PIMCO’s Bill Gross says that the U.S. government needs to be bolder in its handling of the financial crisis — and says that bank nationalization is not the answer to the problem.
“The U.S. and global financial systems require credit creation and foreclosure prevention, not bank nationalization as currently contemplated by some,” Gross writes in his latest market commentary on PIMCO’s web site. “Trillions will be required in the U.S. alone and it is critical that there be a high degree of policy coordination among all nations, which avoids protectionist measures reflective of failed policies in the 1930s.” Rather than using the “shock and awe” tactic that PIMCO brass has recommended, government officials response “has been more like ‘don’t bother us, we’re working on it,'” Gross says, adding, “Get moving. Risk being bold – Washington.”
As for what investors should do right now, Gross reiterated PIMCO’s recent philosophy of “shaking hands with Uncle Sam”; that is, “buying agency mortgages, and other developing areas of government policy support in the credit markets”.
Gross says the credit creation and foreclosure prevention of which he speaks involves risk. “The private system is the heart of capitalism and generates most of its productivity, so more government usually involves less prosperity and certainly more inflation,” he says. “PIMCO recommends a 180-degree turn towards government only as a last resort. They have the only credible checkbook in town.”
More government action could well lead to inflation, but that’s okay. “Policymakers are more than vocal about attempting to reflate the economy, which in essence means a hoped for return to nominal GDP growth levels of 5-6%, the majority of which might actually come in the form of higher prices as opposed to increased production,” he says. “This Faustian bargain would be acceptable if only to stabilize what now appears to be an even more dangerous deflationary debt liquidation.”
Gross also has a warning about the strength of the dollar: “Global willingness to accept American dollars is being tested. Granted, the U.S. currency has appreciated strongly against its counterparts during most of this crisis, but technical short covering as opposed to a flight to quality may have been the dominant consideration. Watch the dollar. If it falls hard, there may be nothing policymakers can do to restore the ensuing financial chaos.”
Why not nationalize banks, like Sweden successfully did? Gross says the Swedish approach centered on a handful of banks, as opposed to the U.S.’s 7,500 banks, plus other S&Ls and credit unions. “Regulators are overwhelmed as it is, and if you thought Lehman Brothers was a mistake, just standby and see what nationalizing Citi or BofA would do,” he writes. “PIMCO would not dispute the need to further capitalize systemically important banks via convertible bonds held by the government, which unfortunately dilute shareholders’ interests. To go further, however, and ‘haircut’ senior debt or even existing preferred stock similar to that issued via the TARP would create an instability policymakers should not want to risk. In turn, forcing creditors to take haircuts would undermine other financial sectors such as insurance companies and credit unions.” The U.S. should recapitalize lenders while “maintaining the basic infrastructure of credit markets”, Gross says. “Outright nationalization and haircutting of creditors will do just the opposite.”
