankruptcies of subprime originators and servicers will not help an already faltering U.S. economy. But foreclosure losses as a percentage of existing loans will be small and the majority of homeowners have substantial amounts of equity in their homes. Because this is the reality of our U.S. housing market, analysts and pundits now claim weâre out of the woods: the subprime crisis is or has been isolated and identified for what it is â a small part of the U.S. economy. It will not be loan losses that threaten future economic growth, however, but the tightening of credit conditions that are in part a result of those losses. To a certain extent this reluctance to extend credit is a typical response to end-of-cycle exuberance run amok. And if one had to measure this cycleâs exuberance on a scale of 1-10, double-digits would be the overwhelming vote. Anyone could get a loan because shabby credits were ultimately being camouflaged within CDOs that in turn were being sold to unsophisticated foreign lenders in need of yield as opposed to ¼% bank deposits (read Japan/Yen carry trade). But there is something else in play now that resembles in part the Carter Administrationâs Depository Institutions and Monetary Control Act of 1980. Lender fears of potential new regulations can do nothing but begin to restrict additional lending at the margin, as will headlines heralding alleged predatory lending practices in recent years. After doubling over 18 months between 2005 and the first half of 2006, non-traditional loan growth has recently turned negative, and lendersâ attitudes are turning decidedly conservative as shown in Chart 1. Bulls and bears argue over websites as to the percentage of all lending that subprime and alternative mortgage loans provide but while important, the argument obscures the critical conclusion that tighter lending standards and increased regulation will change the housing outlook for some years to come. As past marginal buyers are forced to sell their home to prevent foreclosures, so too will future marginal buyers be restricted from buying them. No one really knows the amount that homes must fall in order to balance supply and demand nor the time it will take to do so, but if one had to hazard a conclusion, it would have to be based in substantial part on affordability statistics that in turn depend on financing yields and home price levels in a series of different scenarios as outlined in Chart 2. The chart shows the amount that home prices or mortgage rates (or a combination of the two) need to decline in order to revert back to affordability levels in 2003, a year which might have been the last to be described as a ânormalâ year for home price appreciation. Since then, 10+ annual gains have been the rule whereas average historical estimates provided by Robert Shiller may have suggested something on the order of 4-5%. By that measure alone, homes are likely 15-20% overvalued (3 years x 5%+ annual overpricing). Chart 2, in addition suggests much the same thing. If mortgage rates donât come down, home prices need to decline by 20% in order to reach prior affordability levels. If rates do come down, home prices will drop less. Chart 2, while somewhat subjective and time dependent, introduces the critical connection between home prices and interest rates. PIMCO cares about housing and its fortunes, but primarily because of its influence on yields. And while the Fed may be willing to allow U.S. homeowners to suffer a little pain as indeed they have in recent quarters, a double-digit decline would risk consequences that few central banks would be willing to underwrite. So a forecast of home prices almost implicitly carries with it a forecast for interest rates. To prevent a double-digit decline in prices, PIMCOâs statistical chart suggests that mortgage rates must decline a minimum of 60 basis points and the sooner the better. The longer yields stay at current levels, the more downward pricing pressure will build as foreclosures/desperate sellers dominate price trends as opposed to prospective buyers. While the Fed, as pointed out in last monthâs Investment Outlook must be cognizant of an array of asset prices in addition to housing, homes are the key to future equitization trends, and fundamental therefore to the outlook for consumption. You may want to take this looming grim reality with a grain of salt or suggest as old worlders do that itâs not real at all if it canât be touched or if it doesnât touch you. Not so. Donât take my word for it though. Investigate the Fedâs own study, written in September of 2005 (Monetary Policy and House Prices: A Cross-Country Study) covering housing cycles in aggregate and individually for 18 countries over the past 35 years. This studyâs important conclusion for PIMCO and our clients is that if home prices in the U.S. have peaked, and are expected to stay below that peak on a real price basis for the next three years, then the Fed will cut rates and cut them significantly over the next few years in order to revigorate an anemic U.S. economy. Strong global growth (not part of this studyâs assumptions) may temper historical parallels and provide a higher floor than would otherwise be the case. Nonetheless, prices for houses that I can see and touch every day outside my office are morphing with bond yields inside my computer screen to produce a reality show that speaks to an ongoing bond bull market of still undefined proportions. William H. Gross Managing Director
the fed is NOT going to lower rates by 125 basis points! it would take them at least a year to lower rates by that much.. at LEAST!
It won't save it. Lending standards have tightened, and the market psychology towards housing as a "can't lose" proposition has shifted. These psychological shifts.....they are long in the making and in the reversal. I like Bill Gross, but he clearly is pumping his own, massive, multi-billion dollar agenda here. He holds billions in bonds. If the fed cuts rates, he makes another couple hundred of million dollars just like that. Thanks for the advice anyways, Bill.
I think he's saying that as prices decline the Fed will find reason to ease, and I guess that means if they only lower it 1/2%, we'll be looking at a 10 or 15% decline. That was the way I read his chart, anyway. Right now, they aren't going to admit they will need to ease. It would scare the sheep even more if they did. I would guess they don't start until the year is lost for home construction and real estate. Its just the way they are. They aren't going to do anything to help until the damage has already been done. Generally, people want to have sold and bought before school is out in May. Feb and March have already been lost, and I bet the credit crunch takes a bite out of Apr and May as well. Once May is past, the companies will be forced to cull their flocks to the bone and dig bunkers for a skeleton crew to survive the winter. Time will tell.
Lower rates by 1.25%, send inflation sky high & for what???? To save the arse of idiots who bought McMansions they never could afford????? To heck with that!!! THEY made the stupid purchase, not me. Why should I suffer with higher inflation to save their arse???? They can go to H in their two Land Rovers, McMansions, Granite Countertops & shiny $500 faucets! I lived responsibility. Don't penalize me for them!
Yeah baby!!! Open up that liquidity tap and let those freedom dollars flow! The 'Greenspan Doctrine.'
Right buddy, And kill the dollar even more. Let's go, let's do it!!! Who is with him? Housing is going to get killed either way, nothing can be done about that. Economics 101, self-profiled prophecy. If the consumer believes that a price will be up (in this case DOWN) in future (lets say 6 month), then they will buy the product at current price (opposite for housing). In order for them not paying the higher price later. Simultaneously, bumping up the price (vice versa for the housing case).