The best way to help the ailing U.S. housing market recover from the $1 trillion of losses it faces will be to cut the cost of mortgages via the U.S. housing bill and rescue package for mortgage finance giants, the manager of the world's biggest bond fund said.
"Lowering the cost of mortgage credit via the omnibus housing/GSE bill now placed before the Congress and the president is the best way to begin the long journey back to normalcy," wrote Bill Gross, chief investment officer of Pacific Investment Management Co (PIMCO) in his August Investment Outlook letter. (See CNBC interview below)
Mortgage finance companies Fannie Mae and Freddie Mac got some help on Wednesday when the House of Representatives passed a massive housing rescue bill after the White House dropped a threatened veto, paving the way for passage of measures aimed at shoring up the home market.
The worst conditions in the housing market since the Great Depression have put many existing mortgages at risk.
A total $5 trillion of mortgage loans are in risky asset categories, Gross wrote, adding that "nearly $1 trillion of cumulative losses will finally mark the gravestone of this housing bubble." "The problem with writing off $1 trillion from the finance industry's cumulative balance sheet is that if not matched by capital raising, it necessitates a sale of assets, a reduction in lending or both, that in turn begins to affect economic growth, creating what Mohamed El-Erian fears as a 'negative feedback loop,"' Gross wrote.
El-Erian is co-chief investment officer and co-CEO of PIMCO.
Since last year, exposure by global financial institutions to subprime mortgage debt and structured finance products has resulted in more than $400 billion of write-downs and losses.
That has led financial institutions to raise capital and cut dividends.
"Currently, in the United States, asset price deflation is the menace at hand, not goods and services price deflation," wrote PIMCO managing director Paul McCulley in a Global Central Bank Focus article on PIMCO's web site.
"Asset price deflation in the context of deleveraging is, in my view, much more nefarious than modest goods and services price deflation, since asset price deflation undermines the capital base of levered financial intermediaries, begetting yet more deleveraging and further asset price deflation," McCulley added.
Until the housing market reaches a bottom and U.S. home prices are headed higher, investors should stay in high-quality assets, wrote Gross, who manages the $130 billion PIMCO Total Return Fund.
U.S. homes purchased in or after 2004 are now at risk of their mortgages turning "upside down" otherwise known as "negative equity," Gross noted.
That is when the value a house can fetch falls below the mortgage the homeowner owes.
Some 25 million U.S. homes are at risk of falling into negative equity, which in many cases results in foreclosures, Gross noted.
"For now, investors should remain in high-quality assets until -- until, well -- until the prospect for home prices points skyward or until the cows come home, whichever one's first," he wrote.
A major problem the housing market now faces, Gross wrote, is that 30-year fixed mortgage rates are now higher than when the Federal Reserve began cutting the fed funds rate in September 2007.
Once factoring in both the total costs of buying a home and the fact that U.S. house prices, which peaked in 2006, are still falling, "it is obvious that homes are not the bargains that starving realtors claim they might be," Gross wrote.
U.S. mortgage rates are the highest in a year, based on Mortgage Bankers Association data.
According to some measures, U.S. house prices have already fallen some 18 percent from their 2006 peak and many economists expect at least another 10 percent decline.
PIMCO's McCulley also said it was the right course of action for the U.S. government to "backstop deflating assets" such as houses by supporting Fannie Mae and Freddie Mac.