Bill Gross, founder and chief investment officer of PIMCO, the world's largest family of bond funds with $746 billion in assets under management, believes that without government intervention, home prices could drop as much as 20 percent over the next two years. U.S. News spoke with Gross about what he thinks the government should do to prevent such losses. Excerpts:
Why do you think housing prices are declining?
The simplest explanation is because they went up too much.... It's hard for a home to go down in price significantly unless there's been a bubble. The reason for a significant bubble is not only low interest rates back in the 2003-2004 time period but a significant amount of near-fraudulent behavior in the mortgage market with no-documentation loans and—[as] I call them—"funny money" mortgages. Not all of them are fraudulent, but there certainly was an egregious overreach in terms of the private marketplace that made it possible for anyone and everyone to buy a home.
So now, as the easy lending is not only being pulled back but eliminated, then [the climbing prices], almost by necessity, come to an end. Those are some of the primary reasons, but down the list would also be slow employment. People are getting laid off, and the American wage earner who is the homeowner basically can't afford a home as easily as they could before.
What would stop those declines?
Two things would stop it: One is monetary policy in terms of lower interest rates. Obviously the Fed has lowered interest rates and will probably do more, and that helps out existing homeowners to some extent. For those with [adjustable-rate mortgages] it does, if they don't have to adjust upwards and can begin to adjust downwards.
But the housing decline is really a function of people not buying homes as well as people trying to get out. The old ARM is basically being shunned, so affordability rests on the 30-year mortgage. So what [Fed Chairman Ben] Bernanke is doing is helping, but the fact is, the 30-year mortgage hasn't come down like the fed funds rate. So the Fed has a problem. They can lower short-term rates, but they don't have any control over the 30-year mortgage. That's controlled by us, the Chinese, and anybody else that wants to buy them.
That's a problem and will continue to be a problem. Then it's up to the fiscal side, to Congress, to make changes in terms of regulations and additional programs. They need to use a government agency that's been around since the 1930s, the Federal Housing Administration. We need the FHA to provide mortgages with, at least in my opinion, a subsidized interest rate. Instead of 5.5 or 6 percent, they could put 4 or 5 percent and minimize, if not eliminate, the down payments, so people can afford to buy not only a new home but an existing home.
It might bring up the question as to, "Isn't that the same as down payments provided a few years ago [that caused the problems]?" Yes, but now a government agency is overseeing the list of buyers as opposed to "greedy" loan originators that just ran it for a fee. I think that's what's required.
So it's necessary for the government to essentially subsidize mortgages?
Yes, I think so. You need an interest rate below existing interest rates. I think they need to subsidize it. Let's not get ridiculous, but with a 4.5 or 4 percent interest rate and 0 percent down for people who have demonstrated good credit and a willingness to pay on time. Let's get it over with and move forward. Otherwise, nobody knows for sure, but the futures market is projecting another close-to-10-percent decline in housing prices. If that's correct, we're really in trouble. We need to do something.
Wouldn't the kind of program you're suggesting be expensive?
It's really a program nowhere near as expensive as the $150 billion [stimulus package] being proposed in terms of putting checks into hands. [The cost] would be minimal.
It seems that you’re saying a stimulus package alone won’t solve the housing problem.
Definitely not. You could make an argument that the $500 or $1,000 rebate check would be spent to make mortgage payments. I can't dispute that, but for the most part, that program is a consumption-oriented program. [Taxpayers] will pay down credit cards, use it for gas, and that 30-year mortgage payment is just going to have to wait. It's OK as an emergency stopgap thing, but the real problem is in the housing market, and that's where Washington should be really focused. I get the sense they're beginning to get it.
Without any sort of government intervention, what would happen to the housing market?
Nobody knows, but I think we'd eventually see, over the next 12 to 24 months, a national housing decline of upwards of 20 percent, and that is a serious development. We witnessed that really in two periods. In the 1930s, and that was called the Great Depression. And recently, in Japan, in terms of deflation of their property market, and the Japanese economy has never really recovered from their property deflation in the 1990s.
A housing deflation of that proportion has to be avoided or else there are serious consequences for the economy. It affects employment, incomes, and the mentality of the American consumer and homeowner. If your house is down 20 percent, you're not in a rosy disposition to spend money anywhere. You think you're getting poorer by the second. We have to avoid that.