Bill Gross Was Right
Kurt Brouwer August 10th, 2007
Pimco’s Managing Director, Bill Gross, is probably the most well-known bond fund manager in the country, if not the world. He also pens a monthly investment outlook that usually contains solid insights into the financial markets together with whatever is on his mind at the time.
His August commentary contained a fair amount of social commentary and that may be why his main point was overlooked a bit. Here are a few excerpts [emphasis in the original] that spell out his point:
‘…Some wonder what squelched the hunger of potential lenders so abruptly, while in the same breath suggesting that the subprime crisis is “isolated” and not contagious to other markets or even the overall economy. Not so, and the sudden liquidity crisis in the high yield debt market is just the latest sign that there is a connection, a chain that links all markets and ultimately their prices and yields to the fate of the U.S. economy…
…As Tim Bond of Barclays Capital put it so well a few weeks ago, “it is the excess leverage of the lenders not the borrowers which is the source of systemic problems.” Low policy rates in many countries and narrow credit spreads have encouraged levered structures bought in the hundreds of millions by lenders, in an effort to maximize returns with what they thought were relatively riskless loans…
…The bloom came off the rose and the worm started to turn, however, when institutional investors – many of them foreign – began to see the ratings downgrades in ABS subprime space. Could the same thing happen to levered structures with pure corporate credit backing? To be blunt, they seem to be thinking that if Moody’s and Standard & Poor’s have done such a lousy job of rating subprime structures, how can the market have confidence that they’re not repeating the same structural, formulaic, mistake with CLOs and CDOs? That growing lack of confidence – more so than the defaults of two Bear Stearns hedge funds and the threat of more to come – has frozen future lending and backed up the market for high yield new issues such that it resembles a constipated owl: absolutely nothing is moving...
I’ve known Bill for many years and interviewed him for our last book, Mutual Fund Mastery. We’ve also used Pimco Total Return and other Pimco funds for many years, so I can attest to his knowledge and expertise.
In this commentary, I believe he was pointing out a crucial insight. That is, many banks around the globe have become highly leveraged. The subprime lending mess was the catalyst that caused them to rethink many of the deals they have struck and now they are pulling back on a broad range of lending activities until they figure out how bad things are. Suddenly, lots of very smart bankers and others have rediscovered that four letter word–Risk.
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