Department of "Huh?!": What Is Bill Gross Saying? Edition by DeLong

If nominal GDP growth had just jumped from 4%/year to 7%/year and if the consequence had been the real growth had gone from 2.5 to 3.0%/year while core inflation had gone from 1.5% to 4.0%/year and nominal ten-year Treasury rates had gone from 2.5 to 6.0%/year, I would say that the market had spoken: thet too much (risky) debt could not be cured by issuing lots more (safe) debt. But if that is happening at all, it is happening in some alternative universe: not here, not now.

Here and now the principal immediate disease of the economy continues to be (in Wicksellian terms) that the natural rate of interest is lower than the market rate and is in fact less than zero, (in monetarist terms) that nominal GDP is too low and is expected to grow too slowly given the current level of wages and prices, (in Bagehot-Minsky-Kindleberger-Reinhart-Rogoff-Koo terms) that the risk tolerance of the market is too low given the still-extraordinary level of leverge, (in Bernanke-Gertler-Hubbard terms) that a wave of moral hazard and adverse selection has overwhelmed and broken the credit channel. All of these diagnoses are not quite identical, but the overlap between them is enormous. And they all admit of the same cure: Jubilee. A reduction in risky debt and its replacement in portfolios by an increase in safe debt. This can be accomplished through either guarantees of risky debt by the credit-worthy, by explicit write-downs and refis, or by the I-word. [Inflation - ed.]

Oh, there are other more chronic diseases of the American and the world economy: globalization one wrong, overfinancialization, overhealthcareadministrationization, rising inequality, financialunderregulationization, et cetera--and some of these played a role in setting up the current crisis. But you don't have to fix a tire through the puncture. And we shouldn't believe that we must.

Bill Gross is sort of an MMer. He believes creating demand is the way to go, but it's being blocked in all advanced nations. Although Gross did suggest the GSEs refinance unilaterally at the expense of the Chinese and rich investors.

If risky debt is replaced in portofolios (balance sheets) by safer debt, this will lead to more spending / investment.

DeLong writes "that the risk tolerance of the market is too low given the still-extraordinary level of leverge, (in Bernanke-Gertler-Hubbard terms) that a wave of moral hazard and adverse selection has overwhelmed and broken the credit channel."

Which is maybe why the Fed and Obama administration will hit the mortgage market with a jubilee at the expense of the Chinese and rich. Which is why higher inflation and targeting NGPD should be used at the Fed.

Why can't the Fed just say our long term goals are NGDP S18 trillion*/year and core inflation at 2 percent?

DeLong:

If nominal GDP growth had just jumped from 4%/year to 7%/year and if the consequence had been the real growth had gone from 2.5 to 3.0%/year while core inflation had gone from 1.5% to 4.0%/year and nominal ten-year Treasury rates had gone from 2.5 to 6.0%/year, I would say that the market had spoken: thet too much (risky) debt could not be cured by issuing lots more (safe) debt. But if that is happening at all, it is happening in some alternative universe: not here, not now.

This seems to be the question, whether QE can work or has worked. Does it need to be sustained to work? Did QE1 and 2 work?

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* or whatever the trend rate of growth is for the economy running at capacity.

PIMCO Founder To Deficit-Obsessed Congress: Get Back To Reality by Brian Beutler

Bill Gross is saying what Bernanke and other are arguing: stimulus now, mid-term deficit reduction later. Hopefully if the economy continues in the doldrums Bernanke will do QE3.

(via Krugman)


Maybe Gross is admitting he was wrong about rates shooting up once QE2 ends.

Rule by Rentiers by Krugman

The Decline of PIMCO Macro by Krugman

I first talked to the Pimco people in, I think, 1991, when I was asked (and paid) to talk to them about economic issues; don’t remember the subject. It was a striking experience, sartorially: I showed up in Newport Beach in my gray business suit, and they were all in casual shirts and slacks, some (as I remember it) with fashionable stubble.

Since then, of course, Pimco has continued to be a huge success; Bill Gross is without doubt a great investor. I have often found the economic analyses coming out of Pimco deeply enlightening. And in 2009-2010 the firm won big by betting, correctly, on interest rates staying low.

For the past year or so, however, Pimco seems to me to have been making less and less sense. Gross bet big on the idea that rates would spike when quantitative easing ends; I guess he has three weeks to be vindicated, but it sure doesn’t look like it. And the economic logic was all wrong. Now Mohamed El-Erian is claiming that inflation in China and Brazil is Bernanke’s fault; again, the economic logic is all wrong.

What’s strange about this is that nobody was better at laying out the logic of deleveraging and its consequences than Pimco’s Paul McCulley. But maybe that’s the explanation: McCulley has moved on.

Anyway, El-Erian’s latest sort of shocked me; it sounds as if he’s making up his own version of macroeconomics. And that’s not something you should do unless the existing models have failed -- which they haven’t.

Bill Gates, Warren Buffett, George Soros and the usual "philanthropist" media darlings have nothing on him

PIMCO's Bill Gross is a mensch:

Richard Green:

At Tuesday's conference on the Future of Housing Finance, Bill Gross suggested that anyone who was current on a Fannie/Freddie loan should automatically be refinanced to the current mortgage interest rate of about 4.5 percent. This should happen instantaneously, without underwriting.

I am trying to see the downside of this. It reduces the probability of default, because it reduces the present value of the loan balance and payments. It only rewards those who pay their mortgages on time. And as Bill Gross pointed out, it would amount to an enormous stimulus (what he didn't point out is that the stimulus would be at least partly funded by foreign holders of MBS*).

(via Mark Thoma)

Ezra Klein points out Gross's idea doesn't need 60 Senate votes and doesn't add to the deficit.

Huffington Post business reporter Shahien Nasiripour writes:

But it's more than just a Wall Street versus Main Street issue. Investors in mortgage-backed securities -- like pension funds, unions and retail investors -- would be hurt by the program. And over the long term, so could homeowners.

Mortgage refinancings involve paying off an old mortgage and taking on a new one with better terms, like a lower rate. Investors who own bonds backed by home loans with 7 percent interest, for example, would essentially lose out on that extra income. Also, wiping out those higher-rate mortgages that back bonds that are trading above par -- meaning their current price is above face value -- would rob investors of that additional gain.

Banks that own those securities would also lose out on that income, as would asset managers and other large investors in mortgage-backed bonds, like the Chinese government, Gross said. Fannie and Freddie, which have tens of billions of dollars in mortgage holdings in their portfolio, would also suffer from that loss of income. PIMCO, too, Gross said.

"At PIMCO, we'd be affected by $3 or $4 billion in terms of a refunding loss," Gross said. "But I'm here as a public advocate, not as a private [investor]. When I go back to Newport I'll be back to managing that portfolio." PIMCO is based in Newport Beach, Calif.

Homeowners could end up losing too, said Joshua Rosner, managing director at independent research consultancy Graham Fisher & Co.

"As a result of another prepayment-shock and the inability to model future prepayment shocks, investors would become even more unwilling to invest in [mortgage-backed securities] going forward, or would begin to demand higher yields going forward," Rosner wrote on the popular finance and economics-focused blog, The Big Picture. The prepayments -- refinancings lead to old mortgages being paid off -- would cost investors "more than half a trillion [dollars] in lost interest income," he wrote.

Tough titties, the economic clitoris need stimulation pronto. STAT!**

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*mortgage-backed securities
**Medical term used to imply urgent or rush. It may appear in lower case letters as stat or in capital letters as STAT, as in "Treatment may include STAT surgery." The term is derived from the Latin word "statim" which means immediately. Oh and btw Mr. Joshua Rosner, wasn't the whole problem that investors were stupid about motgage-backed securities in the first place?