From the May 2007 issue of Investment Advisor • Subscribe!

May 1, 2007

Bill Gross on the Housing Crisis

Loan losses will threaten future growth, the bond king says, but not for the reasons you might think

In an April essay discussing the housing market and the subprime lending issue, Bill Gross, manager of the $102 billion PIMCO Total Return Fund, discusses a grim reality in what was once the American dream--owning a home. "U.S. homeownership has expanded from 65% to 69% of households since the turn of the century, in part because it became so easy, and so cheap, to finance a home," he writers. However, "home prices, as measured by the National Association of Realtors, have gone down by 2% nationally over the past 15 months and there's fear in the air that it could get worse."

Gross attributes the problem not to the "frequently heralded increase in subprime delinquencies or defaults," but rather "foreclosure losses as a percentage of existing loans will be small and the majority of homeowners have substantial amounts of equity in their homes." Yet this phenomenon is something Gross thinks leads analysts to believe "the subprime crisis is or has been isolated and identified for what it is--a small part of the U.S. economy."

Agreeing, Gross writes that loan losses will not threaten future economic growth, "but the tightening of credit conditions that are in part a result of those losses" will.

"To a certain extent this reluctance to extend credit is a typical response to end-of-cycle exuberance run amok....But there is something else in play now that resembles in part the Carter Administration's 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 lenders'' attitudes are turning decidedly conservative..."

Reprints Discuss this story
This is where the comments go.